• All companies recorded a stronger qoq earnings led by Top Glove (+50%) and Kossan (24%), mainly due to higher sales volume

• Demand prospect remains positive supported by higher volume arising from Covid- 19 as well as margin resilience on greater manufacturing and cost efficiency.

• We estimate sector earnings to grow c.18% in CY20 and valuations raised to +1SD to reflect the enhanced earnings growth moving forward. Upgrade to OVERWEIGHT

• Kossan is our top pick due to undemanding valuation and superior profit growth.

Glove universe under coverage earnings within expectation

Overall, 4QCY19 results for glove companies were in-line with our estimates, recording stronger qoq earnings growth mainly due to increased sales volume c.6-13%. We believe demand for Malaysian-produced gloves have improved in 4QCY19 with elevated buying patterns especially from US (partly due to tariff hike on China glove and flu season). The gloves sector has outperformed the KLCI with share prices of all stocks appreciating more than 10% YTD following stronger qoq earnings performance and potential benefits from Covid-19 outbreak, in our view (Chart 1). Star performers were Top Glove (+21%) and Kossan (+15%) due to their strong earnings and improved margins.

Outlook: Better CY20 earnings amidst Covid-19 outbreak

Unabated worldwide spread of Covid-19 with more countries affected and new hotspots emerging namely South Korea, Italy and Iran have led to the WHO advising the world community to beef up their healthcare supplies. Given the uncertainty as to when this outbreak could be contained, worldwide glove demand is expected to spike and remain strong for the immediate future. Global demand for gloves increased by average 12% during SARs and H1N1 outbreaks. As for long-term outlook, the virus outbreak is set to generate greater global healthcare awareness especially in emerging countries. Together with ongoing automation and cost efficiency efforts, these would benefit glove manufacturers in sustaining their long-term growth. Additionally, softening ringgit against USD would also benefit glove players.

Change in earnings forecast

During the period, we raised our utilisation rate assumption for glove companies under our coverage to 85-90% (versus 80-85% previously) for FY20-21 to factor in higher demand arising from Covid-19 outbreak. Consequently, the average earnings FY20-21 for companies in our coverage increased by 3-8%. Upside risk to our forecast, is faster-thanexpected higher demand caused by prolonged and worsening outbreak especially in developed nation. Our sensitivity analysis indicates that for every 1% change in volume would impact our earnings estimates by 1-1.5%.

Upgrade to OVERWEIGHT on the sector

We upgrade our sector call to OVERWEIGHT from NEUTRAL as we expect higher earnings performance on rising demand and better margins. Overall, we estimate earnings growth of c.18% in CY20 (vs CY19: +3%). We have raised our PE valuation to +1SD above 5-yrs historical forward mean to capture the surge in future earnings. Sector valuation is elevated, trading at 31.7x forward PE, above its 5 years mean (refer chart 7). We have a BUY call on Kossan (TP: RM5.70), Top Glove (TP: RM6.30) and Supermax (TP: RM1.95).

Kossan is our Top pick. We like Kossan due to its strong earnings growth of c.21% in CY20 (vs peers average at c.18%) on the back of build-up in demand and improved margin. Additionally, the stock is currently trading at 24x forward PE which is relatively more attractive compared to its peers Hartalega (40x) and Top Glove (30x) as well as trading c.25% discount to average sector peers.

Prospect of rising demand likely to support valuations

Moving from the past several quarters of lacklustre demand, glove industry is now seeing restocking activities being ramped up as the Covid-19 outbreak enforces higher hygiene standards. Based on past experience involving SARS and H1N1, glove industry had shown higher sales volume and margins which led to improved earnings by circa 8-30% qoq during the period. Valuation for individual glove stock as well as sector had risen above +1SD forward PE during H1N1 period as shown in charts 4 & 5.

We believe rubber glove stocks deserved further re-rating and should trade above +1SD to better reflect rubber glove prospects in anticipation of greater demand and earnings performance as well as constant evolution activities (e.g. automation and cost efficiency) taken to maintain a resilient margin. All in, we have raised our PE valuation to +1SD above 5-yrs historical forward mean (refer table 1).

Source: BIMB Securities Research - 4 Mar 2020