The fresh round of tariff threats led us to take a closer look at the US-China trade friction. We identified Malaysian’s furniture, wood-based panel and glove makers as potential winners if the 10% import tariff is set in motion. That said, the spat is still ongoing and may just negatively affect the technology and EMS sectors (exporters). Nevertheless, Inari, VS Industry and Globetronics continue to provide compelling values despite the market perceiving them to be losers.

WHAT’S NEW

• Fresh round of tariff threats. Last week, the US Government upped the ante on the trade war dispute with China. In a fresh attempt, Trump’s Administration is looking to impose a 10% tariff on more than 5,000 new Chinese imports worth US$200b. This threat followed after China fought fire with fire - the US slapped 25% tariff on US$34b of Chinese goods and Xi Jinping’s Administration reacted tit-for-tat by matching tariffs on the same amount of American products. The chronological timeline of the trade war between US-China (so far) can be found in the next page of this report. Nonetheless, the conflict seems to have recently abated, seeing how ZTE’s case was resolved.

ACTION

• What to lookout for domestically? The US and China make up 24% of Malaysia’s total export value. Based on ranking, China (13%) is Malaysia’s second biggest export partner followed by America (9%). After vetting through the list of items that may be slapped by a 10% tariff, we identified sectors which could benefit from the recent US trade tantrum. For this round of confrontation (if it occurs), we see Malaysia’s furniture, wood-based panel and glove manufacturers coming out as possible victors. We flag out some prospective winning stocks below while a more comprehensive screening result can be found at the later part of this write-up.

a) Within the furniture space, Lii Hen Industries and Latitude Tree Holdings are two stocks which caught our attention considering 70-90% of their sales are directed to the US. Furthermore, both have solid balance sheets with a net cash position, making up 10- 20% of their corresponding market capitalisation. Valuation wise, they are trading at <10x PE while offering commendable dividend yields of >3%.

b) For wood-based panel makers, potential beneficiaries would be Mieco Chipboard, Evergreen Fibreboard, and HeveaBoard. That said, the US forms only <10% of their total sales. Among them, HeveaBoard has the sturdiest financial position with a net cash pile of RM23m (5% of its market cap) while Mieco and Evergreen have net gearings of 0.6x and 0.1x respectively. They trade at an average PE of 12x.

c) In the rubber glove sector, possible winners (but receiving only minimal spillover benefits) are Top Glove, Hartalega, and Kossan. About 25-50% of their sales are fuelled by the North American region. However, consumers are mostly nitrile glove users (the trio produces this) while vinyl gloves were targeted for import tariffs instead. On a larger scale, the risk-reward profiles for these stocks are unfavourable as valuations are stretched at +2SD above their five-year mean PE.

• Pocket of opportunities. We see opportunity to buy certain stocks amid fears relating to the ongoing trade tussle between the US and China (worries are perceived in nature, nothing has transpired): a) Globetronics - improving visibility for revenue growth, b) Inari - strong revenue prospects, high earnings quality, with potential upside from new contracts, and c) VS Industry - staging recovery in quarters ahead from the operational commencement of more assembly lines for key customers.

ESSENTIALS

• Why is Trump picking on China? President Trump is resorting to protectionism to “Make America Great Again”. We gathered that the percentage of tariffs vs total US imports is expected to rise to ~7%, a level not seen since 1970. This is no thanks to the slew of new tariffs being imposed across multiple countries. In order to effectively plug the trade deficit, the prime default target would be China as the country is the largest trade partner of the US. We note the trade imbalance between the US-China has been widening sharply since 2001 when China first joined the World Trade Organization (WTO). Currently, the gap stands at ~US$375b.
• How is China reacting thus far? China has reiterated it does not want a trade war with the US but is not afraid to fight if it is forced to do so. Besides, they have filed a complaint to the WTO over the Trump Administration’s latest antics. If the dispute persists and WTO does not step in to intervene in a timely manner, we are concerned the rising tensions would escalate into a full-blown trade war situation. Things may turn uglier if President Trump decides to withdraw the US from WTO entirely - this move is undesirable as it will undermine the universally accepted trade rules set by the international community.
• Can the relationship be mended? We believe the US-China relationship is not entirely broken and amicable solutions can be reached (provided there is a win-win for both parties). For example, the seven-year crippling ban which was supposed to prevent ZTE Corp (China’s second-largest telecom equipment maker) from doing business with American suppliers was lifted recently. To recap, this was imposed in April to punish ZTE for violating US sanctions against exporting to Iran and South Korea. However, it was resolved after ZTE paid US$1.4b in fines to the US government and agreed to overhaul its leadership. From this, we deduce and expect both countries to avert a full scale trade war.

Source: UOB Kay Hian Research - 20 Jul 2018