Investment Highlights

• 4QCY23 results mostly below expectations, mainly due to Red Sea logistics disruption. 2 out of 3 glove makers under our coverage came in below expectations while the remaining one was above expectations. Both Hartalega Holdings (Hartalega) and Kossan Rubber Industries (Kossan) missed our expectations and consensus’, primarily attributable to lower-than- expected sales volume as a result of Red Sea-related shipment delays. For instance, Hartalega experienced a delay of 600mil pcs medical rubber gloves or 13% of 4QCY23 sales volume. Assuming 600mil pcs rubber gloves were sold by Hartalega in 4QCY23 with average selling prices (ASP) of US$19-20/1K pcs and deducting 40% of revenue for variable costs (ie. raw material, packaging, chemicals and distribution expenses), our estimated pretax loss associated with Red Sea crisis was RM30mil in 4QCY23. This implies total PBT in 4QCY23 at RM38mil (vs. reported RM8mil), which was higher than RM34mil in 3QCY23 and our earlier forecast.
  
  For Top Glove Corporation (Top Glove), the QoQ loss-narrowing results for 3 consecutive quarters were largely above expectations. The better-than-expected result was mainly attributed to profit margins improving on the back of cost-cutting initiatives.

• In 4QCY23, sales volume improved QoQ for glove makers with relatively lower exposures to regions impacted by Red Sea crisis. Domestically, the QoQ sales volume growth trajectory is rather mixed, depending on whether the revenue mix is skewed towards regions impacted by the Red Sea crisis or not. For instance, Hartalega experienced a 3% QoQ decline in 4QCY23 sales volume in contrast to a QoQ growth guidance back in 3QCY23 result briefing. Similarly, Kossan’s sales volume came in below our expectation. These were mainly due to customers delaying the orders for rubber gloves and adopted a wait-and-see approach in response to the escalation of sea freight rates and challenges in securing ships back in late-2023 . Notably, the 2 glove makers have relatively greater proportions of their revenues coming from USA (40%-50%) and Europe (20%-30%), both of which were affected by Red Sea crisis.
  
  On the other hand, Top Glove registered a higher-than-expected 9% QoQ increase in 4QCY23 sales volume, mainly supported by the group’s higher revenue exposure to less impacted regions in Asia (32%), Latin America (12%) and Eastern Europe (12%). Regionally, Thailand-based Sri Trang Gloves’ (Sri Trang) 4QCY23 sales volume reached a record 8.8bil pcs (+16% QoQ) since its listing back in mid-2020, with plant utilisation rate (PU) reaching 72% based on installed capacity of 51bil (production volume was 9.2bil pcs in 4QCY23). USA and Europe accounted for 33% of Sri Trang’s revenue mix in 4QCY23. For most Chinese players, they have been running at full capacity for nitrile medical rubber gloves since 2QCY23.
  
  Demand recovery in 1QCY24 materialises but asymmetrical. Going into 1QCY24, Hartalega’s PU improved MoM and will be able to achieve ~90% in March 2024, compared to 58% in 4QCY23. Our PU is estimated based on installed capacity of 31bil pcs/annum. In 2QCY24, Hartalega is confident in maintaining ~90% PU based on guidance from customers. We believe that Kossan’s PU in 1QCY24 should be as high as Hartalega’s given their similarity in terms product mix, customer profile and selling prices that are supported by Kossan’s low-cost structure . Top Glove’s PU has also improved from 22% in 4QCY23 to 32% in Mar 2024, based on installed capacity of 95bil pcs/annum. The slower recovery in terms of PU for Top Glove was possibly due to: (a) lower decommissioning activities at 5% of original 100bil pcs/annum capacity in 2023 compared to Hartalega’s 30% and Kossan’s 27%, (b) more aggressive pricing strategy due to its relatively higher cost structure , and (c) competition from more competitive latex-focused Sri Trang. The PU recovery of these 3 glove makers in 1QCY24 substantiates our earlier view that inventory replenishment of rubber gloves could commence by 1QCY24F without a need to reduce average selling prices (ASP). Additionally, the relatively stronger recoveries observed in Hartalega and Kossan support our opinion that the pace of recovery could be asymmetrical among Malaysian players.
  
  Given that the majority of over-stocking occurred between 2Q-3QCY21 coupled with the standard 3-year expiration period for medical rubber gloves, we continue to believe the demand recovery observed in 1QCY24 could persist over the coming quarters. Furthermore, China’s major players were running at full PU since 2QCY23. Going forward, we do not anticipate any material capacity expansion from China. This is based on China’s largest player, Intco Medical (Intco), whose percentage of construction- in-progress relative to the sum of fixed assets and construction-in-progress in 3QCY23, was comparable to the pre-pandemic period, as opposed to the trend observed during its aggressive expansions between 2020-2021 . Therefore, any nitrile medical rubber glove inventory replenishment beginning since 1QCY24 could mostly be sourced from Malaysia.

• ASP weakened in 4QCY23… ASP for medical rubber gloves declined by 5% QoQ (in MYR denomination) among Malaysian players and 2% (in THB denomination) for Sri Trang. We do not have Intco’s 4QCY23 ASP QoQ movement given that the group has not published its annual report at this stage. However, we gather that they are maintaining the ASP for 3.0-3.5g nitrile medical Glove Sector 08 March 2024 …yet cost-pass-through mechanism is progressively reinstated in 1Q2024. Malaysian players guided that they are able to raise ASP to partially pass on higher operating costs eg. raw material and natural gas. Rubber glove distributors have responded more positively in this round in contrast to previous price hikes back in Feb-May 2023.
  
  Based on our survey with respective local glove makers, we found that Hartalega and Kossan are practising more competitive pricing strategies in 2024 amid gradual demand recovery, compared to Top Glove. Both Hartalega and Kossan have no intention of maintaining ASP when there is a decrease in raw material prices for the sole purpose of expanding currently depressed margins. Hence, this is consistent with Hartalega and Kossan relatively higher PU in Mar 2024.

• The momentum of Chinese glove makers restricted by USA FDA continued since 4QCY23. USA is the largest purchaser of medical rubber gloves worldwide during the pre-pandemic period . Based on the Red List (for manufacturers) obtained from USA’s FDA import alert number 80-04 – Surveillance and Detention Without Physical Examination of Surgeon's and Patient Examination Gloves, we observed that 9 additional glove makers were added to the list YTD2024 . Surprisingly, all 9 are Chinese glove makers but not from other nations.
  
  Since 2023, USA has become more quality-conscious with the trend of restricting Chinese glove makers increasing on a QoQ basis , following a period of laxity in quality checks in 2020-22 (ie. there were no newly-added rubber glove manufacturers to the list in 2020-21 and only 2 in 2H2022, compared to a historical annual average of 8 in 2010-19). This was possibly due to Covid-19-related fatalities remaining elevated and volatile in 2020-1H2022.
  
  Recall that generally, an import alert against a particular country/manufacturer/shipper informs the FDA's field staff and public that FDA has enough evidence for detention without physical examination (DWPE) of products that appear to be in violation of FDA's laws and regulations. The list of countries/manufacturers/shippers subject to DWPE is known as the “Red List”. If the country/manufacturer/shipper cannot provide sufficient evidence to FDA to overcome the appearance of violation or recondition the products to correct the violation within 10 business days from detention, the detained products will be issued with a refusal of admission. Consequently, the country/manufacturer/shipper can work with USA’s Customs and Border Protection (CBP) and FDA to either destroy the products or ship away from USA within 90 days of refusal.
  
  Hence, we continue to believe that the medical rubber glove quality issues could be a medium-to-long-term problem for Chinese glove makers to resolve given China's consistent failure to achieve quality levels comparable to Malaysia and Thailand since 2010. This means that Malaysia could be a preferred location for USA’s medical rubber glove distributors to gradually diversify away from China to prevent future order detentions given that our country exhibited relatively stable quality over the pre- pandemic and post-pandemic years compared to China and Thailand.
  
  Furthermore, we do not discount the possibility that other major glove buyers in the world (eg. Europe - the 2nd largest world glove buyer) ) could follow suit. This is supported by the stabilisation of Covid-19-related fatalities in European countries and a Frost & Sullivan 2022 study, which revealed that only 9 (40%) of the 22 glove brands examined passed the testing for (a) freedom from perforation (BS EN455-1 standards), (b) force at break (BS EN455-2), and (c) glove thickness and weight . We believe the influx of inferior products into European markets could be due to laxity in quality checks during the pandemic period.

• The local capacity-related headlines should gradually transition from “decommissioning” to “expansion”, but at a rational pace and skewed towards competitive players. Malaysian glove manufacturers have transitioned from "aggressive expansion" during the pandemic period to "capacity expansion scale-backs" in 2022 and "decommissioning" in 2023. We believe 2024 could be the start of some local cost-competitive glove makers announcing expansion plans, such as commissioning already-completed plants or increasing capex for building new factories to further capitalise on the relatively stronger recovery of these players. We believe both Hartalega and Kossan ought to be highlighted, especially for Hartalega’s more efficient NGC 2.0 with fully-built plants and a capacity of 9.5bil pcs/annum. Regionally, we gathered that major Chinese players are not expanding and commissioning new lines despite running at full capacity with available spaces in China. According to Intco, they are identifying new locations outside China for future expansion in view of increasing trade tension between USA and China. Separately, Sri Trang guided in its recent result briefing that the group will maintain current capacity until PU hit >90% vs. 72% currently. We believe Sri Trang’s expansion will be latex-focused given that the group’s current revenue mix is 80% latex rubber gloves and 20% nitrile rubber gloves, which we think will be a challenge to Top Glove.

• We reiterate OVERWEIGHT on the sector with BUYs on Hartalega (FV: RM3.20/share) and Kossan (FV: RM2.26/share), while maintaining HOLD on Top Glove (FV: RM0.86/share). Recent share price weaknesses for Hartalega (-20% from its peak in late-Jan 2024) and Kossan (-14%) were predominantly due to market gradually pricing in the weaker-than-expected results reported by Hartalega and Kossan last month as investors are now sceptical on the timeliness of demand recovery. Nevertheless, we view this as an opportunity for investors to bottom fish for Hartalega and Kossan as their high PU of ~90% in Mar 2024 and continued quality issues among Chinese glove makers in YTD2024 could meaningfully address doubts about demand recovery and re-catalyse market interest.

Source: AmInvest Research - 8 Mar 2024