The just concluded 1QCY13 results season was within  our expectations, with four of the stocks under our coverage reporting results that came in generally within ours and the consensus expectations. Sales volume largely grew YoY across all the companies, led by Kossan.  Looking at the 1QCY13 results, Kossan and  Hartalega Holdings were the most resilient in combating the minimum wage policy implemented on 1 Jan 2013. Top Glove and Supermax were, however, slightly impacted by the minimum wage. All in, we expect the sector to remain resilient, underpinned 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 in the 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.  Our top pick in the sector is Kossan Rubber Industries (“KOSSAN”, TP: RM4.88). 

1QCY13 results were largely within expectations.  All four rubber glove stocks that we cover reported 1QCY13 results that came in within ours and the market expectations. Sales volume largely grew YoY across all the companies led by Kossan (23% YoY; +2% QoQ), Hartalega (+16.9% YoY; +2.3% QoQ), Supermax (+8.1% YoY; +0.2% QoQ), and Top Glove (+20% YoY; +3% QoQ) due to capacity expansions as well as higher demands fueled by the lower ASPs due to the easing input f raw material prices. 

Minimal impact from minimum wage to glove players’  margins.  Interestingly, the margins of Kossan and Hartalega have been resilient, which demonstrated their ability to pass the cost through to counter the higher cost from the minimum wage. However, Top Glove and Supermax appeared to be affected by the minimum wage policy. Supermax registered a weaker 1QFY13 PBT margin of 11.5% compared to 12.6% in 4QFY12. Similarly, Top Glove Corporation, which reported its 2QFY13 (Dec 2012 till Feb 2013) results last month, was hit by a RM8m increase in salaries due to the effect of the minimum wage. Typically, customers are given a time of two to three months before new ASPs take effect. As such, we are not overly concerned of further margin erosions as an estimated 3-5% increase in the ASPs, which was informed to customers in Jan 2013, will take effect from the second quarter onwards. We expect higher volume sales as well as gradual implementation of automation to mitigate the effects of minimum wage in subsequent quarters. Recall that we had previously highlighted that the rubber glove players would be raising their ASPs by 3-5% to counter the effect of the minimum wage policy. In addition, these players have invested in the automation and computerisation of their manufacturing processes and have gradually reduced their reliance on manual workers to further minimise the adverse effect of the minimum wage policy. Some of the automations put in place include the: (i) automated mechanical stripping system (removing gloves off hand moulds) and (iii) glove puller and stacker system. The benefits from automation will, however, some time to flow through to mitigate the effects of the minimum wage policy.

Not to worry about potential high energy costs going forward. Looking ahead, we believe that the rubber glove players may face higher production costs emanating from the persisting high energy prices. Effective Jun 2011, the government has raised the gas price by 7% to RM16.07 per mmbtu from RM15 per mmbtu. There will be a subsequent 8-19% price increase every 6 months until 2015. However, the dateline for the last review in December 2011 has passed and yet to be effected. At the same time, in 2011, the electricity tariff rate was raised by 8-10%. The hike in energy prices was expected, in line with the Government’s subsidy rationalisation programme. We are, however, not overly concerned on the potential hikes since energy cost makes up only 8-9% of the production cost.

Demand for gloves still intact, nitrile gloves continue to lead. We believe that the average 10% demand p.a. for rubber gloves over the next few years is still intact. 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. 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 to SR sales value ratio of 61:39 in 2011 to 57:43 in 2012, and the sales volume ratio of 58:42 in 2011 as compared to 54:46 in 2012.  The quantity of NR gloves exported in 2012 rose 7% to 22.2n 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 driven by nitrile gloves. We also expect latexbased gloves to continue to register positive volume sales as well due to the stable latex price. 

We continue to like Kossan because: (1) its valuations are undemanding with the stock trading at just 9.1x its CY14 EPS or at a 38% discount to its larger peers like Top Glove’s 14.2x and Hartalega’s 13.9x for CY14, (2) it is gradually raising its dividend payout ratio (Kossan recently declared a final seven sen taxexempt dividend. This brought its total full-year FY12 DPS to 12.5 sen, implying a 38% payout ratio – well ahead of its <20% payout ratios in the past three years, and (3) the fact that Kossan is not just a rubber glove play but a bet on its TRP division, which is growing strongly at a rate of >20% QoQ at the pre-tax profit level over the past few quarters. 

Source: Kenanga