Apart from Top Glove which will report results by end March, rubber glove companies under our coverage reported a 19.5% qoq increase in 4Q19 earnings, supported by stronger demand from the US. Overall sector performance for 2019 was within our expectations, but fell short of the street’s, as profits constituted 94% and 92% of respective forecasts. We are expecting a stronger 2020 (growth of 13.6%), as we believe that the sector would likely benefit from stronger demand arising from Covid-19 and a weak RM against the US$. Maintain Overweight: Top Glove and Kossan are our top BUYs for the sector.

Demand Started to Recover in 4Q19

We believe that 2019 sector earnings, which grew a mere 1.3% yoy, were negatively impacted by both a labour shortage and also weaker demand from the US for the first 9 months of 2019. As manufacturers have started sourcing labour from other countries to mitigate the shortage issue, we see limited downside risk to our capacity growth forecast of 11-12% for 2020 and 2021. The strong earnings growth of 19.5% qoq in 4Q19 is a good indicator that demand from the US has returned, as buying patterns have started to normalise since import tariffs were imposed on China gloves beginning 3Q19, in our view.

Covid-19 Will Have a Positive Impact on Earnings

We are raising our sector earnings forecasts for 2020 by 2-3%, as we are expecting stronger earnings growth in the 1H20 arising from stronger demand due to the outbreak of Covid-19. Our channel checks indicate that the lead time for delivery has increased from the average 30-45 days in early January 2020 to more than 60 days recently (some have guided that their lead time is now at 4 months). With most manufacturers already operating at above 85% utilisation rates, manufacturers should have the flexibility to increase selling prices, which could lead to better margins, in our view.

Being Rational Is Key to Sustainable Growth

Despite the recent surge in demand for rubber gloves, manufacturers are sticking with their current expansion plans, where we expect total capacity by the Big 4 to increase by 11-12% in 2020. We believe that manufacturers will continue to act rationally, as the current surge in demand may not be sustainable, and a significant increase in capacity over current levels might lead to an overcapacity in the following years. The average demand growth for rubber gloves is around 6-8% a year. Historically, in years where there is a surge in demand due to a pandemic, a slowdown is expected in the subsequent year, as inventories are worn down.

Still Has Room to Re-rate

The sector is currently trading at around +1SD above its historical mean, but there could be more upside to share prices. Based on our observation, glove stocks have traded +2SD above their historical averages in the periods where there is strong demand for rubber gloves (supply disruption or pandemic). We are keeping our Overweight call on the sector, as we believe that the improving prospects (strong demand and weak RM against US$) could lead to a further re-rating of the sector. Top Glove and Kossan are our top BUYs for the sector.

Source: Affin Hwang Research - 5 Mar 2020