Call downgraded to UNDERWEIGHT from NEUTRAL rating due to overstretched PER valuations and the fast improving MYR against the USD. Rubber glove stocks under our coverage have performed well since early 2017 till now, led by HARTA (+140%), TOPGLV (+96%) and KOSSAN (+21%). Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion compared to pedestrian earnings growth over the past eight quarters and 12-month period. Our analysis suggest that strong surge in price movements of the glove stocks have been mainly due to changes in the P/E multiple and not so much on 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, key upside risk is the stronger-than-expected demand. We have UNDERPERFORM and MARKET PERFORM calls on HARTA (UP; TP: RM10.00); KOSSAN (UP; TP: RM6.85); and TOPGLV (MP; TP: RM9.40), respectively.

Valuations stretched at mid-teens to high-teens valuations. Rubber glove stocks under our coverage have performed well since 2017 till now, led by HARTA (+140%), TOPGLV (+96%) and KOSSAN (+21%) in line with the strong demand and a more stable supply-demand dynamics underpinning earnings recovery. 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.

Massive PER expansion but pedestrian earnings growth over the past eight quarters and 12-month period. Anecdotal evidence suggest that rubber gloves stocks’ share price rally was led largely by massive PER expansion compared to pedestrian earnings growth over the past eight quarters and 12-month period. The chart below depicts that price movements of the glove stocks have been mainly due to changes in the P/E multiple and not so much on earnings growth. For example, Hartalega’s PER expanded from 18x to 39x but EPS only rose an average 10% over the past eight sequential quarters. Similarly, Top Glove’s PER expanded from 17x to 27x but EPS only average 9% growth over the past eight quarters.

Capacity slowly building up again. Following a period of capacity consolidation starting back in mid-year 2016 which led to falling ASPs, nascent signs of glove-makers ramping up capacities are building up again. The robust demand is attracting players to ramp-up production. In anticipation of higher demand and switching from vinyl gloves, players are raising capacities again.

Demand led across the board mainly from nitrile and natural rubber. From our checks with rubber glove players under our coverage, demand is mainly from nitrile and natural rubber instead of vinyl. Contrary to market expectations of a massive industry switch from vinyl to rubber gloves, Top Glove’s 2Q18/1H18 demand growth was led largely by emerging markets that are not predominant vinyl consumers. Specifically, demand growth for natural rubber gloves stems from emerging markets, where healthcare awareness and hygiene standards are rising steadily, particularly Asia (ex-Japan) and Eastern Europe, which respectively saw 60% and 40% boost in sales volume for 1H18 compared with 1H17 of which they are not vinyl gloves consuming nations.

Downgrade to UNDERWEIGHT from NEUTRAL rating. Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion compared to pedestrian earnings growth over the past eight quarters and 12- month period. Our analysis suggest that price movements of the glove stocks have been mainly due to changes in the P/E multiple, not so much on 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 stronger-than-expected demand. We have UNDERPERFORM and MARKET PERFORM calls on HARTA (UP; TP: RM10.00); KOSSAN (UP; TP: RM6.85); and TOPGLV (MP; TP: RM9.40), respectively.

Source: Kenanga Research - 6 Apr 2018