Highlights / Comments

• The impact of crude oil price on this sector will be indirect on the price of raw material, nitrile. Nitrile prices move in correlation with the price of their main feedstock, butadiene, which in turn follows the footsteps of crude oil prices.

• This relationship is backed by strong correlations between crude oil and butadiene of 0.82, as well as butadiene and nitrile of 0.87.

• Hence, the weakening of crude oil price will result in lower prices of butadiene – a globally traded chemical – leading to lower nitrile prices.

• From the sensitivity analysis carried out, the findings showed that the main beneficiaries in an environment of falling nitrile prices are Kossan, followed by Top Glove and Hartalega.

• We understand that our findings may be contradictory to the general view which expects Hartalega, the world’s largest nitrile glove manufacturer, to top the list. The contrasting result is due to less amount of nitrile used by Hartalega, as they are producing the world’s lightest nitrile gloves, weighing a mere 3.7g.

• We learnt that the cost savings gained from lower nitrile prices have to be passed back to customers too, the same case with waning latex prices.

• Nevertheless, this will provide a cushion to absorb the rising prices of other cost of production such as fuel, electricity, and labour, which will contribute to a more sustainable margin.

• Hence, we believe there is limited impact in this scenario. With the absence of near-term catalyst, we maintain neutral on the sector.

• Update on Ebola: As at 21 st November 2014, there have been 15,351 cases with 5,459 deaths. Transmission remains in western African countries, hence, no material impact as yet.

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 on the sector with the following ratings:

• Hartalega (HOLD, TP: RM7.43, 16.2x CY16 EPS pegged to 1SD above 5-year historical average P/E).
• Kossan (HOLD, TP: RM4.49, 12.8x CY16 EPS pegged to 1SD above 5-year historical average P/E).
• Top Glove (HOLD, TP: RM4.56, 13.5x CY15 EPS pegged to 1SD below 3-year historical average P/E).
• Karex (BUY, TP: RM3.43, 19x CY15 EPS pegged to average P/E of international peers).

Source: Hong Leong Investment Bank Research - 4 Dec 2014