Investment Highlights

• We downgraded the sector to UNDERWEIGHT from NEUTRAL after share prices spiked 19%-50% over the past 1 month despite glove makers’ financial performance likely to remain weak in forecasted FY23-24. While losses are likely to narrow in 2QCY23F onwards, our forecasted earnings cannot yet support the current high valuations.

• Still unable to conclude that customers’ inventories have depleted. We gathered that plant utilisation rate (PU) exhibited some modest improvements in early 2023 compared to late 2022. Glove makers under our coverage recorded an improvement of 6%-20% in sales volumes between 4Q2022 and early 2023. The improved PU in the industry could easily lead investors to conclude that customers are beginning to replenish depleting inventories after overbuying in 2021.
  However, we advise investors to remain cautious and observe for another 2 quarters (i.e., 2Q-3Q2023), particularly the magnitude of PU changes after average selling prices (ASPs) begin to rise in 2Q2023. As for now, we gathered that Malaysian glove makers experienced a decrease in PU in 2Q2023 as a result of ASP hikes. This could imply rubber glove distributors still have inventories and poses a risk that they still have the discretion to delay replenishment longer or even later than our assumption by 3Q2023.

• ASPs increased, but at the cost of lower PU. In the recent March briefing, Top Glove Corporation (Top Glove) guided that it has increased the price of nitrile medical rubber gloves from the 5-year low of US$17/1K pcs in Feb 2023 to US$21/1K pcs in May this year, a US$4/1K pcs increase. In contrast, another glove maker under our coverage increased ASP by a mere US$0.5-1/1K pcs (+<5%) to US$19-20/1K pcs between 1Q to 2Q2023.
  Based on channel checks, Chinese glove makers have increased ASPs from as low as US$14-15/1K pcs to US$16-17/1K pcs (inclusive of 7.5% US tariffs) during the same period. However, we gathered that the increase in ASPs was accompanied by a lower PU among Malaysian glove makers, as not all customers accepted the increase in ASP. This raises concerns about the sustainability of ASP hikes in 3Q2023.

• Loss-narrowing trade is happening, ... The cost/1K pcs increased by US$1-3 in January-March 2023, mostly attributable to higher natural gas prices (+15%) and electricity tariff (+5.4x). On a positive note, natural gas prices are expected to decrease by 15% (translating to US$0.2-0.4/1K pcs). Coupled with rising ASPs in 2Q2023, this suggests that losses will narrow for Malaysian glove makers from 2Q 2023 onwards.

• …but share price has reflected more than enough. While losses are likely to narrow, our forecasted earnings cannot yet support the current high valuations. The share prices of glove makers under our coverage have rallied 19%-50% over the past 1 month, translating to FY23F/FY24 PE of 19-40x, which is higher than their 10-year average of 14-26x. Notably, the buyers were institutional investors.
  We believe the excessively optimistic share price rallies were driven primarily by trading or performance tracking purposes, as opposed to fundamental investment decisions. Based on Bloomberg data, we believe that the average costs of most institutional investors were RM0.975/share (vs RM1.05/share now) for Top Glove, RM1.95/share (vs RM2.10/share now) for Hartalega and RM1.29/share (vs RM1.36/share now) for Kossan. This suggests that they are in profitable positions of 5%- 8%, albeit near investment cost.
  As for now, we gathered that the market is still bearish or neutral on the 4 largest Malaysian rubber glove makers (i.e., 60% Sell, 29% HOLD and only 11% BUY) and glove makers are trading 43%-80% above their 10-year average PE valuations. Hence, we believe that once new catalysts emerge in other sectors (especially during the quarterly results next month), institutional investors may re-allocate and take profit from glove-related positions to invest into other sectors, triggering downward pressure.

• 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 (24% of market cap), Kossan’s RM2bil to RM0.78/share (57% of market cap) and Top Glove’s RM255mil to RM0.03/share (3% of market cap). We expect their strong balance sheet positions to support cash flow requirements in the upcoming 2 loss-making quarters (i.e., 1Q-2Q 2023). Furthermore, scaling back capacity expansions by glove makers could partially preserve cash holdings. In our view, Kossan’s net cash position among peers offers the strongest buffer against negative shocks.

• Key considerations for upgrading the sector to Neutral: (a) faster-than-expected increase in ASP and PU, (b) further easing of operating costs i.e., natural gas, electricity tariff and raw material, and (c) more reasonable share price ranges.

Source: AmInvest Research - 18 Apr 2023