Rollout of vaccination in major glove consuming countries like the US and EU have resulted in lesser urgency for distributors to pre-book supplies in advance, as buyers are wary locking-in glove supplies at high prices. We expect ASPs to trend lower, given easing tight supply situation and stronger incoming supplies from China over the next 3 to 6 months. Commitment to further improve social compliance practices are also expected to weigh down on the glove makers’ profitability in the short term. We cut our sector’s earnings for FY21-24F by 1- 58% as we factor in a lower ASP assumption. We downgrade our rating on Hartalega and Kossan to HOLD, while keeping our recommendation on Top Glove a BUY. With that, we also downgrade the rating on the rubber glove sector to NEUTRAL. This report marks a transfer in analyst coverage.

Demand should sustain... Similar to other major viral respiratory diseases, health experts believe that Covid-19 will also, be seasonal with winter dominance; this implies that a resurgence of Covid-19 cases is likely during every winter. Furthermore, with Covid-19 potentially becoming an endemic, we reckon that testing activities might become a norm going forward. Therefore, the demand for gloves is unlikely to suffer from a sharp decline although the Covid-19 situation in some of the major glove consuming markets has improved.

…but ASPs will decline from here on. As evident from the improved situation in US and EU, better vaccination coverage can help prevent severe illness and has also resulted in lesser urgency for distributors to replenish inventories back to its usual 2-3 months level. Besides, buyers are currently holding back on purchases, in order to avoid stocking up at high prices where glove makers are expecting ASPs to gradually decline by c.30% QoQ. Hartalega expects ASP to start stabilizing in 1QCY22 and based on our own estimates, ASP should reach c.USD30 per thousand pieces by then, which would still be higher vs pre-Covid levels of c.USD22 per thousand pieces.

Intensified competition from China. Supported by the pandemic-led demand spike, China based Intco Medical and Bluesail Medical have revealed aggressive capacity expansion plans. Intco and Bluesail targets to have an installed capacity of 120bn pieces and 52bn pieces by 1QCY22 and end-CY21 respectively, implying a capacity growth of 130% and 30% for both in the next 3 to 6 months, raising concerns over a potential oversupply situation. In the event where incoming supply profoundly outstrips demand, we believe all the glove makers will scale back on their expansion plans and be more disciplined in the commissioning of new lines, so as to not flood the market with excess supplies or put downward pressure on the ASPs, ultimately normalising any imbalance on the demand and supply of rubber gloves.

Better compliance to weigh down on profitability. Glove manufacturers under our coverage are committed to further step-up on their social compliance practices, despite already outdoing certain established standards. Improved compliance would lead to higher cost for the glove makers, which in our view, could cause slight margin compression in the short term as buyers are regaining bargaining power and the rise in costs might not be fully passed on to the buyers.

Year-long ban on Top Glove lifted. With findings showing that Top Glove’s products are no longer produced by forced labour, the ban imposed by the US Customs and Border Protection (CBP) on its Malaysia-made gloves has been lifted and exports to the US are allowed to resume effective 10 Sept. Prior to the ban, the North American market accounts for c.25% of the Group’s total sales volume, but it has since plunged to 8% of total sales volume after the ban was imposed. We understand that the freed up capacities were redirected to other markets like Eastern Europe and Latin America, at a more competitive pricing, in a bid to reduce idle capacities. Sales volume to Eastern Europe and Latin America increased from 17% and 8% before the ban, to 21% and 12% respectively in 3QFY21. Although we are positive over this new development, we do not expect the sales to the US market to return back to its original level immediately, as we believe that buyers have sourced their supplies from other glove makers, be it local or foreign.

Downgrade to NEUTRAL. Given the current headwinds, we believe the short term prospects of the glove makers are no longer as rosy, as the projected lower ASPs, higher compliance costs and intensified competition are seen to weigh down on glove makers’ profitability. We lower our sector earnings forecast by 1-58%, as we impute a lower ASP assumption. We downgrade our rating on Kossan and Hartalega to HOLD, but we are keeping our recommendation on Top Glove as BUY. As such, we downgrade our rating on the rubber gloves sector to NEUTRAL. This report marks a transfer in analyst coverage.

• Top Glove. We lower our earnings projections for FY21-23F by 1-41%, as we take into account the lower ASPs. Our TP is subsequently lowered to RM4.00, implying a PE multiple of 11x (at 3-year historical sector mean) on its CY22F EPS of 35.6sen per share. We maintain our BUY rating on Top Glove, as we believe that the decline in ASP has been priced in by the market at current valuations.
•  Hartalega. We cut our earnings forecasts for FY22-24F by 12-58%, to account for the falling ASPs. Our TP on Hartalega is lowered to RM6.50, derived from a PE multiple of 12x on its CY22F EPS of 54.2sen per share. Our valuation represents a 10% premium to peers like Top Glove, but is warranted, given good management track record and innovation leadership. However, with the limited upside, we downgrade our rating on Hartalega to HOLD.
•  Kossan. We revise our earnings estimates for FY21-23F lower, by 1-37%, to factor in the anticipated decline in ASP. Based on a PE multiple of 7x (at - 0.5SD of its 3-year historical sector mean) on its CY22F EPS of 38.1sen, our new TP is RM2.65. We deem the valuation discount justifiable, considering Kossan’s relatively smaller installed capacity as compared to its peers. We downgrade our recommendation on Kossan to HOLD, given the limited upside.

Source: Hong Leong Investment Bank Research - 14 Sept 2021