Upcycle Seems to Have Been Cut Short

• The glove sector is entering a phase of declining ASP (and hence profit) trend on increased supply and rising vaccination rates. Competition is intensifying among both existing and new entrants. ESG risk adds further pressure on glove companies’ earnings and valuation outlook.
• We are switching our valuation method from DCF to PER multiple, and downgrading the sector to Neutral. Hartalega is our preferred pick.

Glove Makers' 1H21 Review

• Despite the record profit in 1HFY21, share prices of glove players declined by -18% to -30% year-to-date in anticipation of the normalization of ASP (and hence, lower profit) on softening demand urgency due to expanding supply and higher vaccination rates, especially in the US and European countries which are the key markets for Malaysian gloves companies.
• Elsewhere, ESG risks (relating to the treatment of foreign workers) are heightened for Malaysian glove players in their export markets, particularly in the USA. In early May 2021, the US Customs and Border Protection (CBP) has seized latex gloves worth MYR2.85m (4.7m gloves) produced by Top Glove (SGX:BVA) in the Port of Kansas City in Missouri due to information that the gloves were allegedly made by forced labour.

The Best Is Over

• ASP has peaked in 1H21 and earnings upcycle seems to have been cut short with faster-than-expected decline in ASP in 2H21, and shorter lead time due to moderated demand for gloves on rising vaccination rates. The US CBP’s withhold release order (WRO) on Top Glove has also accelerated the decline in ASP as Top Glove is diverting orders away to other regions with lower ASPs.
• In recent con-calls with analysts, both Hartalega and Top Glove have guided for lower ASPs in the coming months. Intensifying competition among the existing and new players (especially the rapidly-expanding China glove producers) could further pressure ASP. According to a Frost & Sulivan report, ASPs for nitrile/latex gloves are expected to decline by -59%/-52% to US$35/20.4 per 1,000 gloves by 2023, from current US$85/42.7 per 1,000 gloves, respectively.

Change in Valuation Method; Downgrade to Neutral

• The glove sector has been de-rated on concerns of declining ASP trend and lack of strong catalysts over the medium term.
• We lower our FY22/23/24 earnings forecasts for Hartalega by -21%/-19%/-6% after assuming lower blended ASPs for FY22/23/24 of US$65/44/29 per 1,000 gloves, while maintaining our earnings forecasts for Kossan and Top Glove as we have already assumed lower ASPs during last results season.
• We are now switching our valuation method for the sector from DCF to PER multiple. We prefer PER over DCF method in view of the oversupply risk post- 2022, which could lead to fluctuations in ASP and changes in capacity expansion plans, hence resulting in significant volatility with regards the assumptions we use for the DCF method.
• Our valuation is based on -0.5 standard deviation of the respective glove counter’s historical 1-year forward PER mean between 2014-2018 (pre-COVID-19).
• We
  • downgrade Kossan to HOLD with a new target price of MYR3.20 or 20x CY23 PER, while
  • maintaining HOLD on Top Glove with new target price of MYR3.98 or 16x CY23 PER, and
  • maintaining BUY on Hartalega at MYR9.80 or 22x CY23 PER.

• Our preferred sector pick for the glove sector is Hartalega. With strong focus on technology/innovation and ESG factors, as well as good rapport with its long-term customers, Hartalega should weather the headwinds well.

Source: Maybank Kim Eng Research - 2 Jul 2021