We downgrade our OVERWEIGHT rating to NEUTRAL on the rubber gloves sector. Rubber glove stocks under our coverage have performed well in 2017 YTD, led by HARTA (+120%), TOPGLV (+51%) and KOSSAN (+25%) in line with the strong demand and a more stable supply-demand dynamic which underpinned earnings recovery. Our downgrade is largely premised on rubber gloves players’ stretched PER valuations vis-à-vis earnings growth. Near-term headwinds including appreciation of MYR against the USD, gas tariff hikes, and potential higher minimum wage could derail earnings. On the flipside, a key upside risk is the faster-than-expected ramp up in new capacity. Our TOP PICK is TOPGLV with an OUTPERFORM rating. Target Price is RM9.40 based on 24.5x FY19E EPS. The PER valuation of TOPGLV (20.6x FY19E PER) is trading at unjustifiably steep discount to HARTA (34.5x CY19E PER). The valuation gap should narrow considering that Top Glove has similar levels of net profit and growth rate compared to Hartalega.

Valuations stretched at mid-teens to high-teens valuations. Rubber glove stocks under our coverage have performed well in 2017 YTD, led by HARTA (+120%), TOPGLV (+51%) and KOSSAN (+25%) in line with the strong demand and a more stable supply-demand dynamics underpinning earnings recovery. However, due to the run-up in share prices of rubber glove makers, players’ PER valuations appear stretched vis-à-vis earnings growth. However, earnings growths of rubber gloves players are growing at an average of between -1% and 10% over the past eight quarters. We believe the share prices have appreciated ahead in anticipation of the upcoming quarter reporting season.

Strengthening of Ringgit (RM) vs. US dollar (USD), a negative to rubber glove players in the short-term. The recent strengthening of the MYR against the USD is a near-term negative to rubber glove players over the short-term. Since rubber gloves players’ sales are USD-denominated, theoretically, an appreciating ringgit against the dollar will lead to less revenue receipts for glove makers. Ceteris paribus, a 1% appreciation of RM against USD will lead to an average 1%-2% decrease in the net profit of rubber glove players.

Share prices of rubber glove makers appear to have decoupled from USD/MYR movements over the past one year. With the RM strengthening against the USD of late, probably one of the key concerns for investors is whether share prices of glove makers will fall in tandem. While there is strong positive correlation between glove stocks and stronger USD, that relationship is strongest over the 3-5 year period. However, over the past one year, it appears that the link has weakened (with Kossan and Harta even showing negative correlations), suggesting that these glove stocks should not be purely viewed as currency proxies anymore. Moreover, given the strong demand coupled with players judiciously planning their capacity expansion, we expected sustained earnings growth to underpin current valuations.

Roll-over forward valuations from FY18E to FY19E. All in, we roll over our valuations from FY18E to FY19E and raised our +1.0 SD to +1.5 SD to better reflect their resilience and constant evolving and progressing to increase earnings and hence shareholders value. Moreover, the past two quarterly results are indicative of rubber gloves players achieving record quarterly earnings ahead. Consequently, we expect rubber glove stocks to continue showing strong quarterly earnings over the next subsequent quarters due to the strong demand underpinned by new capacity expansion.

3QCY17 results broadly mixed. Results of the glove makers under our coverage from the recently concluded 3QCY17 results season were broadly mixed. Supermx Corporation was within but with weak visibility ahead. Kossan Rubber was below due to the slower-than-expected ramp-up in new capacity. However, Hartalega Holdings was above due to higher-than-expected volume sales. Hartalega announced unprecedented record quarterly earnings compared to the mediocre performance of other glove players under our coverage. Hartalega’s stellar performance was due to availability of capacity from NGC’s plant 2 and 3 resulting in strong volume sales (+34%) compared to other players’ slower-than-expected ramp-up of new capacity.

Our TOP PICK is TOPGLV. Target Price is RM9.40 based on 24.5x FY19E EPS. We raised our valuation closer to +2.0SD in order to narrow the gap with Hartalega’s. The PER valuation of Top Glove (20.6x FY19E PER) is trading at unjustifiably steep discount to Hartalega (34.5x CY19E PER). The valuation gap should narrow considering that Top Glove has similar levels of net profit and growth rate compared to Hartalega.

Source: Kenanga Research - 5 Jan 2018