- We are retaining our OVERWEIGHT recommendation on the rubber gloves sector following recent reports reaffirming the trend of low and stable natural rubber (NR) and nitrile (NBR) prices (~55% of costs) in 2013. We believe that soft input costs coupled with the trend for thinner gloves will lead to lower glove prices, spurring demand (2013: +10%-15%).

- Last year, Malaysia’s rubber glove exports (63% of world market share) climbed 15% (2011: -4.5%) on the back of a 6% decrease in ASPs (2011:+15%). We anticipate a similar trend in 2013 with a 12% rise in volumes translating into an average sector earnings growth of 17% (2012: 24%). This excludes any potential surge in demand should the current H7N9 outbreak escalate into a global pandemic.

- We gather that NR prices are expected to remain depressed this year as global output looks to surpass consumption, a third consecutive year of surplus. Higher yields from huge replantings in 2008-2011 and growing output contributions from Vietnam (2013: +5.5% YoY) will, amongst others, boost NR production by 4%-5% this year. Additionally, inventories in Qingdao, China’s main import hub, have also soared to an all-time high of 366,900 tonnes.

- Last week, the International Tripartite Rubber Council concluded its Asean Plus 2013 Rubber Conference with no announcements on measures it intends to take to prop up NR prices. This unexpected gesture resulted in a MTD pullback in latex prices of 5.5%. We understand that further discussions will be held at its next meeting in Indonesia in May 2013.

- Although NR gloves are still a key segment (2012: 54% of exports), the trend is towards synthetic gloves (2012: 46% vs. 2011’s 42%), whereby NBR input costs have also been on a downward trend, hovering at US$1,330/tonne in March 2013. Prices slipped 24% YoY and are flat YTD mainly due to additional naphtha crackers being commissioned (16 new plants this year) on top of low utilisation rates at existing plants (65%-75%).

- We do not anticipate a resumption of stronger global NR and NBR demand growth in 2013 as recovery in the global auto sector remains subdued and the European debt crisis lingers on. China, the world’s largest rubber consumer (34% of global demand), will aim to draw down its high stock levels and has said that its tyre output may only rise 4% this year in contrast to the average rate of 8.4% a year between 2007 and 2011. In addition, North American truck build slots for 2Q13 remain 41% unfilled (2Q12: 28%).

- To put things into perspective, our back-of-envelope calculations indicate that for every 10 sen decline in NR prices, sector earnings would on average rise by 5%, led by Top Glove at 8%. Meanwhile, a USD100 decline in NBR prices would see Hartalega benefit the most, with a 9% jump in earnings. Despite that, we expect sector EBTIDA margins to expand a meagre 1-2 ppts, constrained by delays in plant automations and time lag from cost pass-through.

- At present, we are maintaining our FY13F-FY15F estimates, of which we have incorporated price assumptions of RM6.50/kg for NR and USD1,400/tonne for NBR. Our slightly more conservative NR price assumption reflects our view of a possible short-term price intervention by the tripartite.

- We continue to like Top Glove (BUY, FV: RM6.50/share) for its well-executed volume strategy and Kossan (BUY, FV: RM4.60/kg) for its relatively cheap valuations (PE of 10x vs. sector’s 14x). In addition, these 2 groups are better-positioned to capture any sudden hike in demand for healthcare products as a result of the H7N9 bird flu. While the former has additional capacities at its plants (current utilisation rate of 60%-70%), the latter has exposure in the Chinese face masks market. Supermax and Hartalega are HOLDs with fair values of RM2.15/share and RM5.10/share, respectively.

Source: AmeSecurities