Investment Highlights

• We are keeping our NEUTRAL call for the glove sector. 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 circa 8–10% in 2020. 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 the pressure on selling price will continue in 2020 as the “Big 3” producers (Top Glove Corporation, Kossan Rubber Industries, Hartalega Holdings) are still in expansion mode. There is also an influx of latex glove supply coming from Thailand’s Sri Trang as the group plans to increase its capacity to 30bil pieces by end-2020 from 22bil pieces in 9M19. 2020 will see an enlarged supply of gloves by circa 17.6%, although the expansion is at a gradual pace. As this exceeds the organic demand growth expectation of 8–10%, we believe the average selling price (ASP) will continue to be weighed down.

• We anticipate operating margins pressure to remain in 2020 as we believe the “Big 3” producers will continue to be hit by intense competition, higher labour costs, mixed raw material prices and higher gas tariff. We believe labour cost will continue to rise as more scrutiny is placed into the glove manufacturers’ labour practices and we expect a stricter regulation on foreign worker recruitment.

• Our house projection for the USD/MYR rate is an average of RM4.12 in 2020. We expect the stronger ringgit will add to the downward pressure on the glove producers’ margins. The “Big 3” producers benefited from the weaker ringgit (-3.7% YoY at RM4.14) in 9M19 as exports made up most of the sales although these were inadequate to make up for the weakness in ASP.

• 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 sustained 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 Kossan (BUY, FV: RM4.65). We like Kossan for its expansionary plans and efforts in improving operational efficiency.

• We take this opportunity to cut our FY20F, FY21F and FY22F earnings forecast by 4.7%, 4.0% and 2.3% respectively for Top Glove (BUY, FV RM5.12) to account for increased competition, higher labour requirement and higher latex prices. Our FV is based on a P/E of 27x on FY21F EPS. Our PE multiple is based on Top Glove’s historical average forward PE.  
• We also reduce Hartalega’s (HOLD, FV RM4.87) FY20F, FY21F and FY22F earnings forecast by 2.0%, 1.9% and 1.9% respectively to account for the pressure on ASP as well as tougher operating conditions

Source: AmInvest Research - 11 Dec 2019