Company Update

• Comfort Gloves Bhd’s (CGB) unit, Comfort Rubber Gloves Industries Sdn Bhd (CRGISB) has been included in the US Food and Drug Administration’s (FDA) import alert list (or “red list”) on 15th March 2018 due to violations of the FDA regulations. The detained imports include several series of its examination gloves held under the FDA’s Level 1 detention; Surveillance and Detention Without Physical Examination of Surgeon’s and Patient Examination Gloves (DWPE with surveillance), which will allow the authorities to detain all future shipments from the manufacturer/shipper listed in the alert list without testing.

• Subsequently, CGB has clarified that the inclusion of CRGISB into the US FDA’s import alert list has not disrupted its glove-making operations as the inclusion does not prevent the group from exporting to the U.S., although the group noted that future examination glove shipments to the U.S. will require inspections upon arrival in the country and released only after passing an inspection. CGB is working towards removing its unit from the import alert list through its U.S. agents and is confident of securing the removal from the list.

• In view of the uncertainties as to when the gloves will be removed from the list, we trim our FY19 and FY20 forecast net profit by 21.0% to account for the increased risk, potentially higher costs and shipment delays. In our forecast, we have assumed lower margins as they group is likely to incurred higher compliance cost to meet the FDA’s requirements.

Prospects

Import detentions usually result in one of two outcomes: i) the shipments are released and allowed entry into the U.S. if manufacturers/shippers can provide sufficient proof that its shipments meet FDA compliance requirements, or ii) the shipments are exported back to the country of origin or destroyed.

The manufacturers/shippers can be removed from the red list if the implicated parties can provide sufficient proof that the apparent violations have been resolved. A petition can be submitted to the FDA’s Division of Import Operations (DIO) for removal from DWPE, which outlines the corrective measures taken to prevent future occurrences.

Although the group has guided that its glove shipments can still be exported to the US, we foresee an increased risk of the glove shipments being refused entry or destroyed if CGB fails to provide sufficient proof that it has meet FDA compliance requirements. Other downside risks also include potential delays in shipments, in addition to higher expenses due to storage and testing (i.e.: third party laboratory sampling and analysis) expenses. Meanwhile, recurring violations in the future could subject CGB to more intensive scrutiny by the FDA, which could prompt even more comprehensive proofs to discharge its DWPE status.

Valuation and Recommendation

We trim our FY19 and FY20 forecast net profit by around 21.0% to account for the increased risk, potentially higher costs and shipment delays. We also downgrade our recommendation on CGB to HOLD (from Buy) with a lower target price of RM0.95 (from RM1.20) by ascribing an unchanged PER of 17.0x to its revised FY19 EPS of 5.6 sen on thinner margins, in-tandem with increased costs. The ascribed target PER remains at a discount to the PER of industry bellwethers like Hartalega Holdings Bhd and Top Glove Corporation Bhd due to its smaller market capitalisation and capacity. Potential re-rating catalyst could include the removal of Comfort Gloves from the US FDA’s DWPE list.

Source: Mplus Research - 9 Apr 2018