- We re-iterate our OVERWEIGHT stance on the rubber glove sector, following our recent company visits. Industry outlook remains rosy as already healthy demand (lead time of 40 days to 6 months, depending on glove types) may be further buoyed by the recent discovery of a new strain of bird flu, H7N9, in Eastern China.

- This current outbreak is positive for the domestic rubber glove manufacturers (63% of world market share), should this isolated event manifest itself into a prolonged and global pandemic. The situation should result in an uptick in usage of examination gloves, which make up the bulk of rubber glove exports (88% in FY12).

- To put things into perspective, the last 3 outbreaks/pandemics (2003: SARS; 2007: H5N1 avian flu; 2009: H1N1 swine flu) saw worldwide glove demand rise by between 11% and 24% in the year they occurred.

- Feedback obtained from industry players has revealed a sense of urgency with regard to order fulfillment among their customers. However, at such an early stage, they are still holding out from raising their orders. In addition, the local manufacturers have minimal exposure to the China market as it is dominated by the lower-end plastic (eg. vinyl) variants (86% of demand).

- Even without this catalyst, glove manufacturers have been optimistic about volume growth in 2013. On average, they project glove demand to grow between 10% and 15% (FY12: 166 billion pieces) on the back of:- (1) lower ASPs in-line with the low and stable raw material prices (YTD, latex:-2.7% and nitrile:+8%) ;and (2) sustained re-stocking activities. The top 4 players are investing a capex of RM650mil (+50% YoY) to boost their installed capacity by 14%.

- In view of the near-maximum utilisation rates (average 88%) at the major players’ facilities and oversold positions, the domestic glove makers could find themselves in a situation similar to that of 2009 (H1N1) when demand outpaced supply, leading to an exceptional year for the players. Average earnings growth was at 55% and EBITDA margin expansion was 2ppts.

- While the benefits will accrue to all rubber glove players, we believe Top Glove Corp (BUY, FV: RM6.50/share) is in a more advantageous position, given its lower capacity utilisation rate of 60%-70% and higher product mix of the more affordable latex examination gloves (2Q13: latex:nitrile split of 74:17). As a guide, Top Glove’s incremental demand from the SARS epidemic in March 2003 was 6.5 billion pieces.

- At this juncture, we are maintaining our forecasts as incremental earnings are difficult to quantify. Our top sector BUYs are Top Glove (FV: RM6.50/share) and Kossan (FV: RM4.60/share). Hartalega and Supermax remain as HOLDs, with respective fair values of RM5.10/share and RM2.15/share. YTD, these four stocks have outperformed the FBM KLCI, on average by ~10%.

Source: AmeSecurities