Gas Malaysia Berhad in an announcement to Bursa Malaysia informed that the Government has approved the natural gas tariff revision for non-power sectors in Peninsular Malaysia with effect from 1 May 2014 by an average of 19%. Ceteris paribus, assuming a “no-cost pass through”, an average 19% increase in natural gas tariff is expected to hit rubber gloves players’ earnings by 1-3%. However, we are not overly concerned since rubber gloves players generally are able to pass on the cost increase judging from past experience during electricity and natural gas tariff hikes back in 2011. Hence, we are maintaining our OVERWEIGHT rating for the rubber gloves sector. Our TOP PICK is SUPERMX. We like Supermax because: (i) it is trading at 11.4x FY14E EPS which is at a 30% discount to the sector average and backed by average 15% net profit growth over the next two years and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax eliminates some uncertainty and helps lends credibility to its business model and management. SUPERMX is trading at 11.4x FY14 earnings while KOSSAN is trading at 14.7x 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: RM5.13) and HARTALEGA (TP: RM8.21).

Average 19% tariff hike for natural gas for non-power sectors. Gas Malaysia Berhad in an announcement to Bursa Malaysia informed that the Government has approved the natural gas tariff revision for non-power sectors in the Peninsular Malaysia taking effect from 1 May 2014 by an average of 19%. Ceteris paribus, assuming no cost pass through, the hike in natural gas tariff is expected to hit rubber gloves players’ earnings by 1-3%. However, we are not overly concerned since rubber gloves players generally are able to pass on the cost increase judging from past experience during electricity and natural gas tariff hikes. Fuel accounts for an average 10% of production cost of which natural gas accounts for an average of 7%. Based on our back-of-envelope calculation, players need to raise average selling price by 1.3% to cover the higher natural gas cost. From our observation, earnings of rubber gloves players were not impacted from the hike in gas and electricity tariff back in 2011. Recall, 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 but no price increase has been implemented since then, until now.

+19% volume sales for nitrile gloves in 2013. According to the Malaysian Rubber Export Promotion Council (MREPC) in 2013, the combined total exports of rubber gloves, synthetic rubber (SR) and natural rubber (NR) rose 9% YoY. The overall demand for rubber gloves in 2013 remained resilient led by a solid double digit volume growth from nitrile gloves and a slight reduction in the sales volume of latex gloves. In 2013, the total exports of rubber gloves, synthetic rubber (SR) and natural rubber (NR) combined rose 9% YoY to 44.3b pairs and 5% to RM10.2b in value. In 2013, Malaysia exported 19.3b pairs of SR gloves or an increase of 19% YoY. While latex-based gloves or NR gloves are still dominant (as a percentage to the overall exports of rubber gloves) in Malaysia, the trend towards SR gloves has gained significant momentum. This was evident from the lower NR:SR sales value ratio of 61:39 in 2011 to 53:47 (57:43 in 2012), and the sales volume ratio of 58:42 in 2011 compared to 50:50 in 2013 (54:46 in 2012).

Maintain OVERWEIGHT. Our TOP PICK is SUPERMAX with an OUTPERFORM and TP of RM3.80. We like Supermax because: (i) it is trading at 11.4x FY14E EPS (30% discount to the sector average) compared to an average 15% net profit growth over the next two years and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax eliminates uncertainty and lends credibility to its business model and management. We maintain our OUTPERFORM calls on KOSSAN (TP: RM5.13) and HARTALEGA (TP: RM8.21).

Source:  Kenanga