We dialled into briefings organised by Hartalega and Kossan as they addressed their employee’s exposures to Covid-19 positive cases. Multiple steps have been put to overcome the issue. As guided by management, strong demand and ASPs are expected to last at least till 1HCY21. We maintain OVERWEIGHT on the sector with Top Glove (TP: RM11.05) as our top pick.

We dialled into yesterday’s briefings with Hartalega and Kossan with the following takeaways:

Positive Covid-19 cases. Hartalega did a voluntary precautionary mass testing (PMT) from 7-10 Dec, on 8,772 employees (inclusive of canteen and grocer shop operators), which resulted in 35 positive Covid-19 cases. This makes up only 0.4% of tested employees. Of the 35 cases; 20 are from Bestari Jaya and 15 from NGC Sepang plant. As a result, Hartalega has closed 8 production lines for a month which is estimated to impact 0.5% of total capacity. On the other hand, Kossan also did a voluntary test on all its employees in their 6 sites on 9-10 Dec. Of the 6 sites, 5 sites did not discover any positive Covid-19 cases. However in 1 site, they found 427 positive cases; 419 foreign workers and 8 local workers. This site makes up 25% of total capacity. The plant site has stop production voluntarily to help stop the spreading and to enable it to undergo deep sanitisation. The 2nd testing is set to be held on 16-17 Dec and if all is well, production would start back on 19-20 Dec. Total halt in production would be for 14 days.

ASPs. Management of both companies have guided increasing trend of ASPs moving forward. Hence, we are expecting the upcoming quarters ASPs to increase by +50% QoQ for both Hartalega and Kossan. Both companies are optimistic that ASPs will continue to ascend up until 1Q of 2021.

Catalysts. As we understand, demand requests from customers have not been decreasing or slowing down despite the positive inflow of vaccine news. Rather, the actual demand and supply for gloves would be dependent on when the vaccine is ready for mass immunisation. Hartalega shared their “pandemic allocation” is taken up till Oct 2021, with spot orders remaining between 7-10% of total capacity. While Kossan shared their current lead time is at 15 months (vs. 3Q20: 12 months, vs. pre-Covid-19: 45-60 days). Also, its major customers have locked in orders up till the end of 2021. Current spot orders for Kossan accounts for c.15% (vs.13% in 3Q and 10% in 2Q) of total volume; with the incoming capacity to be focused to supply spot orders. We understand that spot order ASPs are now above USD90 (3Q20: USD70-90) per 1,000 pieces. Overall, management remains upbeat on its earnings prospects at least until 1H21 with a possible softening in 2H21.

Valuation changes:

Hartalega (BUY, TP: RM19.00). To reflect the higher ASPs as guided by management, we raise FY21-23 earnings by +34%/+74%/+21% respectively. We cut our applied PE multiple from 41x (+1SD above 5Y mean) to 24x (-1SD), still tagged to FY21 EPS, to reflect sentiment dent from the positive vaccine development news flow. All in, our TP falls to RM19.00 from RM24.10.

Kossan (BUY, TP: RM8.37). Raise FY21-22 earnings by +102%/+33% respectively on back of management’s latest ASP guidance. PE multiple is reduced from 22x (5Y mean) to 12.5x (-2SD) for the same valuation de-rating reason mention above. Valuation horizon is also rolled forward from FY21 to mid-FY22 to capture some degree of downward earnings normalisation post-vaccine. Overall, TP is lowered from RM9.56 to RM8.37

Maintain OVERWEIGHT. Share price of glove players have seen weakness of late, largely due to vaccine development news flow. However, at current depressed valuations, we reckon that these negatives have been priced in. With the global Covid count still chalking new daily highs, we think the risk to reward ratio seems favourable at current levels. Stay OVERWEIGHT with Top Glove (BUY, TP: RM11.05) as our top pick.

Source: Hong Leong Investment Bank Research - 16 Dec 2020