We are maintaining our OVERWEIGHT rating for the rubber gloves sector. Rubber glove stocks under our coverage have performed poorly YTD, led by SUPERMX (-23%), TOPGLV (-19%), HARTALEGA (-15%) and KOSSAN (-15%), hit by persistent concerns over falling demand, fears of oversupply and higher operating costs. We are not perturbed and believe this presents a buying opportunity and expect the sector to recover in subsequent quarters. Our investment case is based on: (i) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, (ii) earnings growth to resume in subsequent quarters, underpinned by new capacity expansion fueled by sustained demand for rubber gloves, led by nitrile gloves, (iii) ASPs to remain resilient due to higher fuel cost and insufficient nitrile supply to meet demand, and (iv) the sustained low raw material prices. Based on current valuations, rubber gloves stocks are now trading between slightly above mean and +1 SD compared to an average of +2 SD indicating values emerging. We switch our TOP PICK from SUPERMX to HARTALEGA because we like HARTALEGA for its: (i) highly automated production processes model, (ii) solid improvement in its production capacity and reduction in costs leading to higher margins compared to its peers, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position. We also have OUTPERFORM calls for KOSSAN (TP: RM5.13) and SUPERMX (TP: RM3.23).

Mixed bag of results. Rubber gloves stocks under our coverage delivered a mixed bag of results in the recently concluded 1QCY14 reporting season. Kossan and Hartalega came in largely within our and market consensus expectations. However, Supermax and Top Glove came in below both our and market consensus expectations. Supermax’s 1Q14 results were hit by a fire at its Alor Gajah plant leading to a temporary loss of production output. Similarly, Top Glove’s 3Q14/9M14 results came in below expectations compared to both our and the consensus full-year forecasts due to losses from its China operations (vinyl division) and exacerbated by a higher effective tax rate. The positives from Top Glove’s 3Q14 results are completed sale of its subsidiary in China for RM22m which has been the culprit of its weak results recently and its solid margins despite tariff hikes for both electricity and natural gas.

ASPs raised by 1-2%, solid demand and medium-term tight supply for nitrile gloves. We expect margins and earnings of gloves players to sustain in subsequent quarters due to: (i) sustained high demand for nitrile gloves, (ii) slight ASPs increase, and (iii) capacity constraint for nitrile gloves could put upwards pressure on ASPs. Over the last two quarters, the downtrend in average selling prices (ASPs) is not entirely due to price competition but the lower raw material prices as well. We understand that rubber gloves players have generally raised ASPs by 1-2% or USD0.50/1000 pieces to between USD24 to USD27/1000 pieces due to the tariff hikes for both electricity and natural gas price hikes. From our channel checks, demand for nitrile gloves is strong. Players are generally facing full capacity constraint and have to turn away customers due to the overwhelming demand as well as taking advantage of the lower ASPs.

Demand for gloves still intact, growth led by nitrile gloves. 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 compared to 50:50 in 2013.

Oversupply concerns appear overplayed, new capacity to drive growth in 2H2014. Tell-tale signs of oversupply concerns appear overplayed considering that capacity expansion of the four rubber gloves manufacturers under coverage are expected to be delayed and staggered. Kossan’s 5b pieces capacity will only gradually be ramped up starting from Mar 2014 (1st plant) and the other two plants will commence in 3Q2014 (net increase in new capacity for 2014 is 2.5bn pieces). Supermax’s new plant with an estimated 5.3b pieces will only start commercial operations end 2Q 2014 with an estimated net incremental increase of 2.5b pieces. Top Glove is scalling back and only expects 2b pieces new capacity by end 2014. Meanwhile, Hartalega’s NGC plant is only expected to commence commercial production by 4Q 2014 with a net incremental increase of 2.0b pieces by end 2014. If we sum this up, the new capacity is only about 9b piece, which is only 56% of new world demand (if we take global demand at 160b pieces of gloves and assuming a 10% growth, new demand is expected at 16b pieces) which accounts for less than 60-65% of Malaysia market share globally (bearing in mind all the four players under our coverage accounts for an estimated average 90% of production in Malaysia).

Maintain OVERWEIGHT. Our TOP PICK is HARTALEGA with an OUTPERFORM and TP of RM7.48. We like HARTALEGA for its: (i) highly automated production processes model, (ii) solid improvement in its production capacity and reduction in costs leading to better margins compared to its peers, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position. We also have OUTPERFORM calls for KOSSAN (TP: RM5.13) and Supermax (TP: RM3.23).

Source: Kenanga