Competition has continued to remain intense for glove makers, as evident by the pushback from buyers when they attempt to raise prices. Given current climate (low operational efficiency, depressed ASPs and rising production costs), we reckon glove makers’ earnings have yet to bottom as they are now price-takers and the inability to pass on higher costs will continue to hamper profitability. We maintain our UNDERWEIGHT stance on the sector, as we believe the oversupply situation is unlikely to reach equilibrium any time soon. Upside risk to our call includes (i) strong depreciation of Ringgit, (ii) stronger than expected recove ry in demand, and (iii) sharp decline in raw material prices and operating costs.

Navigating challenging times. Glove ASPs have been on a declining trend since mid-CY21, leading to subsequent poor performance reported by the glove makers. Nitrile glove ASP currently hovers around USD18-20 for per thousand pieces, and we think it might further weaken in the coming months, as rivalry in the marketplace has continued to remain intense. This is evident by one of the glove maker’s recent attempt to raise ASPs slightly, but resulted in a sizable decline in sales volume – signifying resistance from buyers given that they are still relatively price sensitive at this point. We anticipate industry utilisation to range around 40-50% in 1H23 (a modest improvement from 30-50% currently) but performance is expected to remain bleak in the quarters to come, considering the improved volumes is likely to be done at the expense of ASPs. Not to mention the cost-plus mechanism adopted previously is also no longer viable under current market situation since the manufacturers are now price takers, and the inability to pass on higher costs (i.e. labour cost, natural gas cost) will continue to hamper profitability.

A balancing act. We note that glove buyers are still unwilling to commit to large orders, as they continue to drawdown on existing inventories. The recent Covid-19 spike in China is also not expected to benefit the Malaysian players, since the Chinese end users are more likely source for supplies within China itself. On the supply side of things, manufacturers have scaled back on their respective expansion plans to curtail excess supplies in the market. Coupled with new entrants exiting the market, we believe this would continue to alleviate pressure on the supply side. However, in absence of a strong pickup in orders, we do not think that reduced supply alone is sufficient to resolve the oversupply situation and the problem could potentially extend into CY24.

Solid financial backing. Strong cash pile accumulated during the upcycle is essential to help glove makers ride through the near-term headwinds. Based on the latest disclosures, all glove counters under our coverage are sitting on a comfortable net cash position of RM0.36bn to RM1.89bn, making up 5.1%/32.3%/69.9% of Top Glove, Hartalega and Kossan’s respective market capitalisation. Delaying capacity expansion plans would also help glove players to conserve more cash for the time being.

Maintain UNDERWEIGHT. The oversupply situation is unlikely to be resolved in the short-term and we expect competition to remain stiff in 1H23. Judging from the lower operational efficiency, depressed ASPs (which could potentially inch lower in 1H23) and inability to pass on higher costs, we are of the view that earnings for the glove makers have yet to bottom, therefore we maintain our UNDERWEIGHT stance on the glove sector. Upside risk to our call includes: (i) strong depreciation of Ringgit, (ii) stronger than expected recovery in demand, and (iii) sharp decline in raw material prices and operating costs.

Source: Hong Leong Investment Bank Research - 5 Jan 2023