Tell-tale signs like normalizing demand, swelling capacities and intensified competition are pointing towards potentially slower subsequent quarters as envisaged in our two previous quarterly strategy reports. In line with the cloudy outlook, share prices of rubber glove stocks under our coverage have fallen between 18-25% YTD led by HARTA (-25%%), TOPGLOV (-20%%), KOSSAN (-19%) and SUPERMX (-18%). We believe all the negatives could have been priced in with valuations trading at more palatable PERs of between mean and +1.0SD five-year forward average which appears undemanding but the sector lacks positive catalysts over the short-to-medium term. Hence, we upgrade our sector rating from UNDERWEIGHT to NEUTRAL. We have MARKET PERFORM calls on HARTA (MP; TP: RM4.85); TOPGLOV (MP; TP: RM4.20); and UNDERPERFORM on SUPERMX (UP; TP: RM1.30). Our Top Pick in the sector is KOSSAN (OP; TP: RM4.95). We like KOSSAN because it is expecting strong high-teens YoY net profit growth in upcoming quarters underpinned by new capacity expansion. TP is RM4.95 based on 25.5x FY19E EPS (+1.0SD above 5-year historical forward mean).

Lofty valuations back down to earth. Rubber glove stocks under our coverage have depreciated between 18-25% YTD led by HARTA (-25%%), TOPGLOV (-20%%), KOSSAN (-19%) and Supermax (-18%), in line with normalizing demand, swelling capacities and intensified competition, which are pointing towards potentially slower subsequent quarters. We believe all the negatives could have been priced in with valuations trading at more palatable PERs of between mean and +1.0SD five-year forward average which appears undemanding. Based on past historical observation, share prices of glove makers moved ahead of upcoming quarterly results. From the analysis below, trend of 1QCY19 share prices is indicating a weak set of quarterly results (1QCY19 or March ended quarter) season.

Competitive pressure, demand tapering off. Tell-tale signs like normalising demand and intensified competition are pointing towards a potentially slower set of results in subsequent quarters. Anecdotal evidence suggests that shorter delivery lead time does indicate that strong demand is tapering off and players ramping up production could result in further ASP pressure. From our channel checks, we gather that competition in the nitrile gloves segment has intensified leading to pressures on ASPs. As such, coupled with the moderating demand and in anticipation of new capacities ramp-ups, we would not be surprised if ASPs come under further pressure over the next two quarters. We understand that over the past six months, delivery lead times (the time frame between order and delivery) have shortened from 60-70 days to 30-45 days, potentially indicating that strong demand is tapering off.

Demand for gloves still intact, longer delivery lead times, 9M18 Malaysia gloves exports recorded 12% YoY growth. We believe that the average 8-10% demand growth p.a. for rubber gloves over the next few years is still intact. In 9M18, the total exports of rubber gloves, synthetic rubber (SR) and latex-based natural rubber (NR) combined rose 12% YoY to 60.5b pairs and 15% in value. Specifically, Malaysia’s exports of SR and latex gloves rose 16.7% and 5.1% YoY, respectively, in 9M18. The Malaysian rubber glove industry marked a milestone in 2018 where for the first-time SR gloves considerably overtaken NR gloves in terms of market share. This was evident from the lower NR to SR sales volume ratio of 37:63 in 9M18.

Upgrade from UNDERWEIGHT to NEUTRAL. Tell-tale signs like normalizing demand, swelling capacities and intensified competition are pointing towards potentially slower subsequent quarters as envisaged in our two previous quarterly strategy reports. In line with the cloudy outlook, share prices of rubber glove stocks under our coverage have fallen between 18-25% YTD led by HARTA (-25%%), TOPGLOV (-20%%), KOSSAN (-19%) and SUPERMX (-18%). We believe all the negatives could have been priced in with valuations trading at more palatable PERs of between mean and +1.0SD five-year forward average which appears undemanding. However, the sector lacks positive catalysts over the short-to-medium term. Hence, we upgrade our sector rating from UNDERWEIGHT to NEUTRAL. We have MARKET PERFORM call on HARTA (MP; TP: RM4.85); TOPGLOV (MP; TP: RM4.20); and UNDERPERFORM on SUPERMX (UP; TP: RM1.30). As such, we upgrade our sector rating from UNDERWEIGHT TO NEUTRAL.

Our Top Pick in the sector is KOSSAN. We like Kossan for: (i) its strong high teens YoY earnings growth expected in subsequent quarters underpinned by new capacity expansion, (ii) it is moving from good to great due to transformation in the manufacturing processes via automation, hence potential margins expansion, and (iii) 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 (+1.0 SD above 5-year historical forward mean) due to Kossan’s expected strong high teens growth ahead.

Source: Kenanga Research - 5 Apr 2019