- Over the past weeks, talks of raw material prices –natural rubber (NR) and nitrile(NBR) – escalating has been rife. The two key events underpinning these concerns are:- (1) rising crude oil prices following armed conflict in Iraq; as well as (2) the development of an El Nino weather system, which may affect the supply of natural rubber.

- Based on Bloomberg data, the price of WTI crude oil had surpassed the USD100/barrel mark in mid-May and continued its upward trend to USD107/barrel as at end-June. Given that nitrile is derived from the by-products of crude oil distillation, there have been expectations of a similar rise in prices (MTD: -1.6%).

- While we anticipate a knee-jerk reaction, we are not too concerned. Contrary to popular belief, nitrile prices move more in tandem with NR prices than crude oil. With prices appearing to be reversing (i.e. continuing their downtrend to ~US103/barrel currently), we do not believe that glove ASPs, which are already under pressure from competition, will be raised.

- On the outlook for natural rubber, the International Rubber Consortium (IRCo) had earlier stated that it anticipates the El Nino (expected in Sept 2014 with a 70% chance) to result in higher NR prices. In our last report, however, we noted that its impact is inconclusive as there was no significant decline in production and prices during the 1982-1983 and 1987-1988 events. But during the 1997-1998 episode, there was a slowdown in output growth in 1997 to 0.4% from 6% in 1996.

- Another factor that may lend temporary support to NR prices is the International Tripartite Rubber Council’s (ITRC) meeting in Kuching this month to discuss the current situation and mechanisms to improve them (including production controls and replanting). The meeting will be attended by representatives from the world’s three largest rubber producing countries — Thailand, Indonesia and Malaysia.

- Meanwhile, the Thai government has announced plans to increase the domestic consumption of NR (e.g. in construction of infrastructure) from 14% presently to 20% instead of engaging in costly market buybacks (i.e. in 2012) to stabilise prices. The plan, however, does not include the 200,000 tonnes of rubber stored in its warehouses, which remains an overhang on the commodity.

- At present, consensus expectations are for NR prices to remain depressed until 2016 in view of the oversupply situation. According to the EIU, the ratio of NR stocks to consumption is 13.5 weeks –the highest since early 2000s. It envisages NR prices to bottom out in 3Q this year before bouncing back in 2015. That said, the upside is limited to 1Q14 price levels. Prices have stabilised at RM4.65/kg wet (-13% YTD).

- While higher raw material prices would be a bane to an already unfavourable operating environment for the rubber glove manufacturers, we are not too troubled by these developments given our more conservative raw material input assumptions of RM5.00/kg wet for NR and USD1,300/tonne for nitrile. Our NEUTRAL call on the sector and earnings estimates are unchanged. Our only BUY is Kossan Rubber Industries (FV:RM5.00/share).

Source: AmeSecurities