- We reiterate our OVERWEIGHT view on the rubber gloves sector following Fitch Ratings’ recent outlook downgrade on Malaysia as we believe the rubber glove players may be indirect beneficiaries of the cut.

- On Tuesday, Fitch Ratings revised Malaysia’s outlook to “Negative” from “Stable” while maintaining the country’s long-term foreign and local currency issuer default ratings (IDRs) at ‘A-’ and ‘A’ respectively.

- The FBM KLCI had reacted with a 1.25% fall (22.5 points) to close at 1,722.6 points the next day while the RM dipped to a 3-year low of RM3.24 per USD. Yesterday, the index recovered slightly to end the day at 1,777.8 points (+0.3%) while the USD:RM exchange rate remained flat.

- A strengthening greenback bodes well for the glove manufacturers given that it is an exportoriented industry with sales quoted in USD/’000 pieces. YTD, the USD has appreciated the most against the RM (+6%) when compared to currencies of other major rubber glove producing countries (Thai Baht: +2% and Indonesian Rupiah: +5%), ensuring that our exports remain competitive.

- Note that net currency exposure is on average c.30%-40% as glove makers enjoy a natural hedge against the USD since part of their raw materials (eg. nitrile) is procured in USD.

- We understand that all the rubber glove companies under our coverage save Supermax Corp (HOLD, FV:RM2.15/share) hedge their currency risk using forward contracts. While this method is meant to protect their receivables, variations in lock-in rates and the subsequent marking-tomarket (unrealised profit/loss) have resulted in fluctuating earnings each quarter although over the year, the gains and losses balance out.

- For example, in Top Glove’s FY12 quarterly results, the group reported forex losses of RM13.3mil in 1QFY12 and a smaller RM2.5mil in 3QFY12 which were offset by a RM15.8mil gain in 2QFY12. As such, we foresee a reversal for the group’s 3QFY13 USD forward contract loss of RM4.8mil in FY13.

- Besides the strong USD, our present positive sector outlook is also supported by:- (1) low and stable raw material prices (latex: -15% YTD; nitrile: -20% MTD); (2) resilient global glove demand (2013F: +12%); and (3) absence of electricity tariff hike and natural gas subsidy pullback in the immediate term.

- No change to our forecasts as our assumed exchange rate of RM3.10 per USD for the coming year is close to our in-house view of RM3.12-RM3.15 per USD. Our top picks for the sector are Top Glove Corp (BUY, FV:RM7.15/share) and Kossan Rubber Industries (BUY, FV: RM6.30/share). Hartalega is a HOLD with a FV of RM6.00/share. The four glove counters closed higher yesterday, with average gains of 2.3%.  

Source: AmeSecurities