Last week’s earnings and target price upgrades on TOPGLOV (OP; TP: RM32.00) and HARTA (OP; TP: RM22.30) by our Healthcare analyst led us to raise the FBMKLCI’s year-end target from 1,531 to 1,618. And, with the recent strong price gains of the other two large glove makers SUPERMX (OP; TP: RM17.10) and KOSSAN (OP; TP: RM14.00), they have fairly promising chances of making it into the FBMKLCI at the next review’s cut-off in November, if they finish the year strongly as per expectations. The crowding into the gloves sector due not only to their potential enlargement in index representations but also passive healthcare ETF inflows from abroad will structurally elevate the PE multiple of the FBMKLCI, which may eventually place Malaysian equity market at an increased premium over those in the rest of ASEAN.

Increased earnings estimates for rubber gloves manufacturers have raised FBMKLCI FY20/FY21 estimates by 1.4%/6.2%: Our analyst Raymond Choo raised EPS estimates for TOPGLOV, HARTA and SUPERMX last week (13th July) which led to FBMKLCI EPS being raised as well (see table 1 below).

Rubber glove has the highest sector growth estimates for FY20/21 within our research universe: Reflecting the latest earnings estimates (see table 2 below), we raised the FBMKLCI’s year-end target from 1,531 to 1,618. The target is arrived at by applying a 17.4x PE multiple to 93.2 sen EPS vs. 87.8 sen previously. 17.4x 1-year forward PE is based on a blended PE of 16.2x on FBMKLCI ex-gloves EPS and 26.6x on gloves EPS. And, 16.2x is 1SD above the 10-year mean, justified by the current low risk-free rate.

From a bottom-up perspective, the FBMKLCI could potentially reach 1,673 based on our latest target prices for TOPGLOV and HARTA: We estimate that each 10% movement in the price of TOPGLOV would move the FBMKLCI by 12 points, and by 8 points in the case of HARTA. Our target prices are RM32.00 for TOPGLOV and RM22.30 for HARTA. These are some 39% and 30% upside, respectively, from their current market prices. Inputting these target prices into the KLCI pricing model yields a level of 1,673 (see table 3).

With a strong expected year-end finish for the gloves sector, there is a fair chance the FBMKLCI will see one or two new inclusions: The ground rules state that a non-component stock will be included if it has risen to at least 25th position by market cap. As of 17th July closing prices, SUPERMX at RM17.70 already ranks 20th. Although KOSSAN at RM13.50 ranks only 26th, it might still be admitted by default as the largest non-constituent to replace an outgoing component, if any that has fallen to 36th place or below. KLCCP and GENM look vulnerable given their current 32nd and 33rd positions, respectively.

Source: Kenanga Research - 20 Jul 2020