Highlights

• In its announcement to local bourse, Gas Malaysia’s natural gas tariff will be revised for the non-power sector in Peninsular Malaysia, effective 1 July 2015. Average natural gas tariff will increase from RM19.77/MMBtu to RM21.80/MMBtu (+10.3%).

• Tariffs for customers under category A (residential segment) will remain at RM19.52/MMBtu while tariffs for other categories will change by -3.3% to +12.1% (Figure #1).

• Gas Malaysia noted that the hike is to take into account the increase of purchase price of gas it procures from Petronas.

• The approval of tariff revision by the Government will be subject to a bi-annual adjustment of both buying and selling prices in an effort to address subsidy rationalisation.

Comments

• Any revision on natural gas tariff will impact rubber product manufacturers because on average, it constitutes about 9% of total cost of production. However, this is something that we have already taken into consideration and imputed in our financial modelling.

• The final impact of the hike will actually depends on how soon glove manufacturers are able to pass it to their end clients, which in our opinion, likely to be about 3-months lag.

• On a different note, we are of the view that the recent share price rally during the outbreak of MERS in South Korea is purely driven by sentiment rather than fundamental. This is primarily because total demand received from customers to total volume is insignificant due to large base. In addition, huge percentage of our rubber products is exported to US and Europe region.

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, as we have already factored this impact into our forecasts.

Rating

NEUTRAL

Positives

• Softening of natural and/or synthetic latex prices, continuous improvement in cost efficiency and US$ appreciation.

Negatives

• Declining ASP and higher labour cost.

Valuation

Maintain NEUTRAL on the sector with the following ratings:

Hartalega (HOLD, TP: RM8.45, 18.4x CY16 EPS pegged to 1SD above 5-year historical average P/E).

Top Glove (HOLD, TP: RM5.42, 15.4x CY16 EPS pegged to 3-year historical average P/E).

Kossan (HOLD, TP: RM6.31, 17.5x CY16 EPS pegged to 2SD above 5-year historical average P/E).

Karex (HOLD, TP: RM3.09, 23.8x CY16 EPS pegged to 2SD above its international peers).

Source: Hong Leong Investment Bank Research - 10 Jun 2015