Highlights / Comments

• 2014: Glove stocks were rather defensive (average return of -4.2% vs. FBM100 Index of -6.2%). Karex, on the other hand, has performed very well, with gain of 22.6%.

• Raw materials: Latex prices have been on a downtrend. However, with efforts to tackle global glut seen from several parties, we expect rubber prices to remain rangebound.

• Fuel: We expect moderate annual increase in electricity cost and biannual price adjustments in natural gas, in line with Government’s subsidy rationalisation plan.

• Labour: Being in a labour intensive industry, labour costs make up 13% of total cost. Hence, most expansion blueprint is focusing on automation to reduce headcounts .

• Forex: Expect MYR to remain weak around RM3. 50/US$. Neutral for glove players due to forex savings pass -through, positive for Karex as it enjoys the USD appreciation benefits.

• Disease outbreak: The deadly Ebola outbreak in western Africa is not expected to be a catalyst as yet.

• Global demand: Glove demand will remain resilient with expected growth of 6% -8% in 2015. Condom demand will grow strongly at 6-year projected CAGR of 9.0%.

• In general, both sub-sectors are experiencing resilient growth. However, the fact that glove industry has to pass on cost savings leads us to prefer condom player, Karex.

• Rubber glove : Low rubber prices, strengthening USD and resilient global glove demand will contribute favourably. Nevertheless, it will be neutralised by unfavourable factors , such as rising fuel costs and wages, as well as the yet -toreach equilibrium between demand and supply of rubber glove. Not forgetting also the industry practice, whereby any cost savings have to be passed on.

• Condom: We continue to be positive in Karex given its favourable outlook from both macro (export -oriented, USDdenominated, robust global demand growth, low condom usage rate) and micro (well-planned capacity expansion, acquisition of ONE ® brand, strong in-house R&D) factors.

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 glove; potential increase in natural and/or synthetic latex prices; 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: RM4.62, 13.5x CY16 EPS pegged to 1SD below 3-year historical average P/E).
• Karex (BUY, TP: RM4.00 as we roll forward valuation, 19x CY16 EPS pegged to average P/E of international peers).

Source: Hong Leong Investment Bank Research - 14 Jan 2015