Highlights

To a certain extent, recent movements in the share price of rubber glove stocks were highly correlated to the fluctuations of greenback against MYR (see Figure #1). While, the fluxes of USD exchange rate were greatly influenced by the US Fed’s decision on QE withdrawal.

Since the emerging noise of possible tapering in June, USD strengthened to a high of RM3.33/USD, resulting in a rally in rubber glove stocks to reach their YTD high levels.

However, the “no taper” stance in the recent FOMC caused the USD to soften almost instantaneously to RM3.15/USD before gradual recovery thereafter.

We do not expect this will result in any change to macro outlook (i.e. growth, inflation, interest rate, etc.) besides that the depreciation pressure on MYR to subside and MYR to trade stronger in the range of RM3.20-RM3.25/USD.

In order to gauge the sensitivity of rubber glove share prices to exchange rate movements, we simulated a simple regression model for the average rubber gloves’ PE by using USDMYR and latex price as explanatory variables. Using weekly readings as our samples (Jan-Sep 2013), the regression model yielded the best fitted statistical result with USDMYR rate at T+6 and latex price at current period.

While keeping latex price constant based on yesterday’s closing price of RM5.51/kg, we computed 6 scenarios of average rubber gloves’ PE by varying the expected USDMYR (see Figure #2).

Notwithstanding the recent adjustment in MYR rate, valuation of rubber glove stocks surged further to a high of 17.3x. According to the sensitivity of the model, a MYR appreciation from RM3.33/USD to ~RM3.20/USD should cause a correction of sector valuation to 16.7x. As such, we believe that share prices could experience some short-term weakness due to the recent adjustment in macro scenario.

Catalysts

Surge in demand in the event of a disease outbreak; more stringent requirements and increased spending in the healthcare sector; appreciation of USD against MYR 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

We maintain our NEUTRAL stance on the sector with unchanged rating and TP for stocks under our coverage. Kossan remains our favourite due to its undemanding valuations relative to peers.

Kossan (BUY, TP: RM7.30 based on 12.8x CY14 EPS).

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

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

Source: Hong Leong Investment Bank Research- 26 Sep 2013