Not much excitement in this reporting season with one earnings miss and two hits. Sector core profit dipped 4% qoq on forex headwinds and cost pressures. The average quarterly bottom-line run rate estimated by the street remains high, so downside risk is not adequately accounted for. We stay tactically bearish on the sector from a valuation perspective. Maintain UNDERWEIGHT.

WHAT’S NEW

• 1Q18 results round-up. Again, there is not much excitement stemming from the rubber glove sector. Two of the three companies under our coverage - Top Glove and Kossan - posted results that were in line while Hartalega missed expectations for the second straight quarter on the back of cost pressures. Sector core earnings contracted 4% qoq due to narrower margins. We note the street is still projecting earnings to rise 28% yoy in view of strong rubber glove demand (mid- to high-teens growth vs 12-year average of mid- to highsingle-digit annually).
• Downside risks still being ignored. Although 1Q18 performance continued to be tepid, share prices of glove makers are generally holding up well (save for Kossan) as the market has developed an affinity towards export-related stocks post Malaysia’s 14th general election. At present, the average sector earnings run rate projected by the street over the next two quarters is RM311m. We find this remains high and is 33% above 1Q18 numbers. In our opinion, consensus could be too bullish, suggesting downside risk is not being adequately accounted for.

ACTION

• Maintain UNDERWEIGHT. We stay tactically bearish on the sector due to overly stretched valuations at +2SD above 5-year forward mean PE. Also, there is a budding risk of shortterm earnings disappointment and this will not bode well with the market. Seeing that interest in this space remains strong, we view it as a fitting opportunity to sell on strength and realise the windfall generated over the past nine months.
• Top Glove: Maintain SELL and target price of RM8.00, based on 18x 2019F PE. While we acknowledge the strong demand for natural rubber gloves and recent weak latex prices are positive developments, the risk/reward profile of the stock is unfavourable due to its rich valuations at +2SD above its 5-year forward mean PE. Some 50% of Top Glove’s sales volume comes from latex gloves (mainly sold to emerging countries).
• Hartalega: Re-iterate SELL and target price of RM8.04, based on 24x 2019F PE.
• Although the stock has been included into the FBMKLCI, there is no structural business evolution to warrant a re-rating. Hartalega is employing a competitive pricing strategy to encourage the take-up of its new anti-microbial gloves; thus, there will be insignificant margin uplift. It is still the most expensive rubber glove stock under our coverage.
• Kossan: Downgrade to SELL with target price kept at RM6.56, based on 18x 2019F PE. Share price shot up 13% since we raised our call to HOLD a month ago. Now we reckon its risk/reward profile is skewed to the downside. We recommend taking some chips off the table especially since competition may be heating up, giving rise to a threat of slower demand (see next page for further elaboration).

ESSENTIALS

• Reasons for sector earnings contraction. Muted top-line growth (+2% qoq) and cost pressures like higher raw material expenses, hike in gas prices and new foreign workers levy caused sector earnings to decline 4% qoq. Despite capacity utilisation rate remaining elevated at well above the 80% mark in 1Q18 (sales volume +3% qoq), forex headwinds (- 5% qoq) was a negative factor. Generally, there was also a 1-2 months’ lag in passing on costs to customers (ASP +4% qoq while expenses spiked up at a much quicker pace).
• Speed bumps ahead? Going forward, there is a rising threat of slower demand as we observe tapering forward orders. We note Hartalega has about two months of forward orders, a tad lower than Feb 18's three months (sold out until Jun-Jul 18). Top Glove is facing the same phenomenon as well; sales backlog for its nitrile gloves has shortened to 40-50 days from 60 days. Another implication from this could be rising competition where more nitrile glove supply capacity is coming on stream. Also, this could be due to a scenario where the vinyl glove undersupply in China is recovering as capacity restarts after 2017’s environmental clampdown, prompting price-sensitive F&B customers to switch back to the more economical glove offerings.
• Transition back to SST has minimal consequences. With Pakatan Harapan (PH) now the new ruling government, it kept its manifesto promise to employ back the Sales and Services Tax (SST) system from the Good and Services Tax (GST) regime. We believe the net impact to glove makers is minimal as exporters were not contributors to the SST while under GST, they escaped as well. Recall, exporters were not charged GST on their oversea sales but were able to claim for input tax credits on GST incurred for costs of production.
• A rapid rise in minimum wage is not ideal. PH’s manifesto also includes raising the minimum wage to RM1,500 from RM1,000 currently (+50%). The intention is to share the incremental cost increase of RM500 on an equal basis between the employer and the government; this is supposed to be implemented in the first term of the PH government being in control but is temporarily postponed due to financial constraints. Besides, PH pledged to reduce the number of foreign workers to 4m from 6m. Indeed, both have a negative impact on the sector if they come into effect. We estimate every 10% rise in labour cost could reduce glove makers’ 2018-20 earnings by 5-6% (to counteract this, ASP has to increase by 1%).
• The ringgit to weaken further? An infant government with a lack of financial ammunition (the total federal debt and liabilities as a percentage of GDP stood at a staggering 80%) are enough reasons to cause a ringgit sell-off. Leading up to the 14th general election, the ringgit against the US dollar depreciated 2% from the start of April. After that, it continued weakening by another 1% until end-May; this could persist over the short term given the murkiness in domestic policies coupled with a strong US economy, prompting a capital pullback to the country from emerging markets. Nevertheless, our in-house economist expects the ringgit to strengthen to RM3.85/US$ in 4Q18.
• Forex tailwind already taken into account. The soft ringgit is still nowhere close to the RM4.50/US$ level back in early-17 (now: RM4.00/US$). The forex assumption we are using to project our financial estimates for the rubber glove sector is at an average of RM4.03 over the next 1-3 years. Hence, we believe this has already somewhat captured the potential upside risk from forex tailwind. Our calculations show that every 1% depreciation in the ringgit vs the US dollar could beef up glove makers’ 2018-20 earnings by 6%.

SECTOR CATALYSTS

•  If the closure of vinyl glove plants at China becomes permanent (which we think otherwise), we reckon our Malaysian glove players deserve a valuation re-rating.
• Benign competition and resilient margins are huge positives for the sector. That said, over the longer term, this is unlikely to happen, in our view.

CORPORATE

Cymao Holdings: To sell industrial land for RM12m cash, more than half its market cap. Cymao Holdings Bhd will dispose of two parcels of industrial land for RM12m cash, which is more than half its market capitalisation at the moment. According to its filing with Bursa, Cymao Plywood Sdn Bhd, a wholly-owned subsidiary of Cymao, has entered into a sale and purchase agreement (SPA) with South Pacific Fish Processing Sdn Bhd for the disposal. The filing said that the disposal of land was a result of the closure of Cymao Plywood’s mill, which will enable the group to unlock the value of land and availability of additional funds for working capital requirements of the group. “The proceeds from the disposal of land will be channeled for the working capital requirements of the group,” it said. (Source: The Edge Financial Daily)

IQ Group Holdings: Gets smart about Japan. IQ Group Holdings Bhd expects Japan to be a key market for its Lumiqs brand in three years, generating an estimated annual revenue of US$12m. Group CEO Daniel Beasley told StarBiz that Japan is a strong market for the Lumiqs brand, as it has about 20 customers in the country. “The product that they are buying is our intelligent LED highbay lighting system, which was released into the market three years ago. The product is for use in commercial premises,” he said. IQ has either sales offices or partners distributing the product in Singapore, Indonesia, Philippines, Malaysia and the UK. According to Beasley, IQ was in the process of relocating the production of about 30% its LED lighting products, which includes sensor lighting and stand-alone sensors to Dongguan, China. (Source: The Star)

Ire-Tex: Appoints new CEO. Packaging company Ire-Tex Corp Bhd has appointed Tan Yeang Tze as its new CEO effective today. Tan, 43, will fill the position left vacant by Saharun Nizam Saharan, who was fired in January just five months into the post. Prior to joining Ire-Tex, Tan was the corporate manager for Daza Holdings Sdn Bhd from Aug 17 to May 18. Concurrently, Tan will continue to serve as a “freelance corporate advisory for various public listed companies” — a position he has served since January 2016. He also used to serve as personal assistant to chairmen and advisors of various public-listed companies between 2003 and 2015. (Source: The Edge Financial Daily)

LBS Bina: To go ahead with Zhuhai project. LBS Bina Group Bhd will not be holding back on its development project to transform the Zhuhai International Circuit in China although the joint development deal with NWP Holdings Bhd has lapsed. The company’s group managing director Tan Sri Lim Hock San told EdgeProp.my that both LBS Bina and NWP Holdings are unable to come to an agreement with regard to certain terms in the Definitive Agreement. “We still have our own alternative plan with regard to the development of this project,” Lim said when asked if LBS Bina will be looking for a new partner. He also gave assurance that the project will not be put on hold because of the termination of the partnership with NWP Holdings. (Source: The Edge Financial Daily)

Maybank: Appoints Michael Foong as CEO, International. Maybank has appointed Michael Foong Seong Yew as CEO, International, replacing Pollie Sim who retired on 1 June. The new role will be in addition to Foong's current role as group chief strategy officer, a position he has held since 2014. Foong first joined the group as chief strategy and transformation officer in 2011. "As an expert in Strategy Development and Business Transformation, Michael has made contributions to International when he oversaw, with the Group President & CEO, the transformation programmes for Maybank Hong Kong, Maybank Philippines and Maybank Cambodia from 2014,” said Maybank in a press statement. (Source: The Star)

Petronas: Seeks court ruling on right to country's petroleum resources. Petroliam Nasional Bhd has gone to court to declare that under the Petroleum Development Act 1974 (PDA) it is the exclusive owner of the petroleum resources in the country, including Sarawak. The national oil corporation said on Monday it had filed an application before the Federal Court seeking for a declaration on the Petroleum Development Act 1974 (PDA) being the law applicable for the petroleum industry in Malaysia. The application is also to state Petronas is the exclusive owner of the petroleum resources as well as the regulator for the upstream industry throughout Malaysia, including in Sarawak. “Petronas believes that the determination by the Federal Court would help provide clarity on its rights and position under the PDA,” it said. (Source: The Star)

Tatt Giap: Plans RM140m project. Tatt Giap Group Bhd plans to develop a RM140m light industrial project in Valdor Industrial Estate in Sungai Bakap soon. Group chairman Datuk Thomas Liang told StarBiz after the company’s EGM that the plan was to turn the 12-acre site of the project into an industrial park. Tatt Giap intends to develop 38 three-storey semi-detached properties and two three-storey detached corporate warehouse cum office buildings. Liang said: “Over time, the sales of the project is expected to contribute positively to the earnings of the group. The project is expected to be completed within 36 months from the date of its commencement”. He noted that the group is diversifying into light industrial properties because “there are still demand for such properties in Penang from overseas investors.” (Source: The Star)

WCT: Withdraws share options for independent directors proposal. WCT Holdings Bhd has withdrawn a proposal to grant share options to its independent non-executive directors from being put forward for voting in Wednesday’s annual general meeting (AGM). The decision was made after taking into consideration feedback received from shareholders and stakeholders, and in consultation with the independent non-executive directors, the group said in a filing with Bursa Malaysia. The independent non-executive directors are Tan Sri Marzuki Mohd Noor, Datuk Ab Wahab Khalil, Datuk Ng Sooi Lin and Ng Soon Lai. WCT Holdings recently announced that its net profit for the first quarter ended 31 Mar 18 increased 16.9% to RM38.39m from a year ago on higher construction billings from local infrastructure projects. (Source: The Edge Financial Daily)

SECTOR

Property: SP Setia expects a revival in property market. The country’s property market, which has been on a downtrend over the past three years, is expected to return to growth following the implementation of the zero-rated Goods and Services Tax from last Friday. President and CEO Datuk Khor Chap Jen said he hoped the move to abolish the GST would help improve buying sentiment, especially among the young and first-time house buyers.” “We are also seeing a decline in property speculation, so property buyers nowadays are those who really want to purchase houses. Housing demand will always be there, but it is now moving towards a stable, gradual increase,” he told reporters after the World Environment Day celebration organised by SP Setia. (Source: The Star)

POLITICS

General: Support for Pakatan to postpone pledges to maintain fiscal deficit. Finance Minister Lim Guan Eng’s action to postpone the five pledges of Pakatan Harapan should be applauded as it seeks to maintain the fiscal deficit of 2.8%, says Tan Sri Ramon Navaratnam. The five pledges include petrol subsidies for cars under 1,300cc and motorcycles under 125cc, higher minimum wage, delayed student loan repayments, national expansion of Selangor’s Skim Pedulu Sihat, and Employees Provident Fund contributions for housewives. The chairman of the Asli centre of public policy studies said. “The debt management will improve considerably with the postponement of the five pledges. The estimated RM1t will now be made more manageable by international financial standards of World Bank and IMF criteria.” (Source: The Star)

Source: UOB Kay Hian Research - 5 Jun 2018