An Imbalance in Supply Demand Is Expected in 2020 With the Glove Players Expected to Increase Supply by C.14% (vs. Annual Global Demand Growth of 8%- 10%). However We Feel This Will Eventually Normalise With the Increase of Glove Demand From US. The RM Is Expected to Continue a Slight Depreciation Bias in FY20 (USDMYR 4.15-4.20) Which Augurs Well for the Sector. We Anticipate Margin Pressure to Continue to Linger in 2020, Due to Intense Competition, Higher Labour Costs and Mixed Raw Material Prices. Maintain NEUTRAL, With Our Top Pick Being Top Glove (BUY, TP: RM5.02) for Its Diverse Product Mix and Prime Position to Chip Away Market Share.

Capacity. We estimate that the top 4 Malaysian glove players will increase capacity by c.14% in 2020 (lion’s share being nitrile capacity). We do note that a short term imbalance is expected to manifest in 2020 with the increased supply outstripping the expected annual demand growth of 8%-10%. However with the divergence of demand from US (due to US-China trade war, China gloves becomes more expensive hence making Malaysian gloves more attractive), we feel that this will eventually play out to normalise demand-supply dynamics. For perspective, 2020 will see an estimated addition of c.23bn pieces vs 19bn pieces in 2019; however, in view of the oligopolistic industry structure, we do not rule out the possibility of a more gradual capacity expansion as an attempt to avoid price competition.

Ringgit view. While the RM has been appreciating in the early days of 2020, our economics team still anticipates a slight YoY depreciation bias for the year on an average basis. This augurs well for the sector in maintaining its cost competitiveness against its regional peers. We project USD/MYR to average USD/MYR4.15-4.20 in 2020 (FY19 average: USD/MYR4.142).

Minimum wage. Budget 2020’s minimum wage has increased to RM1,200 in urban cities (from RM1,100) effective January 2020. Historically, the increase in costs will be passed thru to the customers, although we remain wary on the glove player’s ability to pass thru this immediately given the oversupply situation still persisting in 2020.

Ceteris paribus, we estimate that the impact to net profit is c.1.3%-2.2% for every RM100 increase in minimum wage.

Raw materials. In 2019 the price of butadiene (a core component in nitrile manufacturing) peaked in August at USD1,250/MT before retracing to USD1,165/MT in October (+10% YoY). We expect the price of natural rubber (NR) to range between RM4.0-5.0/kg in 2020, (2019 average: RM4.52/kg) assuming no supply disruptions. To note the price of NR has consistently maintained below RM4.60/kg threshold since August 2019; Top Glove has a relatively higher product mix skew towards NR.

Margin pressure. Of the 3 glove producers under our coverage, Top Glove appeared to suffered the most with a margin decline of 2.57ppts (YoY, from 10.29% to 7.72%), as opposed to Hartalega with a margin decline of 2.13ppts (YoY, from 16.91% to 14.78%). Kossan on the other hand showed margin improvement by 1.53ppts (YoY, from 8.34% to 9.87%) that is mainly thanks to its continuous efforts on improving operational efficiency. We anticipate margin pressure to continue to linger in 2020, due to intense competition, higher labour costs and mixed raw material prices.

Maintain NEUTRAL. The sector currently trades reasonably at 24x, a tad below its 3- year mean of 26x. The change in supply demand dynamics caused by the US-China trade war warrants the take up of extra capacity, however margin pressure may linger given the near term oversupply. Maintain NEUTRAL on rubber products. We prefer Top Glove for its more balanced product mix (NBR: NR; 46%:39%) relative to the other players who are more nitrile heavy (Kossan c.77%, Hartalega c.97%).

Source: Hong Leong Investment Bank Research - 9 Jan 2020