We continue to maintain our Overweight call on the rubber glove sector post the recent release of sector results which were largely in line with our expectations. Although overall production costs have increased by 1.3-1.6% since the start of 2019, we believe glove manufacturers are able to pass this on within the normal time frame, due a balanced supply and demand environment. Supermax and Kossan remain our top picks for the sector.

Automation Reduces Labor Dependency

Starting from January 2019, the government has raised the minimum wage from RM1,000 to RM1,100 as part of the bi-annual minimum wage review. We estimate the increase in the minimum wage would likely lead to 0.8-1.0% increases in production costs. However, we believe that the impact is unlikely to be as severe as with previous hikes due to an increase in automation in production lines since the introduction of the minimum wage in 2013. Since then, most manufacturers have started to automate their equipment to reduce labour dependency. Currently, labour costs account for 8-10% of production costs.

Increase in Utilities Cost Is Lower Than Previous Hikes

Both of the increases in electricity and natural gas tariffs of around 0.5- 0.6% do not come as a surprise to us, due to rising fuel prices. As the increase is not as significant as previous hikes, we believe manufacturers should not have a problem passing this on, as the increase in energy prices has been an annual occurrence for some time. Energy (power & natural gas) costs for the manufacturers comprise around 12-15% of their production costs. Again, as the manufacturers were aware of the increase in costs in advance, the ability to communicate these changes to their clients put them in a more favourable position.

Overall Increase Is Only Around 1.5%

As the overall increase in production costs is minimal at around 1.3-1.6%, manufacturers should not have a problem passing on the added cost in the current environment, in our view. Assuming a worst-case scenario whereby manufacturers are to absorb the incremental cost, the impact to their net profit is around 4-8%. However, we believe the chance of this worst-case scenario playing out is low, as we do not foresee any overcapacity impacting the sector.

Building on a Decent 4Q Performance Base

Earnings delivery for the 4Q18 is within our expectations, as core PATAMI grew by 9.1% yoy or 6.5% qoq, supported by strong demand. We believe that the positive earnings momentum will continue into 2019, albeit the projected overall growth rate of 16% yoy is lower than the 24% yoy in 2018. Earnings growth for 2018 was also stronger partially due to the weak earnings delivery in 1H2017 (low base effect).

Source: Affin Hwang Research - 7 Mar 2019