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Wednesday, April 1, 2020

Rubber Gloves - Demand Surge and MYR Weakness To Amplify Earnings

Maintain OVERWEIGHT. Rubber glove stocks under our coverage have performed well following our upgrade eight months ago. Despite easing off from recent peaks, they remain strong outperformers YTD, led by TOPGLOV (+36%), HARTA (+26%), KOSSAN (+23%) and SUCB (+22%). The stage is now set for a solid FY20 following three quarters of anemic quarterly earnings growth. Coming off this low base due to the lackluster demand of the past 12 months, forward earnings growth will be amplified on re-stocking activities ramp-up due to the current COVID-19 pandemic which enforces higher hygiene standards boosted by better margins from higher ASP and favourable USDMYR. Our target prices for glove stocks are based on +1.5SD to +2.0SD which is to better reflect rubber gloves players’ prospects in anticipation of restocking activities, resilient earnings and their constant evolution and progress to increase earnings. We have OUTPERFORM calls on HARTA (OP; TP: RM8.00); KOSSAN (OP; TP: RM5.90) SUPERMX (OP; TP: RM2.00) and TOPGLOV (MP; TP: RM6.50). Our Top Pick for the sector is HARTA (OP; TP: RM8.00).

PER valuation potentially hitting +2.0SD in tandem with peak earnings in coming quarters. With the lackluster demand of the past 12 months behind us, we see re-stocking activities ramp-up as the current outbreak of the Wuhan virus enforces higher hygiene standards. Our target prices for glove stocks are based on +1.5SD which is to better reflect rubber gloves players’ prospects in anticipation of restocking activities, resilient earnings and their constant evolution and progress to increase earnings. Based on historical valuation at peak earnings, rubber glove stocks namely Kossan, Hartalega and Top Glove are trading at between +1.5SD to >+2.0SD historical forward mean.

Potentially higher ASPs in anticipation of a surge in demand and moderating supply growth in the past 12 months. Signs of demand outstripping supply could potentially lead to higher ASPs. Looking at the stable raw material price, ceteris paribus, hike in ASPs is expected to lead to margins expansion. We understand that some players have raised prices in anticipation of higher demand and we also noted the current high >90% utilisation rate for nitrile-centric players which is a stark contrast compared to the lacklustre demand in 2019.

Weakening of Ringgit (RM) vs. US dollar (USD) is positive to rubber glove players. YTD, the USD had risen by 7% against the MYR (USD1 = RM4.32). Generally, a weakening Ringgit is positive for glove makers. Since sales are USD-denominated, theoretically, a depreciating ringgit against the dollar will lead to more revenue receipts for glove makers. Ceteris paribus, a 1% weakening of RM against USD will lead to an average 1-2% increase in the net profit of rubber glove players.

Parallels with the SARS and H1N1 experience? During the SARS crisis, the infection was first detected in November 2002. Between then and February 2003, there were 5 casualties and over 300 were reported to have fallen ill of SARS in Guangdong province, China. During this period in 2003, Top Glove, Supermax and Kossan Rubber’s revenues and net profits grew between 15% and 25% while HARTA was only listed in 2008. Similarly, during the H1NI period, net profit grew 10-20% for rubber gloves players under our coverage.

Stage set for a recovery in volume growth. More importantly, even before the Wuhan virus crisis sets in, there were nascent signs of a solid uptick in demand for rubber gloves in coming quarters. 4QCY19 results season indicated a positive recovery in demand with players’ volumes sales growing an average 8% across the board led by HART (13%), Kossan (8%), and TOPG (2%). From our ground checks, demand for nitrile gloves is picking up again with players’ new capacities swiftly taken up. We believe this uptick in demand is turning positive and should be reflected in players’ bottom-line in subsequent quarters.

Nitrile gloves' market share to gain further momentum with potential 30% growth. Based on our analysis, we expect nitrile gloves to continue growing and expropriating market share from latex gloves. The growth in nitrile segment is evident. For illustration purposes, going forward, assuming nitrile:latex breakdown of 80:20 (currently at 67:37) and based on estimated global demand of 324b pieces in 2020 (forecast for 2019 is 300b pieces and assuming 8% growth rate in 2020), this implies nitrile growth rate of 20% or an additional 42b pieces from switching to nitrile gloves.

Our Top Pick in the sector is HARTALEGA. We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and reduction in costs, (ii) constantly evolving via innovative products development, and (iii) its nitrile gloves segment, which is booming. Our TP is RM8.00 based on 48x FY21 EPS (+2.0SD above 5-year historical forward mean).

Source: Kenanga Research - 1 Apr 2020

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