We are maintaining an OVERWEIGHT rating on the rubber gloves sector. The recently concluded 1QCY13 results season was within our expectations, with four of the stocks under our coverage coming in generally within ours and the consensus expectations. Sales volume 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 effect of the minimum wage policy implemented on 1 Jan 2013. Top Glove and Supermax were more impacted due to their difficulties in fully passing the cost through in a challenging latex-based market.  However, signs favouring the sector are plenty. Moving into 3QCY13, 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 weakening of the Ringgit against the US dollar, which is positive to rubber glove players and iii) the sustained low raw material price. Our TOP PICK for the sector is Kossan with an OUTPERFORM and a higher TP of RM6.20 (RM4.88 previously) based on 14x FY14 EPS which is 15% discount to Top Glove and Hartalega’s average target Fwd PER; we think the narrower valuation gap between Kossan and the other two players are warranted as it will be seeing its highest ever net profit in 2013 and unprecedented earnings growth underpin by capacity expansion over the next two years, is seeing improving dividend payouts as well as being able to pass on cost efficiently. We have OUTPERFORM calls for HARTA (TP: RM7.10) and SUPERMX (TP: RM2.39) but MARKET PERFORM on TOPGLOV (TP: RM6.36). 

Solid 1QCY13 demand and results which 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 (+17% YoY, +7% QoQ) due to capacity expansions as well as higher demands fuelled by lower ASPs due to the easing raw material prices. 

Mixed fortunes from minimum wage to the glove players’ margins. Interestingly, margins for Kossan and Hartalega remained the most resilient, which demonstrated their ability to pass 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 recently released 3QFY Aug 13 (Mar 2013 till May 2013) results that was hit by an increase in its salary cost due to the effect of the minimum wage and the inability to fully pass the cost through due to the challenging latex-based gloves segment, which accounted for 73% of its production capacity. Going forward, we believe both Supermax and Top Glove will have to largely rely on higher volume sales and efficiency improvement via their automated production lines to counter the effects of the higher wages from the minimum wage policy in the face of a challenging price environment in the latexbased gloves segment.

No major worries on the potential high energy costs going forward. Looking ahead, we believe that rubber glove players may face higher production costs emanating from the 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 not overly concerned on any potential hike in gas price since energy cost makes up only 8-9% of the production cost.

Weakening of Ringgit vs. US dollar is a positive for rubber glove players. Generally, a weakening Ringgit is positive for glove makers. Since sales are USD denominated, theoretically, a depreciating ringgit against the dollar will lead to more revenue receipts for glove makers. The ringgit has weakened by 6% to RM3.16 from an average of RM2.99 against the dollar over the past several weeks. Ceteris paribus, a 1% depreciation of RM against USD will lead to an average 1%-2% increase in the net profit of rubber glove players.

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: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.

Source: Kenanga