What’s New?

• Healthcare theme back in action. Investor interest re-emerged in healthcare stocks as we have witnessed recent rallies in stock prices of manufacturers and distributors of personal protective equipment (PPE) such as rubber glove, face mask and vaccine following pull back in glovemakers’ share prices since August. We opine that interest returning to PPE plays are attributable to concerns of a second wave of pandemic in Europe with potential of another round of economic lockdown as well as market theme of shifting back to healthcare and technology sectors in which these two sectors seemed benefiting greatly from the higher healthcare spending and work-from-home digitalization from cyclical plays underpinned by economic recovery.

• Flash in the pan or sustainable run? To recap, glovemakers’ share prices have corrected 30-50% previously as affected by the positive news flow of vaccine progress. This undeniably has interrupted the bullish momentum of glove counters. We reckon that the market is divided on the sustainability of the sector’s price run as a result of earlier-thanexpected Covid-19 vaccine availability, especially in China. We believe the market will start pricing in normalized earnings and looking beyond the peak earnings for glove players as the hype on the sector could soon fade. Whilst we opine that glove demand could still be resilient post pandemic underpinned by hygiene awareness, we highly doubt the sustainability of high average selling price (ASP). The ASP hike might be end as soon as 1HCY21 mainly due to intense competition as more new players jump on the bandwagon in producing medical gloves (striving for volume in order to attain economies of scale to cover fixed overhead at the expense of ASP) coupled with mass vaccination, possibly by 1HCY21 which will result in supply outweighing demand in the sector. As stock prices run ahead of fundamentals, investors are advised to take profit on glove counters and opt for better alternative as to bargain-hunt other sectors which offer more attractive value and/or riskreward proposition.

Comment

• Unfavourable value proposition. The sudden spike in 2020-2021 earnings of glovemakers is mainly due to a one-off profit surge derived from the pandemic and it is unlikely to be seen in the following years as evidenced by a relatively low 3-year compounded annual growth rate (CAGR) between CY2020-2022 (based on consensus earnings). Moving forward, sectors that were hit hardly by COVID-19 are expected to ‘come back’ strongly in 1HCY2021 following the arrival of vaccine and anticipated economic recovery. Based on our findings, amongst sectors listed in the local bourse, Oil & Gas, Industrial, and Transportation are offering attractive valuations with high potential earnings growths based on market estimates. In contrast, the Big 4 glove makers are showing pricey valuations - negative earnings CAGR rate of -3.4% (CY2020-2022) coupled with EV/EBITDA close to 28.1x (the 2nd highest), which is significantly higher than the median of 17.2x. Hence, we are of the view that investors should focus on cyclical sectors which could benefit instantly from the beginning of economic recovery with share prices yet to return to the prepandemic level.

• Breakthrough developments for COVID-19 drug and vaccine. Japan’s Fujifilm Toyama Chemical has unveiled the promising result for its drug “Avigan” in its phase 3 study in 156 COVID-19 patients with less severity as people who had received the drug recovered in 11.9 days at the median as compared to 14.7 days patients who received placebo. The company is planning to seek approval in Japan and outcome could come as early as next month. Subsequently, the company has already signed a licensing deal with Dr. Reddy’s Laboratories and Global Response Aid to enable production for countries around the world. In addition, the US firm Regeneron claimed that its coronavirus treatment reduces viral levels after results of its first 275 trial patients showed the greatest effect in patients who had not mounted their own immune response prior to treatment. Besides, a coronavirus vaccine being developed in China could be ready as early as November this year, according to a senior Chinese health official. Earlier, China’s military has approved a coronavirus vaccine for use within its ranks that has been developed by its research unit and a biotech firm. Whilst we opine that glove demand could still be resilient post pandemic underpinned by hygiene awareness, we highly doubt the sustainability of rising average selling price (ASP) upon mass vaccination and/or successful drug treatment on Covid-19.

• Above average ERP and Glove sector is no longer perceived as ‘defensive’ Equity risk premium (ERP) is a reliable metric to gauge the risk-to-reward ratio in the financial market. We notice that the glovemakers’ ERP has increased significantly over the past few months (rising sharply from March 2020 when the COVID-19 spread out extensively) mainly due to spike in beta (share price volatility compared to the market as a whole) besides riskfree rate has decreased substantially, i.e. the 10-year MGS (Malaysian government bond yield) was down -18 percentage points YTD. Notably, the top four glovemakers’ ERPs are significantly higher than their 10-year mean, indicating that the market demands greater future return to compensate excessive risk taken at this price level in which investors should take into consideration when investing the stocks in the sector. Also, the sudden surge of beta (of >1) for the glove counters suggests that the sector is experiencing change in investor’s risk appetite as it is no longer perceived as ‘defensive’ in nature especially when market turns bearish.

• Glove stocks rally driven by liquidity, street’s interest and sentiment. Spike in volume traded over the past few months has lifted the glove makers’ share prices to record highs in August 2020. Subsequently, the share prices have come down radically in tandem with the volume transacted in the local bourse. This is evidenced by a strong positive correlation between the volume and the share price. As of 3rd week of September 2020, the correlation of top four glove makers stood at average of 78.8% (the period of study covering bull and bear for the glove makers). In fact, the fading of glove stocks’ interests were partly exacerbated by the corrections of glove makers’ share prices as we witnessed the loss of enthusiasm from the global investors on key words searching like “topglove”, “hartalega”, “kossan”, and “supermax” which have come down significantly in Google search engine. Furthermore, the prevailing strong retail sentiment towards these stocks (at a lesser extent compared with the past few months) coupled with high leverage risk must be taken into consideration for any investment decision. Meanwhile, the divergence between street’s interests which happened in last week warn investors to stay cautious as the relationship between both has been strong over the months. Moving forward, we are of the view that ending of loan repayment moratorium in end of Sept will further douse the street’s interest and liquidity in the glove counters.

Risks to our call:

• Corporate exercise such as share buy-back to support the stock price.

• Slower-than-expected vaccine development in phase 3 trial.

• Prolonged COVID-19 to support the steep ASP.

Valuation & Recommendation:

• Maintain Neutral on the sector on the back of: 1) moderate medium-term profit growth after earnings normalization as market tends to look beyond peak earnings, 2) unappealing value proposition and risk-to-reward as approaching positive vaccine and drug developments, 3) high volatility on the back of prevailing strong retail sentiment towards the sector (at a lesser extent compared with past few months) coupled with high leverage risk, and 4) deceleration of trading volume and market interest upon expiry of loan moratorium. Thus, we maintain our Target Prices for Hartalega at RM16.02 (HOLD) and Top Glove at RM6.83 (HOLD). Earnings wise, no change to our net profits forecasts for both stocks under coverage.

Source: JF Apex Securities Research - 30 Sept 2020