Sector Outlook

• Recapping 1H16… After a stellar performance in 2015 with an average return of 118%, rubber glove companies underperformed the FBM KLCI with average return of -30% YTD versus FBM KLCI at -3%.

• Quarterly re sult review… All rubber gloves companies reported weaker QoQ results (from -7% to -49%) mainly due to weakening of USD, time lag in passing through the rising cost coupled with falling ASP. In term of sales volume, Hartalega outperformed peers with 32% YoY growth, followed by Topglove (+11%) and Kossan (+8%).

• Natural gas tariff revi sion… Average natural gas tari ff will be hiked from RM25.53/MMBtu to RM27.05/MMBtu (+5.95%), effective 15 July 2016. Natural gas constitutes circa 10% of total production cost. In this regard, we had already factored in RM3/MMBtu hike for every 6 months in our model. In near term, this might impact margin due to 2-3 months lag in passing through the cost to customers.

• ASP trend to stabilise… In 1Q CY16, ASP fell by a range of -13% to -26% YoY mainly due to passing through of USD/MYR benefit and intense competition in nitrile segment. We understand that ASP has been adjusted upwards since May 16 which should help to ease the margin pressure.

• Capacity expansion to slow in 2H16 but accelerate in 2017… Total capacity (sum of 4 rubber companies) is likely to grow by only 8% in CY16 given some delay in expansion plan. However, supply will accelerate in CY17 by addition of 16.5bn/pcs per annum (or +14% YoY) if there is no delay. This could lead to oversupply situation given annual demand growth of only 8-10%, putting pressure on the ASP.

• Ringgit upside should be capped… Ringgit has recently weakened back to above RM4.00/US. We now upgrade our USD/MYR assumption from RM3.80/US to RM4.06/US and RM4.00/US for CY16 and CY17 as we see limited room for ringgit appreciation. However, the increase in earnings will be offset by lower ASP assumption.

• Sector is trading clo se to average P/E band… With the share price retracement, sector valuation has eased to current 17.5x from a high of 26x, already close to average P/E band of 17x. We expect sector valuation to stay at current level given the lack of fresh catalyst. Maintain Neutral Call.

Forecast

• After incorporating higher USD/MYR assumptions and lower ASP, our rating on the gloves companies as below: Top Glove: FY16 and FY17 earnings were reduced by 3% and 11% respectively. Maintain BUY with lower TP of RM5.37 from RM6.08 with unchanged 18x CY 17 P/E. Hartalega: FY17 and FY18 reduced by 1% with TP adjusted slightly from RM4.08 to RM4.06. Maintain HOLD. Kossan: FY16 and FY17 earnings reduced by 3% and 4% respectively. Maintain HOLD with lower TP of RM6.53 from RM6.73.

Rating

NEUTRAL

• Positives – Softening of natural and/or synthetic latex prices.

• Negatives – Weakening of USD against MYR.

Top Pick

• Top Glove

Source: Hong Leong Investment Bank Research - 30 Jun 2016