INVESTMENT HIGHLIGHTS

• Expecting a recovery in 4QFY19 earnings

• Earnings to remain resilient despite the current demandsupply imbalance in the glove market

• Newer production lines are more efficient and agile to changes in market demand

• Contact lens segment looks to be on a better footing

• Reiterate BUY with a revised TP of RM2.07 per share

Positive conclusion post meeting. We met with the management of Supermax to discuss: (i) the latest financial performance of the company; (ii) its competitive advantage in dealing with oversupply in the glove market and; (iii) the prospect of its contact lense business. From the meeting, we conclude that: (i) the current oversupply situation of nitrile glove market does not significantly affect the group and; (ii) profitability will further improve once its rebuilding and replacement programme as well as capacity expansion plan are complete.

Expecting a recovery in 4QFY19 earnings. To recall, Supermax’s 3QFY19 earnings dropped by -9.2%qoq. The slowdown in earnings was due to the: (i) declining average selling price (ASP); (ii) dropped in sales lead time from 60 days to 45 days; (iii) higher natural rubber latex price and; (iv) upward revision of gas tariff and minimum wage from January 2019 onwards. Nonetheless, we expect an improve 4QFY19 performance as the effect of upward revisions in ASP due to the costpass through mechanism will be reflected then. In addition, sales lead times have recently lengthened again while the price of natural rubber latex has subsided. These signals improve profitability in the 4QFY19.

Remain resilient despite oversupply situation. From Supermax’s recent performance, we observed that the company is not significant impacted by the current demand-supply imbalance of nitrile glove given that bigger glove manufacturers such as Topglove and Hartalega registered a relatively poorer quarterly performance with earnings declined of -29.4%qoq and -23.7%qoq respectively. The group was able to whether the slowdown well attributed to the: (i) strength of its Original Brand Manufacturer (OBM) segment; (ii) extensive global distribution network of 1,200 independent distributors globally and; (iii) a balance product mix ratio of nitrile to natural rubber gloves at 52:48.

Newer production lines are both efficient and flexible. The group is currently focusing on rebuilding and replacement programme by decommissioning old production lines that are inefficient and replace these with new highly efficient production lines. In addition, first phase of its new 12th plant is on schedule for completion in the 3QCY19. This plant will be equipped with new high-speed and highly automated production lines which have speed capacity between 30,000 to 35,000 pieces per hour (vs between 15,000 to 23,000 pieces per hour at older lines). Apart from efficiency, the new lines improve manufacturing flexibility as they are interchangeable between producing nitrile or natural rubber glove. Therefore, the product mix ratio can easily be adjusted according to market demand.

Expecting improvement in EBITDA margin. Premised on these, Supermax is targeting to improve EBITDA margin to 20.0% as compared to average EBITDA margin of about 16.5% recorded in last five financial years. In summary, the expansion plan will boost Supermax’s production capacity by +4.4b and +3.2b pieces per annum in FY20 and FY21 respectively. By the end of the expansion programme, the group will have a production capacity of 29.4b pieces per annum (+35.0%).

Contact lens segment looks to be on a better footing. For the contact lens segment, the focus is on increasing market penetration rate. On 15 March 2019, Supermax has successfully expanded its product range by adding toric lenses which are for correction of astigmatism in the US market. Apart from that, Supermax has acquired Clayton Dynamics Co. Ltd on 28th June 2019, which principal business is importing, trading and sales of fashion miscellaneous goods such as coloured contact lenses in Japan for a cash consideration of RM3.9m. These will give Supermax a strategic access to the contact lens market in US and Japan which is the first and second largest contact lens markets in the world respectively.

Impact to earnings. We are adjusting our earnings forecasts upwards for FY19F and FY20F to RM144.5m and RM160.9m respectively to take into account the: (i) recovery in ASP; (ii) lengthening sales lead time and; (iii) lower natural rubber latex price.

Target Price. We are revising our target price to RM2.07 per share (previously RM1.74). Our TP is derived via pegging our FY20F EPS of 11.8sen to a revised target PER of 17.5x (previously 16.0x) which is +0.5SD above its five-year historical average PER. We revised our target PER higher as Supermax is catching up in terms of manufacturing capabilities with other bigger glove manufacturers.

Maintain BUY. We expect earnings growth will continue to be sustained going forward given the company’s competitive advantage to endure the oversupply situation in the glove market. Moreover, we are positive on the group’s effort to: (i) rebuild and replace old production facilities aimed at extracting higher production output from existing locations and; (ii) add new capacity via building new plant. At the end of CY20 and post-completion of all upgrading works and building of new plants, Supermax is expected to have an annual capacity of 29.4b pieces per annum. This translates to an increase on Supermax’s production capacity by +35.0%. All in, we are reiterating BUY recommendation on the stock.

Source: MIDF Research - 1 Jul 2019