We maintain a Neutral rating on the rubber glove sector. According to Malaysian Rubber Export Promotion Council (MREPC) in 2012, the total exports of rubber gloves, synthetic rubber (SR) and natural rubber (NR) combined rose 14.9% YoY. The overall demand for rubber gloves in 2012 remained resilient led by a solid double digit volume growth from nitrile gloves and a rebound in the sales volume of latex gloves due to the low latex price input. Moving into 2QCY13, the overall demand for rubber gloves is expected to be resilient, led by NR gloves although SR gloves, which had consistently been taking up the former’s market share, will continue to show better growth prospects. However, re-rating catalysts for the sector are scarce as the stable volume growth and mildly positive weakening trend of the Ringgit vs. USD currency rate are expected to be negated by the minimum wage policy, and over the longer term, higher natural gas prices. Despite our neutral rating on the sector, we have two OUTPERFORM stocks under our coverage. Our top pick in the sector is Kossan Rubber Industries “KOSSAN”, TP: RM3.64). We are looking to upgrade Kossan’s target price pending a company visit. Our tentative new target price for Kossan is RM4.05 based on 11x FY13 EPS, in line with its 6-year historical average, as opposed to RM3.64 currently. We also like Supermax as it is trading at a 25% discount to the sector’s average and a wider 40% discount to its larger peers.

Natural and synthetic rubber gloves exports in 2012 rose. In 2012, the total exports of rubber gloves, synthetic rubber (SR) and natural rubber (NR) combined rose 14.9% YoY to 40.7b pairs and 3.6% to RM9.8b in value. In 2012, Malaysia exported 18.6 billion pairs of SR gloves or an increase of 26% YoY. Correspondingly, in terms of value, SR exports rose 14% YoY to RM4.1b in 2012. The solid growth was due to nitrile gloves. Exports of nitrile gloves in 2012 was 18.5 billion pairs (RM3.9b), making up 99% of the total value of SR gloves exported. However, we note that the exports of NR gloves have deteriorated in value to RM5.6b (-3% YoY) for the third consecutive year in 2012 despite the exports volume rising to 22.1 billion pairs (+7% YoY) due to the rapidly declining latex price input. The US and EU regions were the largest importers of Malaysian SR gloves in 2012 at 9.6 (+20% YoY) and 5.3 (+26% YoY) billion pairs of SR gloves (see Table 1). 51% of the SR gloves were exported to the US. The next largest destination for SR gloves was Germany, which overtook Japan in 2012. In terms of quantity, UK reported the highest growth of 41% YoY in 2012 followed closely by Australia (39%) and Japan (35%). Note that the top ten export destinations for SR gloves were all located in the developed countries except China. Correspondingly, in terms of NR, its exports performance in sales volume fell the most in Belgium, UK, Germany and Italy between 15% and 23%. Only France and Turkey recorded the highest sales volume of 10% and 30% respectively.

ASPs of SR gloves are expected to be more resilient compared to NR gloves. Typically, the ASP for natural rubber gloves will rise in tandem with the increase in the input raw material costs. Conversely, when feedstock cost falls, rubber glove players generally pass on the cost savings to their customers via lowering the ASPs. This has been the mutual agreement between the producers and their customers. We believe a glut and hence a price war in the nitrile segment is less likely, at least in the medium term, due to its resilient demand. In 2012, the ASPs of SR gloves were cheaper compared to NR gloves. For example, in 2012, SR powder-free examination glove ASP was at RM0.20 per pair compared to NR powder-free examination glove ASP of RM0.22 per pair. However, the shift in demand to nitrile, which rose >20% YoY in 2012, and a low single digit sales volume growth in latex gloves, are more likely to lead to a glut and ultimately a price war in the latex glove segment. As such, latex glove producers are currently more susceptible to any sharp increases in their ASPs as compared to nitrile glove makers.

Demand for gloves still intact, moving towards nitrile gloves. We believe that the average 10% demand p.a. for rubber gloves over the next few years is still intact. The overall demand is expected to continue to be led by NR gloves, although SR gloves had consistently been taking up the former’s market share. While latex-based gloves or NR gloves are still dominant (as a percentage to the overall exports of rubber gloves) in Malaysia, the trend is moving towards SR gloves. This was evident from the lower NR:SR sales value ratio of 61:39 in 2011 to 57:43 in 2012, and the sales volume ratio of 58:42 in 2011 compared to 54:46 in 2012. the quantity of NR gloves exported in 2012 rose 7% to 22.2 billion pairs YoY due to the low cost of the raw material input. The demand and strong double-digit growth rate of gloves is expected to be continue driven by nitrile, we expect latex-based gloves to continue to register positive volume sales as well due to the stable latex price.

Kossan is our top pick. We believe Kossan’s re-rating catalysts are gaining momentum via its maiden foray into Indonesia, potentially to expand its technical rubber products (TRP) division there, and also from its gloves expansion following its new land acquisition, which are positive news flows. Kossan is also trading at an attractive valuation of just 10x FY13 earnings as compared to Top Glove’s 14.7x and Hartalega’s 15.4x FY13 PER. The valuation gap should narrow going forward as (i) Kossan moves up the value chain by offering higher margin surgical and clean room gloves and (ii) the fact that Kossan’s product mix contains less natural rubber glove, which makes it more sensitive to movements in the latex price. Judging from the recent acquisitions of Adventa and Latexx Partner at PERs of between 13.0x and 16.0x, Kossan also appears more attractive at its current valuations. This is because Kossan has a bigger market capitalisation and earnings base compared with both Adventa and Latexx Partner.

Source: Kenanga