Highlights/ Comments

According to the World Meteorological Organisation (WMO), sea surface temperatures have reached El Niño (see Figure #1) thresholds but atmospheric indicators remain neutral, hence El Niño is not considered to have started.

WMO places the odds of El Niño occurring at 60% between Jun and Aug and 75-80% between Oct and Dec. A moderate strength El Niño is anticipated.

Generally, El Niño is known to cause droughts in Australia and Southeast Asia and floods in the United States and South America, affecting supplies of crops including rubber.

Among the three past El Niño events, two have caused rubber prices rising >50% (see Figure #2). The exception in 2006 was most likely due to the weak intensity of El Niño.

Despite the high probability of El Niño occurrence, we do not view this as a near term catalyst to rubber prices due to several reasons:

1. Estimated surplus. Supply in rubber market has been outpacing demand since 2011 (see Figure #3). According to The Rubber Economist, it is expected to remain in surplus for another three years causing gluts of 652k tonnes, 483k tonnes and 316k tonnes in 2014, 2015 and 2016, respectively.

2. Slowdown in China. China is expected to register a GDP growth rate of 7.5% in 2014, which is the slowest since 2002. A slowdown in China, the world’s largest rubber consumer, would mean a slowdown in rubber demand, hence casting a shadow on the price.

3. High rubber reserves. China’s main rubber-trading hub, Qingdao, has recorded an inventory level of 270k tonnes, while Thailand government is still holding on to 210k tonnes of rubber stockpile (circa 29% and 37% of 2013 world surplus, respectively).

Nevertheless, El Niño might be able to provide a support level to the declining rubber price (-12% YTD).

Industry players’ views are in line with ours, which do not expect major impact from El Niño on rubber prices.

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

Mismatch between demand and supply in rubber gloves; potential increase in natural and/or synthetic latex prices; further depreciation of USD against MYR.

Forecasts

Unchanged.

Rating

NEUTRAL

Positives – Softening of natural and/or synthetic latex prices, continuous improvement in cost efficiency.

Negatives – Weakening of USD against MYR.

Valuation

Maintain NEUTRAL stance on the sector with the following stock ratings:

Hartalega (HOLD, TP: RM5.78 based on 16.2x CY15 EPS).

Top Glove (HOLD, TP: RM4.56 based on 13.5x CY15 EPS).

Kossan (HOLD, TP: RM3.91 based on 12.8x CY15 EPS).

Source:Hong Leong Investment Bank Research - 3 Jul 2014