We upgrade our sector rating from NEUTRAL to OVERWEIGHT. Our investment case is based on: (i) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, (ii) earnings growth to resume in subsequent quarters, boosted by higher ASPs, (iii) weakening of the MYR against the USD. Rubber glove stocks are presently trading at more palatable valuations following retracement in YTD 2019 share prices of rubber glove stocks under our coverage led by HARTA (-15%), TOPGLOV (-14%), KOSSAN (-9%) and SUPERMX (-5%). Based on current valuations, we believe all the negatives are largely priced in, rubber gloves stocks are now trading between slightly above mean, which appears undemanding. We have OUTPERFORM calls on HART (OP; TP: RM5.85); and KOSSAN (OP; TP: RM5.25). Our Top Pick in the sector is HARTA (OP; TP: RM5.85). We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and reduction in costs, (ii) constantly evolving via innovative products development, and (iii) its nitrile gloves segment, which is booming.

Lofty valuations back down to earth. Rubber glove stocks under our coverage have depreciated YTD led by HARTA (-15%%), TOPGLOV (-14%), KOSSAN (-9%) and SUPERMX (-5%), 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. We are not perturbed and expect stock prices to Outperform again in subsequent quarters. Our investment case is based on: (i) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, (ii) earnings growth to resume in subsequent quarters, boosted by higher ASPs, (iii) weakening of the MYR against the USD.

Oversupply concerns overplayed. From our analysis, there are nascent signs indicating that oversupply concerns appear overplayed considering that capacity expansions of the four rubber gloves under coverage are expected to be delayed and staggered.

ASPs pressure, temporary rough patch. In the last two years, the sector has become a victim of its own success. The frantic pace of capacity expansion has resulted in a mild excess supply for rubber gloves leading to ASPs compression and flattish or lower profits over the past two quarters. However, we take comfort that this is nothing more than just a temporary rough patch. However, with the rubber gloves players becoming aware of the intense competition since four months ago, among measures taken to mitigate the impact of competition were; (i) slowed new capacity expansion, (ii) more measures to maintain margins, including automation and other cost reduction initiatives, and (iii) intensifying sales efforts to penetrate emerging economies. Having experienced various cycles of oversupply, we believe players are now better at responding to competitive pressures. We see the ASPs pressure problem in the sector fully sorting itself out within another quarter. Recall, while pricing adjustments were made, there was a time lag of two months before the cost increase could be shared out with customers.

Upgrade from NEUTRAL to OVERWEIGHT. Our investment case is based on: (i) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, (ii) earnings growth to resume in subsequent quarters, boosted by higher ASPs, (iii) weakening of the MYR against the USD. Based on current valuations, we believe all the negatives are largely priced in, gloves stocks are now trading slightly above their respective mean, which appears undemanding.

Our Top Pick in the sector is HARTALEGA. We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and reduction in costs, (ii) constantly evolving via innovative products development, and (iii) its nitrile gloves segment, which is booming. Our TP is RM5.85 based on unchanged 36x CY20 EPS (at +1.0SD above 5-year historical forward mean).

Maintain OP on Kossan. We like Kossan because it is trading at an unwarranted 28% discount to peers’ PER average considering that its net profit growth is the highest at 23.7% compared to peers average at 12%. Our TP is RM5.25 based on 25.5x FY20E EPS (+1.0SD above 5-year historical forward mean).

Source: Kenanga Research - 3 Jul 2019