This article first appeared in The Edge Malaysia Weekly, on February 22-28, 2016

The year-long rally in rubber glove stocks seems to be losing steam. The strengthening of the ringgit, the possibility of a hike in the foreign worker levy and the reduction of export volume by rubber producers appear to be weighing on their performance. However, glovemakers could remain investor favourites as these factors are expected to have a minimal impact.

The ringgit has strengthened close to 4% against the US dollar in the past month, dipping below 4.40 since mid-January. It has been hovering at 4.10 to 4.20 for the past week.

Kossan Rubber Industries Bhd and Top Glove Corp Bhd both shed more than 20% between Jan 19 and Feb 5. Hartalega Holdings Bhd’s share price fell 16.6% over the same period while Supermax Corp Bhd’s declined 17% between Jan 19 and Feb 12.

Since then, the counters have rebounded but not by much. Supermax led the pack as it saw an 11.1% gain between Feb 12 and last Wednesday.

Like many other export-oriented counters, glovemakers bebefited from the ringgit’s weakness against the US dollar last year.

A fund manager observes that the share prices of glovemakers often move in tandem with the movement of the greenback against the ringgit. He adds that US dollar movements have always been a catalyst, either positive or negative, for the rubber glove sector. 

“The impact on earnings is actually not as pronounced as the impact on the risk appetite for the sector. When the US dollar is strong, investors turn from other traditional sectors to hide in companies whose revenue is denominated in US dollars, such as exporters and gloves. You can also expect the inverse should the ringgit strengthen against the US dollar,” says the fund manager.

He adds that the valuations of glove manufacturers tend to run ahead whenever the market expects the US dollar to strengthen further, which was the case over the past 14 months.

“At this juncture, my opinion is that the opposite is happening — the correction on gloves has overshot due to investors expecting the ringgit to rebound more against the US dollar,” he says.

Currently,Hartalega looks the most expensive with its trailing 12-month price-earnings ratio (PER) of 32.21 times while Top Glove appears to be the cheapest at 18.96 times. Supermax’s PER is at 19.55 times and Kossan’s stands at 23.38 times. An industry player says whether the fluctuation of foreign exchange rates affects earnings depends largely on the companies’ hedging policies.

“We do adjust our hedging policy according to currency fluctuations. We might take a shorter hedging period as opposed to a longer one when the US dollar is strong and vice versa. So because of this, there might not be a big difference in the company’s net profit due to foreign exchange rates,” says the industry player.

It is interesting to note that nitrile glovemaker, Hartalega, saw a foreign exchange loss of RM21 million in its cumulative nine months to Dec 31, 2015. Despite that, it managed to chalk up a net profit of RM195.9 million for the period under review, up 26.6% from a year ago.

Meanwhile, the government’s move to increase the annual foreign worker levy has been put on hold due to strong protests from employers. The plan was to increase the annual levy from RM1,250 to RM2,500 per person for those in the manufacturing, construction and services sectors beginning Feb 1. This came as a surprise to employers who had received no prior warning of the hike.

According to AllianceDBS Research, while glovemakers tend to have a large pool of foreign workers in their manufacturing facilities, they have been passing the existing levy to the workers. Even if it was absorbed by the manufacturers, earnings would only be marginally impacted as the cost can be managed through automation.

“We expect minimal impact on earnings as the cost of the higher levy will be shared with the workers or passed on completely. If absorbed, the impact of the hike will be 10 sen to 25 sen per 1,000 gloves. This, in turn, would impact FY2016/FY2017 earnings by 1% to 2%,” says the research house.

As for concerns over the International Tripartite Rubber Council’s agreement to temporarily withdraw natural rubber exports, the fund manager does not think it will significantly impact the rubber glove industry. The fund manager opines that latex and synthetic alternatives are interchangeable these days. This would mean that if the latex price increases significantly, but synthetic rubber remains subdued due to the low crude oil price, manufacturers would switch to the latter.

Latex has fallen from its high of RM11 in 2011 to RM3.47 per kg now. 

This is not the first time the ITRC has agreed to cut exports. According to AllianceDBS Research, the council did it in 2012 and 2013, collectively cutting shipments by 3%, but the price lift was only temporary.

The industry player opines that although nitrile gloves are gaining in popularity these days, there is still demand for natural rubber gloves in certain industries.

“We will just have to pay more for latex if the price goes up. But gloves are cheap these days because of efficiency and technological advances. So I believe higher glove prices if the latex price strengthens would not have a significant impact on us,” he says. He adds that demand for gloves is increasing each year with export volume increasing by more than 30% over 2015.

AllianceDBS Research adds that glove manufacturers and customers have a cost pass-through arrangement, which indicates that any increase in production cost would only affect earnings for one or two months as customers adjust to the new average selling price. 

That said, the fund manager says the fundamentals of rubber glove stocks have not changed much — it is only a matter of the share price overshooting fundamentals due to the weak ringgit.

“The share prices of exporters did well last year. Hence, profit-taking is likely to happen. Unfortunately, there are not a lot of places to hide in the current market environment. There aren’t many companies that can provide a good growth story and decent yields.”

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.