- According to an article in The Edge Financial Daily and Gas Malaysia Bhd’s announcement to Bursa Malaysia, the government has approved the hike in natural gas tariff for non-power sectors in Peninsula Malaysia. This hike will be effective May 1, 2014.

- Based on the revised tariff revision schedule, we believe that the increase for rubber glove manufacturers would be at an average of 19%. Note that some of the companies have exclusive deals with Gas Malaysia given the substantial volume demanded, which results in a better input price in relation to its peers’.

- While this development is negative for the rubber glove manufacturers, we are not surprised as the increase in natural gas has been largely anticipated following the recent hike in electricity tariff.

- Recall, an electricity tariff hike of 15% (4.99 sen/kWh) in Peninsula Malaysia and 16.9% (5 sen/kWh) in Sabah had been effective since Jan 1, 2014. This was not expected to significantly impact earnings as the electricity bill for the players are relatively minimal.

- At present, energy usage accounts for 10%-12% of the glove manufacturers’ total operating costs, with the largest portion attributed to natural gas. Raw materials, namely latex and nitrile, still make up the bulk of total costs at 45%-50%.

- While we are cognisant of the current hostile pricing environment in certain segments (i.e. the nitrile gloves), we reckon that the glove manufacturers would collectively want to raise prices to offset this higher cost. This follows the industry’s practice of passing down any cost increases to customers.

- We also believe that the higher ASPs can be sustained; this is unlike the previous round of upward price revision of ~1% in January to combat the higher electricity costs that were ineffective as other players kept their ASP low in a bid to gain additional sales and market share.

- Assuming a 100% cost pass-through, we estimate the impact of the higher cost structure to reduce the glove manufacturers’ earnings of up to 5%. However, there may be a bigger impact on their sequential earnings in view of time lags.

- We are keeping our estimates for now, pending further clarity and information from the respective managements.

- We also maintain our OVERWEIGHT stance on the sector, with BUYs on Top Glove Corp (FV: under review) and Kossan Rubber Industries (FV: RM5.05/share). Hartalega Holdings (FV: RM6.50/share) and Supermax Corp (FV: RM2.65/share) remain as HOLDs.

Source: AmeSecurities