• Gas Malaysia has announced that it is raising the natural gas tariff for the non-power sector in Peninsular Malaysia beginning 15 July 2019 following the government’s directive for an upward revision.

• According to its announcement to Bursa Malaysia, the average natural gas tariff after surcharge will increase by RM1.74/MMBtu or 5.3% to an average of RM34.66/MMBtu from RM32.92/MMBtu.

• More specifically, the average tariff for glove manufacturers moving forward is RM34.12/MMBtu (+5.4% from RM32.38/MMBtu, previously).

• We are neutral on this news as we believe the impact will be minimal to glove companies as these companies adopt the cost pass-through mechanism. On average, natural gas makes up circa 10%–15% of total operating costs. Raw materials like latex and nitrile still make up the majority of total costs at circa 45%.

• Nevertheless, we do anticipate margins for the glove manufacturers to be slightly impacted in the next quarter due to the time lag in passing on the cost increase to customers (around 1–2 months) before normalizing.

• As we have highlighted in our earlier 2H19 sector outlook report, we foresee operating margins for the glove manufacturers to be slightly under pressure due to the short-term oversupply situation although offset by lower latex and nitrile price and a weaker MYR against the USD.

• We are keeping our earnings estimates. We maintain our NEUTRAL call on the glove sector. 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) a supply glut, triggering a price war that crimps margins; and (2) the inability of glove makers to pass on the rising costs.

• Our top pick is Top Glove (BUY; 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 - 15 Jul 2019