Highlights

We downgrade the sector from OVERWEIGHT to NEUTRAL after it has undergone an industry-wide rerating and we believe that the post-rallied share prices have priced in all the positive catalysts.

Flu fear dwindling. The parallel outbreaks of H7N9 and Coronavirus stimulated positive market sentiments towards rubber glove companies with the concern of them going pandemic. However, the effect appears to be subsiding as the reported cases did not reach the significance compared to the past plagues (see Figure #1).

Demand and supply. In line with industry’s bullish outlook, we have already forecasted global demand to grow at 10%- 15% supported by their rapid capacity expansions. Any fall in demand growth below 10%, may result in glut which will eventually cause ASP to plunge and impact on profitability.

Raw material pricing. Latex and nitrile are already trading at their lows (even during wintering season) and stabilizing. We expect the prices to stay at the current level (latex: ~RM5.70/kg, nitrile: ~USD1.20/kg) and rise gradually over the long term in tandem with global economy improvements, which should increase demand for raw material.

Strengthening of greenback has already been reflected in share prices and neutralise the appreciation of MYR during 2Q13. Our house economist expects MYR to return to RM3.10/USD end of the year when the clarity on Fed tapering emerges.

Gas price hike. Rubber glove players have already inked the new gas sales agreement with Gas Malaysia which includes take-or-pay mechanism. Any gas price increase should be mitigated by the cost pass-through practice.

We do not expect the Medical Device Act 2012 which came into effect to have any material impact on the industry. For example, Hartalega and Kossan’s latex gloves are already certified by FDA under Section 510(k).

Catalysts

Surge in demand in the event of a disease outbreak; appreciation of the USD against the MYR; more stringent requirements and increased spending in the healthcare sector; and lower rubber prices to boost profitability.

Risks

Uptick in natural and/or synthetic latex prices will inevitably erode profitability, depreciation of USD against MYR, natural gas price hike and price undercutting.

Forecasts

Unchanged.

Rating

Neutral

Positives: Latex prices have fallen significantly, production efficiency to continue improving and production shift to nitrile gloves from NR gloves will lead to better cost management.

Negatives: Weakening of USD against MYR.

Valuation

Hartalega (HOLD, TP: RM6.37 based on 17.5x CY14 EPS).

Top Glove (HOLD, TP: RM6.09 based on 16.0x CY14 EPS).

Kossan (HOLD, TP: RM5.76 based on 12.8x CY14 EPS). We raised Kossan’s PE multiple from 10.5x to 12.8x, which derived by discounting 4x to the average of Hartalega and Top Glove’s PE multiples. On average, Kossan has been trading at 4x discount to peers for past 5 years.

Source: Hong Leong Investment Bank Research- 10 Jul 2013