We maintain our OVERWEIGHT rating on the rubber gloves sector. After three quarters in the lull, we believe rubber glove players under our coverage are poised for a re-rating. The positive outlook is driven by commercial production of new capacity expected to come on-stream by 4QCY14 which will drive earnings growth. We believe persistent concerns over falling demand, fears of oversupply and price wars are overplayed and had been addressed in our past two quarterly strategy reports. As an indication, selected stock prices of rubber gloves stocks under our coverage are currently trading close to their previous highs. Our investment case is based on: (i) earnings growth to resume in subsequent quarters, underpinned by new capacity expansion fueled by sustained demand for rubber gloves, led by nitrile gloves, (ii) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, and (iii) the sustained low raw material prices. Hartalega has risen 13% QoQ while Kossan is currently trading at its high. Supermax has been a clear underperformer YTD (-20%) and also the worst performer amongst its peers. We switch our TOP PICK from HARTALEGA to SUPERMX for its: (i) re-rating catalyst upon commercial production of its new plant expected by end Dec (one line has started production) which dispelled market skepticism of persistent delays in the new plant, (ii) steep 40% discount to sector average, and (iii) being a beneficiary of the strengthening USD against RM. We also have OUTPERFORM calls for KOSSAN (TP: RM4.86) and HARTALEGA (TP: RM7.48).

Mixed bag of results. Rubber gloves stocks under our coverage delivered a mixed bag of results in the recently concluded 2QCY14 reporting season. Both Kossan and Supermax results came in below expectations against our forecasts and market consensus estimates. However, Hartalega met both our target and market consensus. Supermax and Kossan Rubber came in below expectations largely due to slower-than-expected commercial production of their new plants. Supermax is still facing some lower capacity issue due to the resumption of scheduled automation programme leading to shutdown of some production lines. The loss in output due to continuation of the automation process will be more than compensated by new output from the Meru plant scheduled for commissioning by 4Q14 onwards.

New in-coming production capacity to kick-start quarterly earnings growth. The stage is set for rubber gloves stocks; namely, Kossan, Supermax and Hartalega to re-rate, underpinned by new in-coming production capacity, gradually starting in 4QCY2014 which will kick-start subsequent quarterly earnings growth. After three quarters in the lull, we believe rubber glove players under our coverage will see a re-rating once commercial production of new capacity comes on-stream by end 4QCY14. Hartalega’s NGC plant is expected to come on-stream by end Dec CY14. Kossan’s Plant (1) with 5 lines was completed in June with commercial production from August 2014. The remaining Plant (2) and (3) with a total of 12 lines are expected to be operational in September and November. On Supermax, we understand that one line from the new plants namely Lot 6059 and Lot 6058 has started commissioning.

Slower-than-expected ramp up in new supply is positive to industry. In the past two quarters we have highlighted that concerns of industry oversupply have been overplayed. In fact, in-coming new supply has been slower-than-expected. 9MYTD, only Kossan and Top Glove have started commissioning their new plants gradually between 2QCY14 and 3QCY14, albeit at a slower pace. As such the slower-than-expected ramp up in new production capacity further reinforce our positive outlook on the sector with lesser concerns on competitive pressure and oversupply issues. Kossan’s scheduled new 5b pieces capacity has been delayed from March to end Aug 2014 which gradually ramp the 1st plant. The remaining Plant (2) and (3) with a total of 12 lines are expected to be operational in September and November (net increase in new capacity for 2014 is 2.0bn pieces compared to our earlier forecast of 2.5b pieces). Supermax’s new plant with an estimated 5.4b pieces has been delayed and can only start commercial operations by 4Q instead of 3Q 2014 with an estimated net incremental increase of 1.5b pieces (earlier projection was 2.5b pieces). Top Glove is scalling back and only expects 2b pieces new capacity by end 2014. 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.

Margins to remain stable, raw material prices easing, 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) easing of both input raw material nitrile and latex prices, and (iii) capacity constraint for nitrile gloves could put upward pressure on ASPs. Over the last two quarters, the downtrend in average selling prices (ASPs) was not entirely due to price competition but on lower raw material prices as well. 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 taking advantage of the lower ASPs.

Maintain OVERWEIGHT. Our TOP PICK is SUPERMX with an OUTPERFORM and TP of RM3.23. We like SUPERMX for its: (i) rerating catalyst upon commercial production of its new plant expected by end Dec (one line has started production) which dispelled market skepticism of persistent delays in the new plant, (ii) a steep 40% discount to sector average, and (iii) beneficiary of the strengthening USD against the RM. We also have OUTPERFORM calls for KOSSAN (TP: RM4.86) and HART (TP: RM7.48).

Source: Kenanga