HLBank Research Highlights

Author: HLInvest   |   Latest post: Fri, 17 May 2019, 10:45 AM


Rubber Products - Keep Your Gloves on for Now

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An imbalance in supply demand is expected to manifest in 2019 with the glove players expected to increase supply by c.15% (vs. annual global demand growth of 8%-10%). The RM is expected to be weaker in FY19 (USDMYR 4.10- 4.30) which augurs well for the sector. The inclusion of Top Glove into the KLCI (the sector’s monolith) will further provide the sentimental anchor to valuations. We maintain our NEUTRAL sector rating given lofty valuations.

Capacity. We estimate that the top 4 in the glove industry will have increased capacity by c.15% in 2019 (mammoths share being Nitrile capacity). We do note that a short term imbalance is expected to manifest in 2019 with the increased supply outstripping the expected annual demand growth of 8%-10%. For perspective, 2019 will see an estimated addition of c.20bn pieces vs 10.7bn pieces in 2018 (see Figure #1). However, in view of the oligopolistic industry structure, we do not rule out the possibility of glove player’s eventually expanding capacity in a more gradual manner to avoid price competition.

A weaker RM. The RM is expected to be weaker in 2019 which augurs well for the sector in maintaining its cost competitiveness against its regional peers. Our economics team projection for 2019 ranges between USD/MYR4.10-4.30 which remains within our forecasted range. Within our coverage, Top Glove is the main beneficiary of a weaker RM (stronger USD) as it has the highest exposure to NR latex gloves.

Minimum wage. Statutory minimum wage has increased to RM1,100 (from RM1,000) effective January 2019. As always, the increase in costs will be passed thru to the customers. Ceteris paribus, we estimate that the impact to net profit ranges between 1.5%-2% for every RM100 increment in minimum wage.

Raw materials. In 2018 the price of butadiene (a core component in nitrile manufacturing) peaked in May at USD1,850/MT before retracing to USD1,130/MT end December. In 2019 we can expect the volatility of NR to parallel the velocity of ethylene (its main feedstock) prices in Asia. We expect the price of natural rubber (NR) to range RM4.0-5.0/kg in 2019, (2018 average: RM4.29/kg) assuming no supply disruptions. To note the price of NR has consistently maintained below RM4.00/kg threshold since October 2018. A lower than expected NR price will primarily benefit glove players with a skewed product mix toward natural rubber (TG and Supermax).

Valuations. Valuations remain lofty with the sector dancing between 2SD (35x) and 1SD (29x) 3 year historical mean PE. We note that further upside could be capped due to the velocity of earnings growth fizzling out due to the mismatch between demand and installed capacity, resulting in downward pressure on ASP.

Top Pick. We prefer Top Glove for its more balanced product mix (NBR: NR; 47%:53%) relative to the other players who are more nitrile heavy (Kossan 77%, Hartalega >95%). Note that NR gross margins range between 20%-21%, whilst Nitrile gross margins hover around 18%.

Maintain NEUTRAL. Maintain NEUTRAL on the sector as we believe that valuations will be anchored by Top Glove’s recent inclusion in the KLCI and due to the export play factor on the back of an expected weaker RM moving forward. Top Glove (TP: RM6.26) is our top pick for the sector.

Source: Hong Leong Investment Bank Research - 8 Jan 2019

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