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Affin Hwang Capital Research Highlights

Author: kltrader   |   Latest post: Tue, 12 Nov 2019, 4:41 PM

 

Rubber Gloves - Forced-labour Charge May Provide Opportunity

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Disposable rubber gloves produced by a Malaysian manufacturer were recently detained by the US Customs and Border Protection (CBP), as CBP believed that the gloves were produced by forced labour. However, we do not think such an action will have an adverse impact on the entire sector, as the Withhold Release Order (WRO) used by the CBP is for the specific company only (WRP). Weak sector sentiment may, however, offer an opportunity to accumulate our top buy ideas for the sector - Kossan and Supermax.

News About the Forced Labour Is Not New

The allegation of forced labour in the Malaysian rubber products sector is not new, as it was first reported by the UK press in end-2018 and early-2019, whereby they had identified 3 companies which had engaged in such. WRP Asia Pacific Sdn Bhd (WRP), whose gloves were recently seized by the CBP, was one of the 3 companies that was identified by the press. Although Top Glove and Karex were also mentioned back then, we believe that the recent changes implemented by the latter two have managed to address most, if not all, of the concerns. The resulting higher labour costs arising from the changes were already reflected in their P&Ls since 1Q19.

Definition of Forced Labour Varies From Country to Country

The biggest challenge for Malaysian companies to avert these allegations results from the continuously changing standards, as the definition of forced labour varies across countries. Our recent checks with the companies under our coverage indicated that they are in compliance with Malaysian regulations, and are subjected to social-compliance audits by their customers from time to time. Most of them have also engaged social activists to conduct independent audits in order to be in compliance with international standards. Ultimately, the companies have limited the maximum allowable overtime (OT) to 104 hours a month (average 4 hours a day) for all their workers.

Automation Is the Way Forward

The increase in labour costs has been relatively steep since the introduction of the minimum wage in 2014, and manufacturers have introduced automation to reduce labour dependency. We believe the increased scrutiny on the sector’s labour practices is likely to speed up the whole automation process. Although the government does provide grants to help with the changes, it is relatively insignificant to the overall investment that the manufacturers need. We believe that the larger manufacturers might be able to increase their market share at the expense of the smaller manufacturers as some of them are unable to invest in automation.

Kossan and Supermax Are Our Top Picks

We believe that the direct impact from the seizure of WRP’s gloves is relatively limited, as the producers would still be able to sell their products in other countries. According to our checks, WRP has an estimated production capacity of 11bn pcs/year (around 5% of Malaysia’s overall capacity), with focus on the nitrile and surgical glove segment. As the overall impact to the sector is relatively limited, we are maintaining our Neutral call on the sector. Kossan (KRI) and Supermax (SUCB) are our top BUYs for the sector, due to their undemanding valuations and higher-thanindustry growth rates. We have SELL calls on Top Glove (TOPG), Hartalega (HART) and Karex (KAREX) due to their rich valuations.

Source: Affin Hwang Research - 3 Oct 2019

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