Investment Highlights

• We are downgrading the glove sector to NEUTRAL from OVERWEIGHT. We believe that selling prices and operating profit margins of the glove companies will come under pressure due to a short term oversupply in the industry.

• Nevertheless, in terms of demand, we expect sales volume to continue to grow at circa 8–10% in 2019. The expected robust growth is underpinned by an expanding global healthcare sector as well as 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 in emerging markets such as India and China is still low at around 2–6 gloves as opposed to circa 100–280 gloves for developed countries. Malaysia’s exports of rubber gloves in 2018 grew 14.0% YoY (+7.6% natural rubber gloves; +18.2% nitrile gloves) while 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.

• We believe there will be pressure on operating profit margins in 2019F stemming from the influx of glove supply of the “Big 3” producers (Top Glove, Kossan, Hartalega). FY19 will see an enlarged supply of gloves by 13%, although the expansion will come at a gradual pace.

• As this exceeds the organic demand growth expectation of 8–10%, we believe ASP will be slightly weighed down initially. It will take 6 to 12 months for demand-supply to reach equilibrium.

• The Big 3 producers enjoyed higher sales volume of between 5.0% and 18.8% in 1H19 while ASP movement was mixed largely on the back of mixed raw material price and USD/MYR movements. As a result, there was a contraction in EBITDA margin for Top Glove and Hartalega but an improvement in Kossan’s in the latest quarterly results.

• Natural rubber price has dropped 1.1% YoY to an average of RM4.56/kg in 1H2019 (from circa RM4.61/kg in 1H2018). However, there was a sudden spike in natural rubber prices where it surged 10.8% YoY and 11.1% YoY in Jan 2019 and Feb 2019 respectively. This has resulted in margin crimping in Top Gloves’ latest results release where the price adjustment was lagged due to a timing mismatch. We believe Kossan might be impacted by this albeit at a smaller scale as natural rubber gloves make up circa 25% of Kossan’s production and the reporting period allows for more time for price adjustment to take effect.

• We estimate that nitrile-based rubber (NBR) price has dropped 2–4% YoY in 1H2019 at circa US$1.05–1.25/kg. This bodes well for the Big 3 as lower NBR prices will widen their products’ margins. Nitrile gloves production makes up circa 95% of Hartalega’s, 45% of Top Glove’s and 75% of Kossan’s total gloves production. We also believe that 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.

• In 1H2019, the USD strengthened against the MYR by 4.7% YoY to an average of RM4.12 (RM3.94 in 1H18). The Big 3 producers benefited from the weaker ringgit as exports made up most of the sales. Our house projection for the USD/MYR rate is RM4.16 (RM4.08–RM4.20). We expect the weaker ringgit will elevate the glove producers’ margins.

• We may upgrade our NEUTRAL call for the sector to OVERWEIGHT should there be: (1) any pandemic disease outbreaks which cause an upsurge in glove demand; and (2) supply constraints for substitute latex and nitrile gloves, resulting in a switch to latex and nitrile gloves. Conversely we may downgrade to UNDERWEIGHT in the event of: (1) the inability of glove makers to pass on the rising costs.

• Our top pick is Top Glove (FV: RM5.66). 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.

Source: AmInvest Research - 9 Jul 2019