Investment Highlights

1. Delta Variant Slows ASP Fall

• A more contagious variant of Covid-19 known as the Delta variant is spreading locally and around the world, causing a resurgence in cases and prompting the reintroduction of new lockdowns. First identified in India, it has shown to be more transmissible and capable of causing more severe sickness. While fears of rising cases may prompt glove counters to react optimistically in the short term.

• The Delta variant would slow the fall in glove ASP, as glove urgency is buoyed by the rise in cases. The smaller rate of fall in ASP would help support earnings in the next 12 months.

• We expect market glove ASP to stabilise at US$30–35 per 1,000 pieces, before tapering off far more gradually due to the following:

1. Individual governments have updated their understanding and handling of pandemic situations, being more capable of preventing outbreaks more severe than previously experienced.
2. Vaccination programmes are making good progress. Pre-existing vaccines still boast high efficacy rates against the Delta variant. Mixing Covid-19 jabs have shown to induce positive immune responses, possibly easing a bottleneck in global vaccination rates.
3. Even in a situation where Covid-19 becomes endemic, we expect it to be maintained at controllable levels. Improved knowledge on Covid-19, vaccine availability and higher vaccinated populations will likely prevent any future global outbreaks.

• Post-pandemic demand projections are still overblown. We believe that the first post-pandemic year will see a flattish to negative growth in glove demand, as opposed to steady growth projections by Frost & Sullivan and MARGMA. This remains intact, as the expected fall in Covid-19 cases is postponed rather than cancelled. We maintain our view that lasting glove demand is not so much driven by a blanket “paradigm shift” brought about by increased healthcare awareness. Instead, it is driven by more organic sociopolitical and legal structural issues such as healthcare outreach, enforceability of glove mandates as well as medical malpractice laws. These imply a slower and more gradual growth than current demand projections.

2. EMCO Shutdowns to Affect Production, Possibly Widening the Supply-demand Differential

• Top Glove, Hartalega and Kossan Rubber have confirmed that they will be shutting down factories located in areas affected by the EMCO.
   
• About 55% of Top Glove’s total group capacity are produced from factories affected by EMCO. Its remaining factories in Malaysia are under 60% workforce MCO regulations and have a utilisation rate of 70–75%.
   
• We estimate factories producing >90% of Hartalega and Kossan’s full glove capacity are located in areas affected by the EMCO.
  • Hartalega: Klang, Bestari Jaya, Labu
  • Kossan: Klang, Kapar, Jeram
     
• Supermax may also be severely affected, as the majority of its factories are located in Kapar and Kinta (Perak).
   
• On the other hand, Careplus has confirmed that its factories will continue operating under MCO conditions, as all of its factories are located in Senawang, Negeri Sembilan.
   
• A shutdown will likely further slow down the decline in glove ASP, as supply is temporarily capped. We believe that the EMCO will be implemented for at least one month, before a return to MCO conditions. We do not discount the possibility that these companies be granted approvals to resume production, given the importance of gloves in managing the spread of Covid-19.
   
• We adjust the fair values of glove companies to incorporate EMCO and MCO disruptions, slower declines in glove ASP and a sharp drop in post-pandemic glove demand (Exhibits 1 & 2). We lower our PE ratios to factor in factory closure-induced negative investor sentiment. We urge investors to look past supernormal profits brought about by the spike in cases due to the Delta variant. The variant may result in gentler drops in quarterly earnings, but we doubt will affect post-pandemic glove demand in a significant way, even if the virus becomes endemic.
   
• We maintain our HOLD call on Top Glove with a reduced fair value (FV) of RM3.66/share based on a PER of 14x CY22F FD EPS, incorporating an ESG-adjusted discount of 3% of our 2-star rating. EMCO and MCO disruptions will reduce profits in the near term, offsetting the additional earnings brought about by slower decline in glove ASP in FY22. We expect the pandemic to be largely kept under control by FY23, hence a reduction in FY23 earnings
   
• We keep our HOLD call on Hartalega with a lower FV of RM6.87/share based on a PER of 15x FY23F FD EPS, incorporating an ESG-adjusted premium of 3% of our rating of 4 stars. Similarly, we expect lockdown restrictions to soften potential gains from slower decline in glove ASP in FY22, before a sharper drop in glove demand by FY23.
   
• Kossan remains a HOLD with a reduced FV of RM2.96/share based on a PER of 15x FY23F FD EPS, rolled over from FY22F. There is no ESG-related adjustment based on our rating of 3 stars. We also expect lockdown restrictions to soften potential gains from slower decline in glove ASP in FY22, before a sharper drop in glove demand by FY23.

Source: AmInvest Research - 7 Jul 2021