Investment Highlights

• The World Health Organisation (WHO) has reported an outbreak of novel coronavirus (2019-nCoV) in Wuhan, China. Outside of China, the virus has been detected in the US, Japan, Taiwan, Thailand and South Korea in patients who travelled from Wuhan. According to The New York Times, Dr Zhong Nanshan, a top Chinese government-appointed expert, the new coronavirus can be transmitted from human to human. The illness has killed at least four people and infected more than 200 people.

• Recall that during the previous major pandemic outbreak, glove companies’ earnings and share price were affected. During the 2003 SARS outbreak (November 2002 – March 2003), the share prices and earnings for Top Glove, Kossan and Supermax rose as shown in Exhibit 1 and Exhibit 2. The same happened during the 2009 pandemic H1N1 outbreak (June 2009 – August 2010).

• According to the US Centers for Disease Control and Prevention (CDC), the SARS outbreak of 2003 affected 8,098 people worldwide of which 774 died.

• On the other hand, the WHO confirmed a minimum of 18,449 deaths during the 2009 H1N1 pandemic influenza (although a research team led by the CDC estimated a global death toll of more than 284K, according to the Center for Infectious Disease Research and Policy from University of Minnesota.
   
• We believe that location plays an important role in the spike in demand for gloves during pandemic outbreaks.
   
• Although the glove companies’ net margins improved by around 0.6–6.8ppts during the 2003 SARS outbreak (see Exhibit 3), we believe this was partly due to an organic improvement in profitability due to capacity expansions (net margins remained flattish post-outbreak). At that time, the SARS outbreak was more prevalent in China and other countries in Asia instead of America and Europe (see Exhibit 8).

• In comparison, during the 2009–2010 H1N1 pandemic outbreak, the glove companies’ net margins surged by 3.4– 9.7ppts and remained high before falling after the WHO announced that the outbreak had been contained. We believe this was due to the highly-contagious nature of the disease as well as the affected location. As shown in Exhibit 9, the highest death toll from the 2009–2010 pandemic was in the US. Europe was also badly affected by the outbreak. We believe the demand from gloves was stronger as glove consumption per capita is typically high in the America and Europe regions.

• We believe that orders for gloves during the outbreak were high as customers stock up as a pre-emptive measure. However, post-outbreak, there was an excess supply in the customers’ inventory which lowered sales growth subsequently. For instance, Top Glove’s revenue surged 36.0% while net profit climbed 45.0% in FY10. Subsequently in FY11, revenue dipped 1.2% while net profit fell 53.9%. The earnings pattern is similar for the other glove players.

• During the SARS outbreak, the sector PE traded at 11.5x and peaked at 18.2x (close to +2 SDs), as shown in Exhibit 6. During the H1N1 outbreak, the sector P/E traded at 12.2x while it peaked at 17.2x (+2.5 SDs), as shown in Exhibit 7.

• We are upgrading our call to OVERWEIGHT from NEUTRAL for the glove sector as we expect demand to rise. We raise the PE valuation for Top Glove, Kossan and Hartalega to 30x, 25x and 35x respectively. Currently, we forecast the revenue for glove companies under our coverage to increase by more than 10% each for in 2020. We will review our earnings forecasts during the results’ release in February when the respective management give better clarity.

• We would also like to note that we believe the recent strengthening of the MYR against the USD will minimally impact the glove companies. Based on our sensitivity analysis, a 2% appreciation in the MYR against the USD will reduce net income by around 1%–1.5%. This is because the glove companies typically pass on cost increases and savings to customers within 1 to 2 months. We believe glove companies are more impacted by sharp movements in the USD/MYR which leaves the companies with less time to pass on the costs.

Source: AmInvest Research - 22 Jan 2020