We are upgrading the rubber glove sector from a NEUTRAL rating to an OVERWEIGHT. Due to our recent upgrade of Hartalega Holdings to an OUTPERFORM, we now have three out of four rubber glove stocks under our coverage on OUTPERFORM calls. All in, we expect the sector to remain resilient underpin by: i) the overall resilient demand for rubber gloves, led by latex gloves, although nitrile gloves, which have consistently been taking up the former’s market share, will continue to show better growth prospects; ii) the possible increase of cases of H7N9 bird flu virus China, which could further underpin the importance of hygiene and thus potentially increase the demand for examination rubber gloves and iii) the defensive and captive earnings stream nature of the rubber glove industry. We have rolled forward our valuation base year to CY14 from CY13. Our top pick in the sector is Kossan Rubber Industries (“KOSSAN”, TP: RM4.23).

 

If the H7N9 bird flu virus cases deteriorate, there would be a high likelihood of a pent-up demand for rubber gloves. New cases of the H7N9 bird flu virus traced in China could further underpin the importance of hygiene and thus potentially increase the demand for examination rubber gloves. According to the World Health Organisation (WHO), there have been 126 cases of H7N9 bird flu, all but one of which were diagnosed in China, with the other in Taiwan being by a man who had travelled from China. So far, 24 people has died from the disease. The cases are going up daily – about 20% have died, 20% have recovered and the others are still sick. The WHO considers this a serious threat and is on an alert and developing diagnostics and vaccines, specifically against the virus. So far, the H7N9 virus is being transmitted only to humans from chickens but there are worries that it could mutate into a form that could be passed from one person to another. Five mutations are known to be necessary for that to happen and H7N9 already has two of them.

 

Natural and synthetic rubber gloves exports in 2012 rose 15% YoY. 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 18.6b 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 18.5b 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 22.1b 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 9.6b (+20% YoY) and 5.3b (+26% YoY) 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 at between 15% and 23%. Only France and Turkey recorded the highest sales volume of 10% and 30% respectively.

 

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 latex based gloves, although nitrile based 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 nitrile-based or 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 22.2b pairs YoY due to the low cost of the raw material input. The demand and strong double-digit growth rate of gloves are expected to continue to be driven

by nitrile although 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 rerating catalysts are gaining momentum via its maiden foray into Indonesia 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. We like Kossan because: 1) its valuations are undemanding with the stock trading at 9.2x CY14 EPS or at a 38% discount to its larger peers (vs. Top Glove’s 14.5x and Hartalega’s 13.3x for CY14); 2) Kossan is not just a rubber glove play but a bet on its TRP division, which is growing strongly and expected to contribute positively to overall earnings. The TRP division has been growing at >20% QoQ at the pre-tax profit level over the past few quarters. For FY12, the division’s pre-tax profit rose 62% YoY and accounted for 14% of the group’s pre-tax profit compared to 12% in FY11 and 3) It is gradually raising its dividend payout ratio. Kossan recently declared a final 7 sen tax-exempt dividend, bringing its total full-year FY12 DPS to 12.5 sen (which implied a 38% payout ratio – well ahead of its <20% payout ratios in the past three years).

 

Meanwhile, we like Hartalega for: (i) its “highly automated production processes” model, (ii) the solid improvement in its production capacity and reduction in costs, leading it to achieve better margins compared to its peers; (iii) its superior quality nitrile gloves through product innovation and (iv) its positioning in a booming nitrile segment with a dominant market position.

 

Source: Kenanga