We upgrade our sector rating to NEUTRAL from UNDERWEIGHT and raise our call for HARTA, TOPGLOV and KOSSAN to MARKET PERFORM (from UNDERPERFORM), while maintaining MARKET PERFORM for SUPERMX. Against our expectations, there was upside surprise from one player in terms of a narrower loss, but glove makers’ 2QCY23 results were undeniably still languishing in a sea of red. While the glove industry might not be out of the woods, we believe the worst is over in terms of earnings downgrades, underpinned by easing cost pressures and savings emanating from decommissioning of older plants moving into 2HCY23. In the meantime, any further decommissioning of older production facilities from local players could take more supply pressures off the sector. Industry capacity cutbacks should bring back more rational competition and hopefully stop the bleeding of the players. Our ratings are as follows: HARTA (MP; TP: RM1.85), TOPGLOV (MP; TP: RM0.75), KOSSAN (MP; TP: RM1.28) and SUPERMX (MP; TP: RM0.80).

Narrowing losses in 2QCY23. Glove players dipped into their third consecutive quarterly losses in the recently concluded 2QCY23 results season. This quarter marked a more stable sequential earnings delivery against our expectations with 25%/25%/50% of results coming above/within/below, which were the same with the preceding quarter. Out of the four companies under our coverage, one beat our forecast (SUPERMX), one came in within (KOSSAN) and two disappointed (HARTA and TOPGLOV).

The positive observation from 2QCY23 results was the QoQ improvement in earnings albeit narrowing losses underpinned by lower production costs such as fuel cost (-17% QoQ for natural gas) and input nitrile raw material cost (-8% QoQ), and slower than-expected decline in ASP. Generally, all players continued to be hit by: (i) excess capacity leading to reluctance of customers to commit sizeable orders and holding substantial stocks on expectations of further price decline, (ii) narrowing losses but margin improvement as costs including energy and input raw material are falling faster than a muted decline in average selling price (ASP), and (iii) reduced economies of scale arising from volume that is less than optimum, particularly, due to poor cost absorption.

Easing margin pressure due to softening input cost and savings from decommissioning old plants in 2HCY23. We expect input raw material prices which accounts for 43% of total production cost to ease or continue to remain weak in the remaining quarters of CY23. Specifically, going into 2HCY23, post wintering season, input latex price is expected to ease as more supply come online, while nitrile butadiene prices will remain depressed due to excess supplies. Moving into 2HCY23, we expect the cost savings initiatives arising from decommissioning of old plants to cushion losses as well. Overall, all players are mindful that the prospect of raising ASP further in subsequent quarters is challenging due to the current massive overcapacity situation, with only a handful of customers agreeing thus far. In fact, ASP is expected to be lower in the next two quarters following the sequential weakness in natural gas price. Since natural gas price has declined sequentially in 2QCY23, glove players are expected to pass on the cost savings to customers. Due to the current competitive pressure emanating from massive oversupply and low industry utilisation averaging 40%, customers can walk away and choose to buy from other players whenever there is an attempt to raise prices. Case in point, buyers can turn to Chinese manufacturers which are still selling below USD20 per 1,000 pieces at USD15-17 per 1,000 pieces. Any attempt to raise ASP could cause a reduction in volume sales, in our view.

Upgrade the sector to Neutral, negatives priced in. While the glove industry might not be out of the woods, we believe the worst is over in terms of earnings downgrades. Consequently, we upgrade our sector rating to NEUTRAL from UNDERWEIGHT. We upgrade our call for HARTA, TOPGLOV and KOSSAN to MARKET PERFORM (from UNDERPERFORM). We also recalibrate our TP for TOPGLOV to RM0.75 (previously RM0.88) based on 1.2x FY24F BVPS (from 1.4x), at a 40% discount (in-line with big cap players) to the sector’s average of 1.7x seen during the last downturns in 2008-2011 and 2014-2015 as we believe the current downturn could go down in history as one of the deepest ever. The changes to our valuation basis, TPs and recommendations for glove stocks are summarised in Exhibit 2.

Oversupply to persist but less acute. We expect the operating environment to continue to remain challenging in subsequent quarters being plagued by massive oversupply. Nevertheless, we expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants.

We expect the operating environment to remain challenging in subsequent quarters, plagued by massive oversupply. Nevertheless, we expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants. Based on our estimates, the demand-supply situation will only start to head towards equilibrium in 2025 when there is virtually no more new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum underpinned by rising hygiene awareness.

MARGMA projects 12%-15% growth in the global demand for rubber gloves annually from 2023, following an estimated 19% contraction to 399b pieces in 2022. It believes the supply-demand equilibrium may return in 6-9 months. However, we beg to differ, expecting the overcapacity situation to persist at least over the next 12 months. We project the demand for gloves to rise by 15% in 2023, which is consistent with MARGMA’s forecast. This will result in an excess capacity of 112b pieces (instead of rising by 4% or 116b as previously forecast) which is similar to CY22. Despite the improvement, the overcapacity still persists which means low prices and depressed plant utilisation will continue to plague the industry in 2023.

Our 2023 forecasts assume: (i) an ASP per 1,000 pieces of USD20, translating to an estimated 10% decline over 2022, and (ii) an average plant utilisation of 50% vs. an estimated 60% in 2022.

In the meantime, we do not have any top pick for the sector.

Source: Kenanga Research - 6 Sept 2023