We are maintaining our OVERWEIGHT rating for the rubber gloves sector. Although rubber glove stocks under our coverage have performed admirably YTD 2013 by rising at an industry average of 61%, which was led by KOSSAN (+148%), HARTALEGA (+53%) and SUPERMX (+43%), in line with our OUTERFORM calls, we expect the sector to remain resilient moving into 1QCY14 underpinned by: (i) the overall sustained demand for rubber gloves, led by latex gloves, although nitrile gloves, which have been consistently 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 prices. Based on past trend, earnings of rubber gloves players were not affected from hike in energy prices and the impact from recent hike in electricity tariff rate will also likely be muted. We also expect any introduction of Goods and Services Tax (GST) and hike in natural gas price to be neutral on rubber glove players. Our TOP PICK is SUPERMX. We like Supermax because (i) it is trading at 12x FY14E EPS (23% discount to the sector average) compared to an average 14% net profit growth over the next two years; and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax removes uncertainty and further lends credibility to the business model and management. Since our upgrade report in Feb 2013, the stock has risen by 43%. SUPERMX is trading at 12x FY14 earnings while KOSSAN is trading at 15x FY14 earnings. We believe the valuation gap should narrow when we consider that SUPERMX’s capacity and net profit are at levels similar to KOSSAN. We also have OUTPERFORM calls for KOSSAN (TP: RM4.46) and HARTALEGA (TP: RM8.13).

Solid sales volume and results in 3QCY13. Reports from the recently concluded 3QCY13 results season were mainly within our expectations apart from Kossan, which outperformed due to better-than-expected margin expansion. The remaining three stocks under our coverage came in generally within our and the consensus expectations. Sales volume grew strongly YoY across the board led by Kossan (21% YoY, +1% QoQ), Hartalega (+18% YoY, -1.8% QoQ), Supermax (+7% YoY, -6% QoQ) and Top Glove (+10% YoY, +3% QoQ) due to capacity expansions as well as stronger demand fuelled by lower ASPs due to easing raw material prices. Interestingly, Supermax’s 3Q13 margins improved further for the second consecutive quarter.

No worries on potentially higher energy cost going forward. Ceteris paribus, the recent hike in electricity tariff is only expected to hit rubber gloves players’ earnings by 2-3%. However, we are not overly concerned since rubber gloves players are generally able to pass on the cost increase judging from past experience during electricity and natural gas tariff hikes. Electricity cost accounts for an estimated 20-30% of fuel costs which in turn make up 10% of total production costs of rubber gloves players. Natural gas accounts for the remaining 60-70%. From our observation, earnings of rubber gloves players were not impacted from the hike in gas and electricity tariff back in 2011.

GST is neutral to gloves makers. Generally, all goods exported out of Malaysia will be zero-rated. This means that the registered exporter does not collect GST on its exports. However, manufacturers, including rubber glove players would have to pay for GST on his business purchases or raw material costs before selling their product but is able to claim credit for the GST paid on the inputs. This means that manufacturers have to plan their cash flow and turnaround time diligently.

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. YTD 2013, the ringgit has weakened by 8% to RM3.28. 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 growth p.a. for rubber gloves over the next few years can be sustained. In 2012, the total exports of 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, which grew 26% YoY. The overall demand is expected to continue to be led by NR gloves, although SR gloves have consistently been nibbling at 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.

Maintain OVERWEIGHT. Our TOP PICK is SUPERMAX with an OUTPERFORM and TP of RM3.06. We like Supermax because (i) it is trading at 12x FY14E EPS (23% discount to the sector average) compared to an average 14% net profit growth over the next two years; and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax removes uncertainty and further lends credibility to the business model and management. We maintain OUTPERFORM calls on KOSSAN (TP: RM4.46) and HARTALEGA (TP: RM8.13) but MARKET PERFORM on TOPGLVE (TP: RM6.10).

Source: Kenanga