Reiterate UNDERWEIGHT due to rich PER valuations and flat sequential earnings growth. Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion as earnings growth has been pedestrian over the past eight quarters. Our analysis suggests that the strong surge in share prices of glove stocks was mainly due to changes in the PER multiple and not so much on earnings growth. Following a period of capacity consolidation starting back in mid-year 2016, which led to falling ASPs, glove-makers are ramping up capacities. Our analysis suggests potential oversupply is looming. Note that previous two oversupply occurs back in year 2014 and 2016. On the flipside, key upside risk is stronger-than-expected demand. We have UNDERPERFORM calls on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM8.85); KOSSAN (UP; TP: RM3.45) and SUPERMX (UP; TP: RM2.60)

Valuations stretched at mid-teens to high-teens valuations. Rubber glove stocks under our coverage have performed well since 2017, until now, led by HARTA (+>100%), TOPGLOV (+>100%) and KOSSAN (+24%) in line with the strong demand and a more stable supply-demand dynamics which underpinned earnings recovery. Due to the run-up in share prices, their PER valuations appear stretched vis-à-vis earnings growth. However, earnings growth of rubber gloves players have been averaging between -1% and 10% over the past eight quarters.

Massive PER expansion but pedestrian earnings growth over the past eight quarters and 12-month period. 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. For example, Hartalega’s PER expanded from 18x to 42x but EPS only rose an average 10% over the past eight sequential quarters. Similarly, Top Glove’s PER expanded from 17x to 30x but EPS only averaged 9% growth over the past eight quarters.

Estimated incoming capacity indicating potential oversupply. 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 emerging 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. Our analysis (see table below) suggests that potential oversupply is looming. Note that previous two oversupply occurs back in year 2014 and 2016.

Demand across the board led mainly by nitrile and natural rubber gloves. 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 2Q18/6M18 demand growths were led largely by emerging markets that are not predominant vinyl glove consumers. Specifically, demand growth for natural rubber gloves stemmed 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.

Shorter lead time indicating strong demand tapering off. We understand that the production of vinyl gloves in China has resumed and normalised in early 2018. Hence, we understand that over the past six months, delivery lead times (the time frame between order and delivery) has shortened from between 60 to 70 days as compared to 30 to 45 days, potentially indicating that strong demand is tapering off.

Mixed set of 2QCY18 results. Results of the glove makers under our coverage saw a mixed bag of results. In the justconcluded 2QCY18 reporting season, Hartalega Holdings’ results were above our expectation due to higher-than-expected volume sales. Kossan Rubber’s results appear to be within expectations in anticipation of higher subsequent quarterly earnings following the commercial production of Plant 16 in July 2018. Supermax missed expectations due to higher-than-expected cost of which we are unable to ascertain as it was not explained in the quarterly results’ note.

Reiterate UNDERWEIGHT. Anecdotal evidence suggests that rubber gloves stocks’ share price rally was led largely by massive PER expansion in view of the pedestrian earnings growth over the past eight quarters and 12-month period. Our analysis suggests that price movements have been mainly due to changes in the PER multiple, and not so much on earnings growth. We have UNDERPERFORM calls on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM8.85); KOSSAN (UP; TP: RM3.45); and SUPERMX (UP; TP: RM2.60).

Source: Kenanga Research - 5 Oct 2018