Investment Highlights

• 4QCY22 earnings were largely below expectations. Out of the 3 glove companies under coverage, 2 underperformed and 1 within (Exhibit 2). The results of Top Glove Corporation (Top Glove) and Hartalega Holdings (Hartalega) missed expectations. Top Glove’s underperformance was related to weaker-than-expected average selling prices (ASP) and plant utilisation rate (PU), while Hartalega was primarily due to lower PU. Separately, Kossan Rubber Industries (Kossan)’s core net profit was largely within our expectation while 14% below consensus estimates. The slight positive variance by Kossan from our earnings estimate was mainly driven by lower-than-expected operating expenses.

• Earnings shrank QoQ and YoY. Sequentially, the sector’s 4QCY22 core earnings decreased by 8.7x from previous quarter primarily owing to a 26% QoQ drop in revenue. The weaker revenue mostly stemmed from QoQ declines of 8%-13% in ASP and 21% in sales volume. The loss was exacerbated by rising operating expenses mainly from natural gas (+24%-25% QoQ).
  YoY, 4QCY22 results shrank by 2.2x in tandem with a 55% drop in revenue. The majority of the revenue decrease was attributed to YoY declines of 33%-48% in ASP and 31% in sales volume. The continuing supply-demand imbalance in the industry resulted in weaker ASP QoQ and YoY, while customers holding off on restocking activities depressed sales volume.

• All in red now from overcapacity amid rising costs. Continued intense competition among regional glove makers stemming from overcapacity and low demand has led to a downward ASP spiral from its all-time peak in 2Q2021. Furthermore, rising operating costs (mainly from energy and labour) have driven Hartalega and Kossan into the red in 4QCY22, while Top Glove widened its losses. Given all glove makers under our coverage have made losses, as have Chinese players, we believe that ASPs could have reached near the bottom.
  Based on our channel checks, Malaysian glove makers are attempting to increase ASP of nitrile medical gloves by US$1- 2/1K pcs from US$17-19/1K pcs commencing in April 2023 with a mixed response from customers currently. We believe this was mainly due to the substantive excess capacity in the industry. All in, we opine that a more sustainable increase in ASP is only viable if customers begin replenishing their inventories, hence boosting industry PU.

• Waiting for stock replenishment cycle. From demand perspective, the industry's PU is running at 25%–45% in 4QCY22 (versus an optimal rate of 80%–85%). We believe this low utilisation to persist until end-2QCY23, which may result in higher operating expenses due to lower economies of scale.
  All in, we anticipate a 17%-21% decline in glove demand in 2022 (Exhibit 3), based on annualised global glove demand in 10M2022 (-21% YoY) and the combined 2022 sales for the 3 glove makers under our coverage, which fell 17% YoY. We gathered that end-customers’ rubber glove stock levels are depleting with 3-4 months of inventories (until end-2QCY23). Hence, we believe improvements could only be seen earliest in 3QCY23 onwards.

• Scaling back capacity expansions. Glove makers have unanimously announced scale-backs of capacity expansions over the coming months. Hartalega guided that its 1st line of NGC 1.5 with a total annual capacity of 19bil pieces will be delayed from the original commissioning date in Oct last year. Also, Hartalega is working to decommission some inefficient lines to cut costs.
  Similarly, Top Glove revised downwards its ambitious expansion plan of achieving total annual capacity of 204bil pieces to 115bil pieces by Dec 2025. Moreover, Kossan guided the deferral of near-term capacity expansion plans to curtail excess supply due to market conditions. We believe this combined scale-backs could relieve some supply-side pressure in the glove industry.

• Still sitting on positive net cash positions. All glove makers under our coverage are backed by positive net cash positions. Hartalega’s net cash of RM1.8bil translate to RM0.51/share (35% of market cap), Kossan’s RM2bil to RM0.78/share (70% of market cap) and Top Glove’s RM342mil to RM0.06/share (8% of market cap). We expect their strong balance sheet position to support cash flow requirements in the upcoming loss-making 2 quarters. Furthermore, scaling back capacity expansions by glove makers could partially preserve cash holdings. In our view, Kossan’s highest net cash position among peers could limit downside pressure to its share price.

• We reiterate our NEUTRAL rating on the sector on expectations that glove makers under our coverage continue to make losses in the upcoming 2 quarters (1Q-2QCY23), mainly due to subdued ASPs since beginning of the year and low PU. Nevertheless, we believe some meaningful price improvements could commence in 3QCY23, driven by customers’ inventory replenishment cycle.

Source: AmInvest Research - 9 Mar 2023