Investment Highlights

• We upgrade our recommendation on the glove sector to OVERWEIGHT from NEUTRAL on the back of robust demand growth expectations for FY19. According to the Malaysian Rubber Glove Manufacturers Association (Margma), the rubber glove industry has been growing at an average of 8–10% for the past 25 years and we expect this to continue in FY19. The expected robust growth is underpinned by the expanding global healthcare sector as well as the increased awareness on the importance of hygienic practices throughout the industry, especially in emerging markets such as India and China. Currently, glove consumption per capita for emerging markets such as India and China is still low at around 2–6 gloves compared with circa 100–280 gloves for developed countries.

• Positively, we believe the nitrile-based rubber (NBR) price will continue to decline due to the falling prices of butadiene, which is an input cost for nitrile gloves, as shown in Exhibit 1. As NBR is a key input material for nitrile gloves, this is beneficial to the “Big 3” producers (Top Glove, Kossan, Hartalega) as lower NBR prices will widen the nitrile rubber gloves’ margins.

• We reckon there could be some pressure on margins in FY19F stemming from the influx of glove supply of the Big 3 producers. FY19 will see an enlarged supply of gloves by 14%, although the expansion will come at a gradual pace. As this exceeds the organic demand growth expectation of 8–10%, we opine ASP will be slightly weighed down initially. It will take 6 to 12 months for demand-supply to reach equilibrium.

• Although the Big 3 producers benefit from a weaker ringgit as exports make up most of the sales, we believe that the recent strengthening of the MYR against the USD is minor as the rubber gloves players will be able to pass on the cost to its customers via an upward ASP revision. Based on our sensitivity analysis, a 1% strengthening of the MYR against the USD will impact the bottom line by roughly 1% for the Big 3 producers. Our house end-2019 projection for the USD/MYR rate is 4.04-4.06.

• All in, we opine that the recent selldown of rubber glove stocks are unfounded as the sector’s fundamentals and growth prospects remain. The headwinds for the sector such as concerns on overcapacity and strengthening of the MYR aren’t new and we believe that as among the largest rubber gloves producers, the Big 3 are capable of weathering it.

• The downside risks which may prompt us to review our call for the sector are; (1) a sudden supply glut stemming from other glove makers (i.e, China), triggering a price war that crimps margins; and (2) the inability of glove makers to pass on the rising costs.

• Top picks for the sector are:

1. Top Glove (BUY, FV: RM6.52/share): We like Top Glove for: (1) its expansionary plans; (2) focus and continual efforts in improving quality and operational efficiency; and (3) its position as the largest rubber glove manufacturer; and 2. Hartalega (BUY, FV: RM5.88/share): We upgrade our recommendation on Hartalega to BUY from HOLD following the recent drop in its share price. We like Hartalega due to its: (1) foresight and execution; (2) visible capacity expansion; and (3) ability to develop proprietary technology which translates into greater operating efficiencies.

Source: AmInvest Research - 11 Jan 2019