3QCY19 results season pleasantly within expectations. 3QCY19 results season for glove makers under our coverage came in within expectations. The star performer was Hartalega which recorded the second consecutive quarterly earnings growth where it achieved mid-teens sales volume growth (+14%) in 2QFY20 driven by new capacity from Plant 5. We continue to remain positive on sequential earnings recovery to gather momentum in subsequent quarters, underpinned by uptick in nitrile demand, to be driven by re-stocking activities. Kossan’s 3QFY19 results came in disappointingly lower YoY and QoQ despite having new capacity from Plant 17 and 18 due to an unexpected labour shortage in 3QFY19 which came without any warning. However, the labour shortage has been resolved. Supermax and TOPG’s 1QFY20 results both showed strong sequential recovery following the easing of input latex raw material cost.

Stage set for a recovery in volume growth. More importantly, there are nascent signs of a solid uptick in demand for rubber gloves in subsequent quarters. 3QCY19 results season indicated a positive recovery in demand and hence volume growth from industry leaders - TOPG and HART. Both players recorded 6% and 14% sequential volume growth, respectively. From our ground checks, demand for nitrile gloves is picking up again where players’ new capacities are being swiftly taken up. We believe this uptick in demand is turning positive and should be reflected in players bottom-line in subsequent quarters.

Nitrile gloves' market share to gain further momentum with potential 30% growth. Based on our analysis, we expect nitrile gloves to continue growing and grabbing market share from latex gloves. The growth in nitrile segment is evident. For illustration purposes, going forward, assuming Nitrile:Latex breakdown of 80:20 (current is 67:37) and based on estimated global demand of 308b pieces in 2020 (forecast for 2019 is 300b pieces and assuming 8% growth rate in 2020), this implies nitrile growth rate of 30% or an additional 51b pieces from switching to nitrile gloves.

Uptick in nitrile demand but intense competition for latex. Looking ahead, the keen competition in the latex segment could negatively impact latex gloves margin. The robust demand for nitrile gloves has led to longer delivery lead times to between 45 to 50 days as compared to 30 to 40 days previously. Although we are positive on growth in subsequent quarters underpinned by uptick in nitrile demand driven by re-stocking activities, players like TOPGLOV and SUPERMX could continue to be plagued with competitive pressure from low margin latex gloves (accounts for an estimated 50% of product mix for both players) which could offset the gains in the nitrile segment.

Investors should focus on nitrile-centric players. Due to the intense competition in the latex segment, we recommend players which are largely nitrile-centric including HARTA and KOSSAN which product mixes hinge largely towards nitrile at 95% and 75% share, respectively. Conversely, TOPGLOV and SUPERMX which are largely latex-centric with product mix between nitrile and latex estimated at 50%:50% are expected to face margins pressure.

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 RM6.00 based on unchanged 36x FY21 EPS (at +1.0SD above 5-year historical forward mean).

Source: Kenanga Research - 2 Jan 2020