Highlights

• Recapping 2016… After a stellar performance in 2015 with an average return of 110%, rubber product companies underperformed the FBM KLCI in 2016 with an average return of -21% versus FBM KLCI at -3% due to lower ASP coupled with rising cost (higher natural gas and labour cost).

• Higher USD trend… Ringgit had depreciated 6% against USD versus its regional peers at a range of 2-3% after Trump’s victory over US Presidential election. Overall,

rubber product companies are likely to pass through the USD benefit to customers but cheaper pricing will help to increase its competitiveness and gain market share against its regional peers.

• Spike in raw material prices… Latex price had surged by 98% YoY to RM6.45/kg mainly lifted by strong auto sales in China (11MCY16 sales +13% YoY). The strong sales were attributed by advance purchase of vehicle after tax was halved to 5% from 10% in Oct15 for smaller car. With the China authority extending its tax break into 2017 but at a higher rate of 7.5%, we expect China auto sales growth to slow down, curbing the rising of latex price.

• Supply to increase in 2H17… Supply only grew by 7% in CY16 but will accelerate in CY17 and CY18 with annual growth of 12% per annum if there is no delay in expansion. This could lead to oversupply situation given annual demand growth of only 8-10%, putting pressure on the ASP especially the nitrile segment.

Financial

• After factoring in higher USD/MYR assumption from RM4.00/USD to RM4.30/USD for CY17 and CY18 and higher latex and nitrile price, our earnings forecasts for companies are adjusted by 2-4%. TP are adjusted by circa 20-25% after we rolled over our valuation to CY18 (Refer Figure 10).

Rating

NEUTRAL ( ↔ )

• Overall, we maintain NEUTRAL stance on the sector for 2017. Stronger USD trend will provide favourable environment for rubber product companies to mitigate rising raw material cost (latex and nitrile) and margin pressure from pricing competition. The sector is now trading at 18x, slightly above sector average P/E band, which has already fully reflected the fundamental of the sector.

Top picks

• Top Glove (HOLD; TP: RM5.49). We continue to like TopGlove for its exposure in the resilient export market with highest earnings sensitivity to USD. Although current TP does not provide sufficient upside to warrant a BUY call, there is upside potential from stronger USD (our assumption of RM4.3/USD versus current rate at RM4.48/USD) and softening of latex price (as a result of slow china auto sales).

Source: Hong Leong Investment Bank Research - 10 Jan 2017