We are maintaining our OVERWEIGHT rating on the rubber gloves sector. Results released from the recently concluded 2QCY13 results season was within our expectations, with four of the stocks under our coverage performing generally within our and the consensus expectations. YoY, sales volume in 2Q13 grew across the board led by Kossan. Interestingly, Supermax’s 2Q13 margins improved QoQ on the back of an estimated 3-5% increase in the ASP, which was already communicated to customers in Jan 2012 but took effect only from the second quarter. The price hike was to mitigate higher wage costs arising from the minimum wage policy; putting to rest market scepticism that Supermax was unable to implement such a move to counter the higher wages. Overall, the resilient demand for rubber gloves and the weakening of the Ringgit against the US dollar are expected drive earnings growth in 2HCY13. Our TOP PICK is Kossan and we also like Supermax for its steep discounts to its peers.

Solid sales and results in 2QCY13. All four rubber glove stocks under our coverage reported 2QCY13 results that came in within our and the market expectations. Sales volume grew strongly YoY across the board led by Kossan (21% YoY, +1% QoQ), Hartalega (+23% YoY, +5% QoQ), Supermax (+11% YoY, +5% QoQ) and Top Glove (+17% YoY, +7% QoQ) due to capacity expansions as well as stronger demand fuelled by lower ASPs due to easing raw material prices.

Not to worry over potential high energy costs going forward. Looking ahead, we believe that the rubber glove players may face higher production costs emanating from the persistently high energy prices. Effective Jun 2011, the government raised the gas price by 7% to RM16.07 per mmbtu from RM15 per mmbtu followed subsequently by 8-19% price increase every 6 months until 2015. However, the dateline for the last review in December 2011 passed without any development. At the same time in 2011, the electricity tariff rate was raised by 8-10% which was expected, in line with the Government’s subsidy rationalisation programme. Nevertheless, we are not overly concerned on any potential hikes since energy cost makes up only 8-10% of the total production cost.

Weakening of Ringgit (RM) vs. US dollar (USD) is a short-term positive for rubber glove players. Generally, a weakening RM is positive for glove makers. Since sales are USD denominated, theoretically, a depreciating RM against the USD will lead to more revenue receipts for glove makers. The ringgit has weakened by 10% to RM3.30 from 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. However, we believe the impact from currency movements (RM vs USD) to glove players earning is neutral over the long-term. This is because glove players typically hedge the foreign currency on a consistent basis, hence in theory any negative or positive impact will be offset over time.

Top pick Kossan, because: (i) of its superior net profit growth of 18% and 27% in FY13E and FY14E respectively compared to an average of 13% and 12% for Top Glove and Hartalega in FY13E and FY14E, (ii) Kossan’s unprecedented earnings growth is underpinned by rapid capacity expansion over the next two years, (iii) it is gradually raising its dividend payout ratio (Kossan recently declared a final 7.0 sen tax-exempt dividend. This brings 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 (iv) the fact that Kossan is not just a rubber glove play but also represents 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. Maintain Outperform with a TP of RM6.88 based on 14x FY14 EPS

We also like Supermax because it is trading at 10.5x FY14 EPS (40% discount to the sector average) compared to its average 14% net profit growth over the next two years. Supermax’s YTD share price performance (+20%) is still lagging other players such as Kossan (+90%) and Hartalega (+40%). Since our upgrade report in Feb 2013, the stock has risen by 20%. A re-rating of the stock is imminent as the latest 2Q13 results registered margin improvement, which dispelled market scepticism that Supermx may be unable to implement cost pass-through to counter the higher cost from the minimum wage. Maintain OUTPERFORM with a TP of RM2.82 based on 12x FY14 EPS (The targeted PER is at +1.0SD level above the 5-year historical average). SUPERMX is a beneficiary of the weakening Ringgit since they do not hedge its US dollar receipts.

We like Hartalega for: (i) its “highly automated production processes” model, (ii) the solid improvement in its production capacity and a 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 position in a booming nitrile segment with a dominant market position. We continue to maintain our OUTPERFORM rating on Hartalega with TP of RM7.32 based on 18x CY14 EPS.

Source: Kenanaga