Highlights

Rubber Gloves – Malaysia - 1Q20 Report Card ~ Prelude to Earnings Windfall

Date: 17/06/2020

Source  :  UOBKayHian
Stock  :  TOPGLOV       Price Target  :  21.90      |      Price Call  :  BUY
        Last Price  :  6.68      |      Upside/Downside  :  +15.22 (227.84%)
 
Source  :  UOBKayHian
Stock  :  KOSSAN       Price Target  :  10.95      |      Price Call  :  BUY
        Last Price  :  6.20      |      Upside/Downside  :  +4.75 (76.61%)
 
Source  :  UOBKayHian
Stock  :  HARTA       Price Target  :  12.95      |      Price Call  :  HOLD
        Last Price  :  14.40      |      Upside/Downside  :  -1.45 (10.07%)
 


  • 1Q20 reporting season saw glove producers’ earnings exceeding expectations on the back of burgeoning demand. However, the full extent of ASP pricing potential and ad hoc sales mix will be realised in the coming quarters. Meanwhile, channel checks suggest ASPs have reached a ceiling at US$160-175/’000 pieces.
  • Despite valuations surging over the recent months, we believe they have yet to fairly price in an impending earnings windfall.
  • Maintain OVERWEIGHT.
  • Top pick: Top Glove

Rubber Glove Makers' 1Q20 Results Round-up

  • Sector earnings came in well above expectations across the board. Sector top-line grew 18.2% q-o-q on the back of higher volume growth of 12.9% q-o-q, primarily on Top Glove reaching its utilisation limit and destocking of its inventory. ASPs for the period were only marginally higher at 0.9% q-o-q as glove producers’ ASP remained locked in and were unable to benefit from the disproportionate demand surge. The RM/US$ was largely unchanged (+0.4% q-o-q).
  • Sector EBITDA margin improved considerably on:
    1. higher economies of scale;
    2. higher ASPs; and
    3. lower raw materials costs with nitrile (-6.6%) more than offsetting latex cost (+3.4%).
  • Against improved margins, core earnings outpaced revenue growth, at 89.1% q-o-q.

On the Brink of Unprecedented Windfall Earnings

  • Over the coming quarters, we expect to see a step change in blended ASPs. After having largely locked in ASPs until April, glove producers are repricing its ASPs upwards on a monthly basis while raising ad hoc sales mix, which commands up to 3x the usual ASP.
  • Furthermore, costs of raw materials (nitrile and latex) have dipped further by 6.6% and 0.9% q-o-q in 2Q20 respectively. However, beyond 2Q20, we expect raw materials costs to recover off multi-year lows and for glove producers to share a fraction of their windfall earnings with their suppliers.

Maintain OVERWEIGHT

  • We also believe elevated demand could well sustain ASPs up to 2Q21, largely underpinning our 2021 earnings outlook.
  • Our OVERWEIGHT is premised on:
    1. multi-fold valuation gains have yet to fully factor in the impending earnings surge over the quarters ahead;
    2. sustained glove demand over 2021; and
    3. scarcity of safe haven earnings growth (2-year earnings CAGR of 123% in 2019-21) as most other sectors face multitude of headwinds.
  • Our top pick for the sector is Top Glove. We also highlight Supermax as a major beneficiary of the glove ASP surge.

Supermax: Super Strategy to Maximise Profit

  • We highlight Supermax as we believe it is by far the best beneficiary of the recent surge in demand for gloves.

Supermax with its OBM model could be an underappreciated diamond.

  • Unlike Hartalega, Top Glove and Kossan which are predominantly OEMs,Supermax has toiled for years to establish its own brand and distribution channels. The benefits are coming to fruition with the surge in ASPs. It currently commands ASPs of close to US$160-175/’000 pieces vs US$150 in May and US$90 pre-COVID period.
  • We gather there is limited upside to current ASPs as various government agencies have implemented redirecting of personal protective equipment (PPE) supplies of close to US$160-175/’000 pieces. That said, Supermax does receive urgent ad hoc orders in the range of US$190/’000 pcs.

OBM alongside its own distribution network fully captures elevated ASPs.

  • Apart from its OBM model, Supermax uniquely distributes its own products as well which makes up close to 55% of overall volume and derives the best margins of up to 700-800% at the gross profit level (based on current prices). Meanwhile, sales through third-party distributors command about 400% margins.
  • Since the COVID-19 outbreak, Supermax has strived hard to increase its sales exposure through these two channels (to 95% of volume mix from 70% previously) to fully capitalise the disproportionate spike in demand to maximise its earnings. With these established advantages, it allows Supermax to be a far superior beneficiary of elevated ASPs relative to the likes of Top Glove.

Most aggressive capacity expansion among Big 4 producers.

  • Aside from commanding margins in excess of peers, Supermax’s capacity expansion amid the windfall earnings is ahead of peers as well at 21.5% CAGR over 2019-21. Top Glove is close behind at 19.7% while Hartalega’s and Kossan’s capacity expansions are limited as available space has been exhausted.
  • By end-22, Supermax is due to usurp Kossan in terms of capacity. Apart from that, its capacity is dedicated to nitrile production.

No change to dividend payout but distribution of treasury shares instead...

  • Supermax is not looking to increase its dividend payout although it anticipates windfall earnings for the year. However, it is looking to distribute its treasury shares as dividend-in-kind instead. It has 68.9m treasury shares, translating into a 5% yield.

…to finance its capacity expansion and maintain a robust balance sheet.

  • Supermax’s addition of close to 20b pieces annually in capacity to its existing capacity of 21.8b pieces over the next 3-4 years would translate to close to RM1b capex. Therefore, to preserve its balance sheet and maintain its net gearing at 0.2x, it necessitates a conservative dividend payout despite the windfall earnings.

Higher raw materials costs going forward despite lower underlying prices.

  • Latex and nitrile costs for Supermax fell 6.6% and 0.1% q-o-q in 4QFY20 respectively. However, going forward, management expects overall raw materials including packaging and chemicals to cost ~10% higher amid lower underlying prices as Supermax looks to trickle down some windfall earnings to its suppliers.

Appears to have well beaten consensus.

  • Based on Supermax’s ASPs and product mix, it appears Supermax could significantly beat consensus expectations of RM395m and the highest projected earnings of RM561m.

Supermax’s valuations could normalise sharply to single-digit PE.

  • With the surge in earnings, Supermax’s one-year forward PE could normalise sharply to single-digit PE. It would trade at a significant laggard to peers. We believe Hartalega, Top Glove and Kossan should be trading at 45.0x, 23.5x and 23.0x PE to their respective financial year ends.
  • Other potential catalysts include being part of the FBMKLCI Index in Nov 20 should a vaccine be not discovered by then.

Top Glove Corporation - BUY/Target: RM21.90

  • Our target price is based on 23.5x 2021F PE, or -0.5 SD of its 3-year forward PE mean. We believe valuations should be at a slight discount to its historical PE mean as it is:-
    1. being pegged to windfall peak earnings,
    2. upside to earnings have mostly been factored in, and
    3. the risk-to-reward at this juncture is increasingly pronounced given the surge in Top Glove Share Price.
  • That said, our PE peg is reasonable given Top Glove is an established FBMKLCI component index constituent and its sublime earnings growth. ASPs are being adjusted 15% m-o-m while lofty ad-hoc prices may represent upside surprise to our earnings. These translate into a 2-year CAGR of 218% (FY19-21F).
  • Furthermore, its explosive q-o-q earnings growth over the subsequent 2-3 quarters should catalyse its valuations going forward.
  • (Using the latest FX rate of RM1 to SGD0.326, we derive target price of 7.14 in SGD term)

Kossan Rubber Industries (KRI MK) - BUY/Target: RM10.95

  • Our target price is based on 23x 2020F PE, or +1SD of its 3-year mean PE. We believe improved visibility over Kossan’s ASP revision is likely to catalyse its valuations going forward. On a q-o-q basis, we expect 2Q20 ASPs to potentially improve by up to a high-single-digit growth rate. 2H20 is expected to see a steep step change in ASPs.
  • Aside from that, Kossan sees firm demand visibility up till 1Q21. It is allocating 15% of volume to meet ad-hoc demand, potentially commanding a premium of 3x usual ASPs. This translates into an attractive 2-year earnings CAGR of 73% over 2019-21).

Hartalega Holdings (HART MK) - HOLD/Target: RM12.95

  • Our target price is based on an unchanged 45.0x 2021F PE, or its +2SD of its 3-year forward PE mean. The premium can be justified by Hartelega’s strong operating efficiency under ordinary circumstances and innovation ahead of peers. Aside from that, the Next Generation Manufacturing Complex (NGC) 2.0 provides visibility over medium-term growth.
  • Nevertheless, our HOLD call is premised on Hartalega’s valuations being priced in at this juncture, which limits potential price upside. Entry price is RM11.50.

Risk

  • Discovery of a vaccine and/or treatment could cause negative newsflow, however, as we have previously highlighted, scaling of global manufacturing to achieve herd immunity may take 12 months and beyond. Aside from that, peak mass testing may translate into lower glove demand as well.
  • Downside risks are spikes in raw materials costs, a strengthening ringgit, sharp ASP reversion and COVID-19 outbreak among the production workforce. Upside risks are supply disruption to the broader industry and a strengthening US$.

Source: UOB Kay Hian Research - 17 Jun 2020

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Labels: TOPGLOV, KOSSAN, HARTA

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