We are maintaining our Overweight call on the rubber glove sector, as we believe that the recent set of results demonstrate the companies are not at significant risk of lower margins due to rising production costs. We are also less concerned about any potential overcapacity issues, as our recent channel checks suggest that the order lead times have normalised to around 45 days. Kossan and Supermax remain as our top picks for the sector.

Clear Winners and Losers in the Recent Results

Although sector earnings for 1Q19 contracted by 4.3% yoy, we believe the results were still broadly in line with both our and consensus estimates, delivering around 22% of our respective forecasts. The decline in profit was mainly due to the weak results of Hartalega (HART), where profits declined by 22% yoy, as its margins were negatively impacted by the volatility of the RM. However, despite facing a similar operating environment, Kossan was able to deliver a profit growth of 32% yoy during the quarter.

Overcapacity Issues Have Eased

Share prices for the sector had corrected by 20% in early 2019, as there were concerns that manufacturers’ margins could contract due to the strengthening of the RM and rising production costs. However, we believe that concerns about overcapacity should ease, as our recent channel checks suggest that the order lead times have normalised to around 45 days from the 30 days earlier this year. We have, however, revised lower our capacity growth forecast for 2019 to 13% from 10%, as some manufacturers have partially delayed their targeted expansion plans for the year.

Lower Costs for 2H19

We believe that the recent weakening of RM/US$ from 4.06 to 4.19 in the past 2 months will have a positive impact on rubber manufacturers’ margins due to the lagging effect of their pricing. Based on our estimates, for every 1% change in the RM/US$, the impact to the bottom line is around 0.3-0.5%. Apart from the favourable currency movement, rawmaterial prices are also on a downward trend. Nitrile prices have continued to trend lower to US$1,050/mt from US$1,145/mt since the beginning of the year.

Being Selective Is the Key

Although we have an Overweight call on the sector, we still prefer Kossan (KRI) and Supermax (SUCB) for their undemanding valuations and higher-than-industry growth rates, and have BUY calls on those stocks. We have a SELL call on Hartalega (HART) due to its rich valuation, and its growth rate is also expected to slow below its historical growth rate. We maintain our BUY call on Top Glove (TOPG) despite having cut our earnings forecasts, as we rolled forward our valuation base.

Source: Affin Hwang Research - 12 Jun 2019