Highlights/ Comments

• Catalysts to persist into 2016. After a spectacular year in 2015, outlook of the rubber products sector is expected to remain favourable. Catalysts of strong USD and subdued latex prices will continue to underpin the sector’s robust earnings throughout most of 2016.

• Capacity expansion to outpace steady demand growth. Global demand for rubber products is expected to grow steadily at a CAGR of 8-9%. However, there could be erosion of pricing command towards 2H16 given the possibility of oversupply of rubber products due to higher installed capacity.

• Raw mat costs contained ... We expect natural rubber and nitrile latex prices to remain subdued due to a supply glut, slower growth in China’s auto industry and butadiene prices.

• ... but production costs to increase. The biannual adjustments in natural gas price and lower electricity rebate will give rise to higher production cost in 2016. In addition, the hike in minimum wage (RM1,000 for Peninsula & RM920 for East Malaysia effective Jan 2016) will also eat into its profitability in 2016. In this regard, most expansion blueprint is focusing on automation to reduce headcounts.

• All-in-all, Neutral call is maintained. Low raw mat prices, strong USD, beneficiary of TPPA and resilient global demand will continue to contribute favourably to the rubber products industry (both glove and condom). However, it will be neutralised by rising fuel costs and wages. For the glove industry, erosion of pricing command is likely given oversupply of gloves. Last but not least, the industry practice of passing on cost savings may also transpire during the year.

• Amongst the rubber glove sector, we like TOP GLOVE (BUY, TP: RM16.25) as (1) it has been the sector’s leader in terms of market share, revenue, and earnings; (2) its fast capacity expansion ahead; (3) cost reduction via product line automation and SAP ERP system; and (4) its P/E valuation has lagged its peers and it is trading at an average 28% discount to Kossan and Hartalega.

Catalysts

• Surge in demand in the event of a disease outbreak; more stringent requi rements 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.

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: RM6.47, 28.5x CY17 EPS pegged to 1SD above 5-year historical average P/E).
• Kossan (HOLD, TP: RM7.81, 16.6x CY17 EPS pegged to 1SD above 5-year historical average P/E).
• Top Glove (BUY, TP: RM16.25, 20.6x CY17 EPS pegged to 1SD below 5-year historical average P/E).
• Karex (HOLD, TP: RM4.52, 26.9x CY17 EPS pegged to 1SD above 2-year historical average P/E).

Source: Hong Leong Investment Bank Research - 13 Jan 2016