Investment Highlights

• 2Q2023 results mostly below expectations. All 3 glove makers under our coverage came in below expectations (Exhibit 2). The underperformance was primarily attributable to a flat or lower-than-anticipated QoQ increase in average selling prices (ASPs) and sales volume disappointment as a result of customers shifting orders to Chinese and Thai competitors in response to recent ASP increases among Malaysian glove manufacturers.

• Lost market share and orders may not return even with lower ASPs. Between 1Q2023 and 2Q2023, glove makers under our coverage mostly registered material QoQ declines in sales volumes, falling by 26% for Hartalega Holdings (Hartalega) and 21% for Top Glove Corporation (Top Glove), after recording improvements of 6%-20% between 4Q2022 and 1Q2023. Kossan's QoQ decline of 3%-5% was less severe. The major reason behind Hartalega’s and Top Glove’s larger sales volume declines was both companies increasing ASPs back in Feb/Mar 2023 onwards, while Kossan did not raise prices to maintain sales.
  However, Intco Medical Technology (Intco), the largest glove manufacturer in China, and Sri Trang Gloves (Sri Trang), the largest glove manufacturer in Thailand, both reported QoQ revenue increases by 9%-10% primarily due to increased sales volumes. This demonstrated that Malaysia has been losing market share to regional competitors after the ASP increases in Feb 2023 onwards, while Intco did not increase ASP and sold at a substantive discount of US$4-5/1K pcs vs. Malaysian products. We believe this move was part of Intco's strategy to draw market share from Malaysia. Meanwhile, Sri Trang increased ASP by only 3% QoQ compared to 10%-12% for Top Glove and Hartalega.
  We remain concerned about the loss of Malaysian orders, as they may not return after enjoying the material discounts and trying the products from these alternative producers, particularly in China. This is similar to what happened when orders shifted to Chinese players in 2021 due to Covid-19 disruptions in Malaysia, causing Malaysia to lose significant market share. For now, we gather that plant utilisation (PU) rates in 3Q2023 remain subdued despite the decline in ASPs.

• Global glove demand surprisingly weaker, delayed timeline for inventory replenishment. Remarkably, worldwide demand currently for rubber gloves is surprisingly lower than pre-pandemic levels, at 54bil pcs in 1Q2023 (translating into annual demand of 216bil pcs versus 250-285bil observed in 2017-19) (Exhibit 3). We believe this is a result of end-users rushing to deplete inventories prior to their 3-year expiry date, as most of the inventories were procured in 2H2020 and 1H2021. Moreover, with recent weak demand recovery in 3Q2023 despite Malaysian glove makers lowering ASPs, we now expect sales volume to remain sluggish in 2H2023 and gradual inventory replenishment among Malaysian glove makers to only commence in 1Q2024 (from 4Q2023 in our July sector update).

• ASPs declined alongside lower raw material prices amid weak demand. After Top Glove took the lead to increase ASP since Feb 2023, normal nitrile medical glove ASP has decreased from US$19-20/1K pcs in 2Q2023 to US$18-19/1K pcs as a result of passing on lower raw material prices amid weak demand (Exhibit 4). We take note that ASP decrease will impact 100% of the revenue (assuming volume remains constant), while the decrease of raw material and natural gas costs will only save 45-50% portion of cost of goods sold (if other cost components are unchanged). Hence, we negatively view the decrease in ASP in 3Q2023, as the net effect on core earnings could be on the downside. Worse still, Chinese players are still selling at US$14-15/1K pcs – at a 22% discount to Malaysia. Consistent with our timeline assumption for inventory replenishment cycle, we anticipate a more sustainable ASP increase to begin in 1Q2024.

• China can trade profitability for market share with the lowest cost structure. Based on 2Q2023 financial results, Intco registered a higher 2Q2023 core net loss of CNY215mil (RM138mil) (excluding government subsidies, investment profits and huge forex gains of CNY470mil) from a core loss of CNY64mil (RM41mil) in 1Q2023, possibly due to continued depressed ASP despite higher volume. Remarkably, Intco has a positive operating cashflow in 1H2023. However, Sri Trang has been profitable since 1Q2023 and improved by 44% to THB109mil (RM14mil) in 2Q2023. On the domestic front, the majority of Malaysian producers posted narrower losses in 2Q2023 mainly due to higher ASP and moderating natural gas prices; with the exception of Hartalega, which enjoyed a tax benefit in 1Q2023. Hence, we believe that Intco is sacrificing earnings for more market share.
  To further understand corporate cost structures amongst regional players, we carried out a PATAMI breakeven cost analysis (Exhibit 5) and found that Malaysian glove makers have the higher cost structures compared to regional counterparts, primarily from the standpoint of energy use, with China using coal and Thailand using biomass. This implies that Malaysian players may have the least flexibility in a price war. Hence, if demand progressively recovers, we believe China and Thailand will benefit first from their cost advantage.

• Malaysian players are decommissioning while regional peers expand in 2023. Malaysian glove makers have recently unanimously announced the decommissioning of inefficient production lines to reduce the cost of production by transferring orders to more efficient production lines. This step taken to remain competitive against Chinese and Thai glove makers amid an uncertain ASP trajectory in 2H2023. In early May, Hartalega announced the decommissioning of its Bestari Jaya facility, accounting for 30% of existing annual capacity of 44bil pcs. Top Glove decommissioned obsolete production lines with an annual capacity of 5bil pcs (5% of existing 100bil pcs annual capacity). Kossan decommissioned annual capacity of 3bil pcs in FY22 and another 6bil pcs in FY23. After this decommissioning, Kossan’s installed capacity will drop by 27% from 33.5bil in 2021 to 24.5bil pcs/annum in end-2023.
  However, Intco’s 2023 semi-annual report announced the increase in annual capacity from 75bil pcs/annum in end-2022 to 79bil pcs/annum in mid-2023 (mainly nitrile gloves). Likewise, Sri Trang increased from 52.5bil pcs/annum in end-2022 to 55.3bil pcs/annum in mid-2023.

• All still in net cash positions with Hartalega having the lowest cash burn rate. All glove makers under our coverage are backed by positive net cash positions. Hartalega’s net cash of RM1.5bil translate to RM0.45/share (21% of market cap), Kossan’s RM2bil to RM0.78/share (56% of market cap) and Top Glove’s RM334mil to RM0.04/share (5% of market cap). We expect these strong balance sheets to support cash flow requirements over the upcoming challenging quarters. Notably, Hartalega currently operates at the lowest cash burn rate with 2Q2023 core EBITDA of RM28mil (adjusted for one-off RM47mil severance payment from the decommissioning of Bestari Jaya facility) compared to Kossan’s RM8.5mil, while Top Glove registered a loss before interest, depreciation/amortisation and tax of RM33.6mil.

• We reiterate our Underweight rating on the sector given the sector’s prospective weak bottomlines in FY23F-25F do not yet support still-high valuations currently. In 3Q2023, we expect glove makers’ financial performances to deteriorate or at best, stabilise QoQ, as opposed to our previous view that earnings could improve QoQ in 2Q2023 onwards, as stated in our sector report published in early July 2023. The changes are primarily attributable to recent decline in ASPs in 3Q2023 to pass along lower operating costs, while sales volume could remain subdued in 2H2023 given that global glove consumption in 2023 could be weaker than the pre-pandemic period and Malaysian glove makers have been losing market share to regional competitors.
  On a positive note, we project the gradual QoQ improvement in 4Q2023 onwards, underpinned by moderating natural gas prices, electricity surcharges and lower operating expenses as a result of decommissioning of less efficient plants (especially for Hartalega and Kossan), as well as customer replenishment cycle to commence in 1Q2024 that could allow glove makers to regain pricing power.
  Despite the recent 10%-30% declines in share prices from their peaks in 2023, glove makers under our coverage are still 20%- 35% higher than share prices prior to the earlier bullish streak (overpricing for 2 major “worst-is-over” scenarios for sales volume and ASPs) that began in mid-Mar 2023. Consequently, the gradual impact of ASP declines in 3Q2023 and subdued sales volume in 2H2023 could continue to dampen near-term market interest in the glove sector.

Source: AmInvest Research - 8 Sept 2023