Reiterate UNDERWEIGHT due to rich PER valuations and flat sequential earnings growth. Anecdotal evidence suggests that the 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 that potential oversupply is looming. Note that the previous two oversupply situations occur back in 2014 and 2016. On the flipside, key upside risk is stronger-than-expected demand. We have UNDERPERFORM call on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM4.45); and SUPERMX (UP; TP: RM1.30). Our Top Pick in the sector is KOSSAN. We like KOSSAN because it is expecting strong high-teens net profit growth in upcoming quarters underpinned by new capacity expansion from plant 16, 17, 18 and 19. TP is RM4.95 based on 25.5x FY19E EPS (+1.5 SD above 5- year historical forward mean).

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 has been averaging between 1% and 6% over the past eight quarters.

Massive PER expansion but pedestrian earnings growth over the past eight quarters and 24-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 24-month period. For example, Hartalega’s PER expanded from 18x to 42x but EPS only rose an average 6% over the past eight sequential quarters. Similarly, Top Glove’s PER expanded from 17x to 30x but EPS only averaged 7% growth over the past eight quarters.

Estimated incoming capacity indicating potential oversupply. Following a period of capacity consolidation starting back in mid-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 switch from vinyl gloves, players are raising capacities again. Our analysis (see table below) suggests that a potential oversupply is looming. Note that the previous two oversupply situations occur 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 for nitrile and natural rubber instead of vinyl. 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.

Reiterate UNDERWEIGHT. 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 inflation in the PER multiple and not so much on earnings growth. Following a period of capacity consolidation starting back in mid-2016, which led to falling ASPs, glove-makers are ramping up capacities. Our analysis suggests a potential oversupply is looming. On the flipside, key upside risk is stronger-than-expected demand. We have UNDERPERFORM call on HARTA (UP; TP: RM5.15); TOPGLOV (UP; TP: RM4.45); and SUPERMX (UP; TP: RM1.30).

Our Top Pick in the sector is KOSSAN. We like Kossan for: (1) its strong high teens YoY earnings growth expected in subsequent quarters underpinned by new capacity expansion, (2) it is moving from good to great due to transformation in the manufacturing processes via automation, hence potential margins expansion, and (3) it is trading at an unwarranted 25% discount to peers and the valuation gap should narrow considering the solid earnings growth ahead. Our TP is RM4.95 based on 25.5x FY19E EPS (+1.5 SD above 5-year historical forward mean) due to Kossan’s strong high teens growth ahead.

Source: Kenanga Research - 4 Jan 2019