- We see the rubber glove manufacturers as prime beneficiaries of Budget 2016 in view of the proposal for a Special Reinvestment Allowance (RA) Incentive for companies that have exhausted their eligibility to qualify for RA. The rate of claim is at 60% of qualifying capex and can be set off against 70% of statutory income from year of assessment 2016 to 2018.

- This proposal is particularly significant for the rubber glove players as most had expired their RA incentives (valid for 15 consecutive years from the year of assessment RA is claimed) between 2012 and 2014 considering their long operating history.

- Such an incentive is also timely for the glove manufacturers given their current capex upcycle. Against the backdrop of robust global glove demand (+9% YoY), we understand that the top four glove manufacturers have allocated capex of RM150mil to RM400mil p.a. for the next three years to boost installed capacity by ~11% p.a.

- The reinstatement of RA essentially means that the effective tax rates of glove companies could be lowered, leading to higher earnings moving forward. Historical data show that the effective tax rates for the top four players averaged at 16% prior to the RA expiries vs. the current 23%. Assuming a conservative 4ppts reduction to the forward effective tax rates, i.e. at 19%, we estimate an average earnings upside of 4%-7% p.a. for the rubber glove players.

- This announcement lends further credence to our OVERWEIGHT call on the rubber gloves sector. We expect the sector to enjoy another round of PE re-rating, with its premium valuations justified by its prime position as exporters operating in a defensive sector and the fact that it is one of the few industries in the market that is experiencing positive earnings upgrades from volume growth and margin expansion.

- While other points in the budget referred to potential cost inflations for the glove manufacturers, namely the 11% hike in the Peninsula Malaysia minimum wage from RM900 to RM1,000 and increase in the floor price of SMR20 and cuplumps, we are not too concerned as:- (1) labour costs make up only ~10% of the glove manufacturers’ total operating costs; (2) the industry has a cost pass-through pricing mechanism; (3) there is an eight-month grace period to the implementation date; and (4) usage of imported bulk latex vs. domestic SMR20 as inputs.

- The latest rally of the rubber glove counters last week saw their share prices once again exceeding our fair values (all except Top Glove’s and by 9% on average). This was despite our constant upward revisions (between two to six times) since our sector upgrade in December 2014. Pending further details from the managements and the share price overshoots, which we view as a positive testament to our BUY calls, we are placing our current fair values for Top Glove Corp (RM10.60/share), Kossan Rubber (RM8.40/share), Hartalega Holdings (RM4.70/share) and Supermax Corp (RM2.05/share) under review.

Source: AmeSecurities Research - 26 Oct 2015