@pjseoew, you may refer to page 6 of Top Glove 3QFY21 briefing deck.

https://www.topglove.com/App_ClientFile/7ff8cb3f-fbf6-42e7-81da-6db6a0ab2ef4/Assets/corporate_calendar/3QFY21%20Briefing%20slides%20090621._Website.pdf

Sales quantity for 3QFY20 is 17.1 billion
Sales quantity for 2QFY21 is 16.3 billion
Sales quantity for 3QFY21 is 15.6 billion (therefore -9% YoY, -4% QoQ)

The quantity decline is against expanded capacities of 78.7b by 3QFY20, 93b by 2QFY21 and 100b by 3QFY21, implying ratio of shipment to quarter end capacity as below
3QFY20 is 17.1*4/ 78.7 = 87%
2QFY21 is 16.3*4/ 93 = 70%
3QFY21 is 15.6*4/ 100 = 62%

However, this ratio is only an approximation to production capacity utilization. Actual utilization during last quarter could be slightly higher if Top Glove has built and held some FG as stock (its inventory value has increased).

Regarding The Star article shared by FortuneBlooming, I agree with the title that other glove makers would fare better than Top Glove which was hit by the CBP ban.

Top Glove situation is unique. It only shipped 15.6 billion pieces in Mar to May quarter, despite capacity reaching 100 billion pieces. This is equivalent to about 62% capacity utilization (or probably close to 70% if we assume all of the RM346m inventory increased was finished goods held in warehouse awaiting shipment; and that could contribute handsomely in the next Q if CBP ban is lifted soon).

But I want to draw attention to two points highlighted in the article which would be relevant to other glove stocks:

First, AMInvest mentions “higher number of order cancellations”. Since last year, thanks to some good sharing from the forum, we understand that customers would place some form of deposits or pre-payment. This pre-payment (can be found on Balance Sheet) currently stands at about RM900 million for Top Glove, slightly over RM1 billion for Supermax, and slightly below RM900 million for Harta. It is supposed to be a good indicator of the order pipeline. But such indicator may be less useful now if high number of order cancellations are allowed to happened. While not sure about the details, business common sense dictates that such deposits would not be forfeited in order to preserve relationship. May be the deposits would be used to contra against outstanding invoices or serve as pre-payment for future orders. Of course, this is just a guess. Bottomline is order pipeline can be rather flexible.

Second is “glove lead times, formerly six months long in the past quarter, have since subsided to 30 to 50 days”. In fact, if I recall correctly, at one point last year order lead time was reported to be as long as one whole year! The drastic reduction in order lead time shows how volatile the situation could be. It may also indicate double ordering by some customers during the desperate time last year (as reportedly also happened in the semiconductor industry).

The reasons I’m citing these is not say the situation is bad. Afterall, profits are still near historical height and supernormal profit would still last for a while. I’m just sharing my observations and lessons I learn from glove stocks -- that some bullish indicators which made into media headlines (like the order lead time) could turn bearish really fast. Investors need to process such info with care.

@pjseow, take note from the Nomura report, management plans to return to its 30% OEM model after demand has normalized.

"Management said that before COVID-19 started, 40% of its volume went to own
distribution centres under OBM, followed by 30% to independent distributors in over
165 countries under OBM and 30% to OEM customers. This changed post March
2020 with 58% going to own distribution centres, 40% to independent distributors in
over 165 countries under OBM and 2% to OEM customers, especially to the big US
distributors. Once demand starts to normalise management expects this mix to return
to pre-COVID-19 status."

I’ll watch out for these few factors:

1. Revenue growth – can expect little growth given the loan book growth has slowed considerably. The management has turned cautious even before the pandemic. But I agree as it’s better to be too cautious than overly aggressive in this personal loan business

2. Asset quality – continues to hold up very well. It’s helped by the job security of its customer base (civil servant) where repayment is mostly through salary deduction.

3. Interest rate – It has benefited from lower funding cost in the past few years during the interest rate down cycle. But 10Y Malaysian government bond yield has recovered from the 2.5% low last year to current 3.2%. How fast will it rise in future, and how might it affect future cost of borrowing and therefore the net margin?

4. Valuation – This is a contentious topic. Some investors here feel that it’s undervalued. Based on Maybank’s projection of FY22E book value of RM2.37, currently RCE trades at 1.24X PB against expected FY22E ROE of 15.1%.

Instead of comparing against valuation of another lender like Aeon Credit (which stirs up a different kind of disagreement with AEONCR investors), I look up at BIMB, which also offers a lot of personal loan to civil servants (although also other banking, stock brokerage and insurance thrown in).

AM Invest projects 2021E BV at RM4.08, which is 0.84X PB, against FY21E ROE of 12.8%. In this not perfect comparison, RCE Capital doesn’t look too much undervalued in a relative sense. Besides, BIMB being a larger cap stock and more liquid could attract larger funds, and therefore in theory should enjoy higher valuation.

Anyway, like it or not, the share price is determined by the market. For me it's good enough to just hold and collect dividends regardless of share price movement, as long as fundamentals remain sound.

Published in The Edge today. "Positive views on RCE Capital maintained, despite FMCO"

I just caught up with the reading of The Edge last week. There was an article by Andrew Sheng, a former central banker, with the title is “What is the best asset allocation strategy”.

Interesting read besides the usual stuff on financial asset allocation. To quote a piece of his thought:

“The principle of strategic asset allocation is much more universal in application, because every day or minute, we are allocating our previous time (another asset) to decide what to do with the short term (the urgent or mundane) or the long term (important but difficult)."

@pjseow, thanks. Yes. I’ve read the prospect section too. It’ll be good if the management can provide more info. Were such questions raised in previous AGM? I fail to locate their past AGM minutes. I feel that if Supermax could emulate Top Glove in investor communication, it could help to attract more serious long term investors.

But I understand you valuation approach --> that current net cash + very near term profits + long term normal profit at average PE is close to/ exceed current share price; even though I don't subscribe to adding cash directly in valuation (also need to subtract net tax liabilities, among others)

Hi Ben, thanks for your clarification.

Just to elaborate on my view on supply-demand dynamic. When I estimate that supply-demand could balance by 2022-23, I still believes in the continuous growing demand driven by pandemic needs, strategic stockpiling and structurally higher demand. I don’t have hard figures. Just that I note glove is not a finite resource. It takes 12m to 18m to build factories and commission production. If ASP continues to offer decent profits, old and new players alike will continue to expand. At some point supply growth could catch up and exceed demand growth. My gut feeling is 3 to 4 years after the pandemic, which is 2022-23, should have offered sufficient catch up time.

@pjseow, that’s a very good information. Thanks for the sharing.

It’ll be interesting to know the details of this direct-to-consumer business.

For industrial scale users, like hospital chains, I suppose personalized selling is required. Does it mean Supermax has already beefed up its sales team on the ground? Supermax does not disclose its number of employee (not to mentioned foreign employees) in its annual reports so it’s hard to guess.

As for mass market users, I wonder whether it now has greater sales through online platforms like Amazon? If yes, has it started doing so before the pandemic knowing that it could possibly capture a larger slice of profits. If not, what held it back then?

In fact many brand companies, even in Malaysia, have adopted this route in recent years. But brands also see the challenge where power is shifted to the platforms. Platforms have more data and know the buying habits of consumers than the brands companies themselves. Platform algorithm could easily channel customers to rival brands except for products with strong brand loyalty.

Of course, brands could build their online platforms (with help from Shopify for example). But as a consumer myself, I only shop for high price items from the brand platforms. For cheaper stuffs it’s far convenient to shop on Lazada or Shopee; and I often pick the cheapest as long as the sellers have reasonably good rating. The ease of price comparison on platforms destroys pricing power and erodes margin.

Anyway, this is a question rather than opinion. I have no idea on how Supermax operates this direct consumer business. It will be good to learn more in order to make some educated projections.

@Pjseow, thanks for your reply. You’ve certainly done a lot of study on this company.

I get your point that the company has shifted from previously 70% ODM + 30% OEM to the current 98% ODM + 2% OEM, and within the ODM it has increased own distribution from 40% to 58%.

However, the reason I feel that there has been no fundamental shift in Supermax business model is pre pandemic it was already 70% ODM. During this period, with even the 70% ODM business, it only managed a median profit margin of about 10%. The margin was actually lower if compared to some pure OEM peers.

I appreciate your peer comparison showing the explosive growth in profits by Supermax during the initial period of the pandemic. I could be wrong, but this could be what happened last year:

Pre-pandemic, both manufacturing and distribution made normal profit. Acute shortages during the pandemic inflated margin at both sides, may be even more at the distribution side. Supermax management was nimble and made a fast decision to cut OEM and enlarged their pie in distribution. In that way they captured both sides of the profits.

If my conjecture is right, we should see Supermax profit margin normalizes faster than its peers in the coming quarters. Of course, I might be wrong, then Supermax profit margin should stay at a higher plateau. If it’s indeed 30% to 40% long term net margin as management has claimed, I agree that would make current share price very attractive.

In the meantime, I would like to draw attention to the segment reporting in the annual reports. For 2020, trading segment has a positive segment results of RM224 million on a total revenue of RM1,480m, or a segment margin of 15%. Given Supermax year end is in Jun, we can expect much higher margin in 2021 Annual Report given the explosive profits subsequently.

However, the trading segment during pre-pandemic years show much poorer result:
Year Segment Revenue Segment Results Segment Margin
2019 RM874m RM1m loss 0%
2018 RM825m RM21m profit 2%
2017 RM575m RM20m loss -3%

As can be seen, before the pandemic the distribution side had a slim margin at best. Perhaps it was weighed down by the high cost in sales, marketing and distribution. Afterall I can imagine it’s not cheap to successfully defend expand brands in rich countries. That I believe was the reason Supermax was previously 70% rather than 100% into ODM. The 30% from the OEM side provided cushion and stability.

So the crux of the question is, how much of the extra profit from ODM is derived from glove shortages during pandemic, and how much extra profit could be truly attributed to the structural change in the ODM business which will persist far into the future.

@pjseow, thanks for your reply.

I now understand that you have work out the PAT for manufacturing and distribution separately, and later combine them to derive at the net margin of 23%.

However, despite the management now emphasizing on its “dual income sources” –consisting of manufacturing and distribution, there is no fundamental change in its business model. For example, in the 2019 (i.e., pre-pandemic) Annual Report, the segment reporting has already separated manufacturing and trading as distinct activities, contributing to RM1.4b and RM0.9b revenue respectively before elimination.

The pre-pandemic median profit margin of about 10% during last decade is based on a business model fundamentally not very different from today. It may be just management now giving this "dual income model" a higher emphasis to signify their OBM advantage during the pandemic period.

If there is no fundamental shift in business model, the higher profit margin may not be justified.

@Ben,

Lastly, “most of the value is contained in earnings that have already been achieved (net cash) and will be achieved within the next 2 quarters”
--> Don’t agree.

Supermax has a net cash of of RM3,675m. At today closing of RM3.82, the net cash of RM1.42 is about 37% of the share price.

But I don’t agree directly adding that net cash to the valuation. And I’m not “really keen on making gloves seem like a bad investment”, as you’ve claimed.

First, its increased in future revenue depends on its expansion plan to bring capacity from 26.2 billion to 48.4 billion. The management states that it would cost RM1.39 billion.

Next, it owed a net RM648 million of tax to the government.

After deducting these two factors, the net cash is reduced to RM1,637 million, or 63 sen per share, or 16% of current share price.

But the more important point is should net cash be just added directly to stock valuation. If the market values stock this way, there wouldn’t be so many companies in Bursa selling below their net cash level, and for long term basis!

There are also quite a number of relatively sound companies with net cash at 30%, 40% or even higher selling at seemingly low valuation. I just quote two examples.

First is Magni Tech which you’re familiar with. Net cash RM334 million, or 77 sen per share, or 32% of current share price. Magni has high cash level for many years, consistent and growing dividends, but the market values it an average 8X forward PE over the last 5 years.

Next example is HLIND. It has a net cash of RM1,582m, or RM4.82 per share, or 47% of current share price. It has strong and growing cash generating capabilities, growing dividend, but market values it at a 10.5X forward PE over the last 5 years.

(Just in case anyone claim that Supermax is valued at even lower forward PE right now, note the above two examples refer to normalized forward PE. Supermax would have a much higher forward PE once earning is normalized).

So is a net cash company any good? Of course financially it’s more stable and better than a net debt, especially a high net debt companies with uncertain cashflow. But the market does not simply translate net cash into valuation. At least not in the multiple examples I've witnessed over the years.

Lastly, I reckon valuation is also a personal choice. I respect your assumptions and decision to add Supermax net cash into valuation. As for me, by not adding to the calculation, I get different answer.

You may be more optimistic about the future and derive a higher valuation, and me the other way round. But I respect this difference in opinions. But don’t assume that I’m “really keen on making gloves seem like a bad investment”. That implies ulterior motive on my part. It leaves a bad taste to an otherwise very healthy and stimulating discussion.

(Part 4, final)

@Ben,

Having clarified points which I hope are misunderstandings, let’s review to your suggested approach.

“assume that the big, and efficient glove manufacturers, will remain aggressive, and that they will proceed with their expansion plans accordingly”
--> Agree. That is the approach I use in my estimate to avoid complication.

“This will in turn cause ASPs and margins to be substantially reduced to ~pre-pandemic levels as early as next year.”
--> Agree. As stated earlier, my guess is ASP normalizes by 2022 or 2023 the latest.

“Assume 90% utilization rate for the entire period”
--> Agree

“We assume that ASPs will normalize at $27.2 for nitrile gloves, and $18.5 for NR latex gloves, as soon as January 1, 2022.”; and
“We assume that Supermax's net profit margin will drop to 15% as soon as January 1, 2022, and after January 1, 2023 it will be down to 10%.”

I have thought about these two points. One challenge for glove share valuation is determine the long term ASP, where opinions differ quite a lot. On the other hand, despite increased in ESG related cost, the unit production cost is still much easier to predict.

At price equilibrium, the ASP will revert to a cost plus model as dictated by the lower cost of efficient producers. The ASP is the stable unit cost + median net profit margin.

But I cannot find enough data from Supermax calculate the shipment quantity, and hence unit cost quarter by quarter over a period of time stretching to pre-pandemic period. On the other hand, Top Glove provides detailed data. So I would use Top Glove as proxy.

I’ve calculated the past 9 quarters of Top Glove total cost (in RM) per 1,000 pieces as below (ignore effects of non-glove business; ignore different glove type composition) –

81.5, 83.2, 81.8, 67.4, 78.3, 99.3, 131.0, 151.2, 134.5

Pre-pandemic, the cost is around RM 80 per 1,000. Recent spikes in cost are due to temporary shutdown and low utilization have driven up unit cost. Higher ESG compliance cost is also a factor. However there is also an opposite factor of ever declining cost due to efficiency improvement.

Therefore, I will assume a unit total cost of RM 100 per 1,000, which is close to the results of quarter ending Aug’2020, where utilization was about 84%.

A cost plus approach will then add median net profit margin (say 10%) to the unit cost (assumed RM100 per 1,000 piece), and multiply the assumed capacity and utilization accordingly.

(Part 3)

@Ben,

Now, lets go over the point you’re raised.

<Reversion to mean profit margin soon>

Yes, I believe in the reversion to mean profit margin. This has happened many times before in other industries due to competitive forces. Any belief that some companies could enjoy structurally higher profit margin post pandemic must be backed up by justification on why the company moats have been widened and/or deepened.

As for “soon”, we need to quantify the timescale. I’ve mentioned earlier that I don’t believe in Frost & Sullivan’s ASP forecast that it would not have completely normalized even by 2025, a full five years after the pandemic! In my own assumptions I prefer to think in terms 2022 or 2023 timescale.
In a nutshell, my best guess is reversion to mean profit margin by 2022 or 23. Is it the worst case scenario? I don’t think so.

<Melting away expansion plan>

I don’t like your choice of word “melting”. I’ve never claimed that Supermax or Top Glove expansion plan would “melt”, nor that Supermax is unlikely to proceed with their expansion plan. Read again, this is what I said

“Just like Intco Medical, Supermax is very aggressive in its capacity expansion plan”

“Either glove players collectively delay & slow down their expansion plan …, or the ASP will drop faster.”

I actually failed to see any contradiction here. It’s a fact that glove producers slowed down/ postponed their plan in the past cycles when demand slowed. Big players here all have the cash to expand aggressively now. If they do expand aggressively, ASP is driven down faster. If they moderate their expansion, the ASP normalization will take longer time.

Adding to previous comments, I also want to further add that
- In projecting future revenue and profit for Supermax, for example, we can have higher volume (assume expansion plan remains) but will have lower ASP; or we can have relatively higher ASP but not so high volume (assume expansion plan slowed). It’s difficult to have both.

- In the past cycles, Malaysian big glove producers seemed to have implicit understanding in moderating their capacity growth in line with demand trend. Such implicit understanding could be harder to achieve with foreign big player(s) emerging. Just look at the dynamics at OPEC, OPEC+ and shale oil producers.

< Drop in ASP, with long-term trend towards ASP below (or very near to) cost of production>

I don’t understand where is the contradiction. Please read again. I believe there is a misunderstanding. Anyway I’ll restate the key points:
- RHB estimated that the cost for US producers is USD40 (per 1,000 pieces)
- RHB then assumed USD40 would “set the long-term global nitrile gloves price”
- I question the logic of why inefficient producers (i.e. US producers) set the global nitrile ASP
- Think about it. Malaysian players like Harta, Top Glove and Supermax current production cost is quite a way below USD40. When they compete to sell in Europe, for example, why would their ASP miraculously be above USD40 just because certain US producers had a USD40 cost structure?
- BTW, I didn’t claim that “non-efficient players will not be affected”. The more expensive US producers could be popped up by federal subsidy or eventually fold, we don’t know.
- More to that. Inefficient players elsewhere, Malaysia and China alike, would also be affected should ASP is near or below their cost level. But if that scenario happens, it’s hard to tell how long as a whole they would sustain before close down or sell out to big players.

(Part 2)

Hi Ben, as always it’s good to hear your view. It makes the discussion meaningful and forces me to think harder about the subject.

But before getting into the topic, I need to spend some time getting a few things out of the way. I don’t want any misconceptions about my position. First, as explained elsewhere, I’m positive on the long-term growth prospect of glove industry. I’ve been holding glove stocks in the past even though I’m underweight now. I’ve also mentioned to you that I’ve added back some Harta recently.

It’s precisely that I’m interested in interested in glove stocks that I highlight the potentially overlooked aspects, and I appreciate constructive responses I received from you for example on where I might have gone wrong. I hope in the process everyone gets a good look on the pros and cons of their investment thesis.

Next, I one to highlight something not directed at you, but to anyone else who might have certain misconception. I sometimes read in the forum that people seriously people raising dissenting views on certain stocks are there to talk down the share price so that they can collect at lower prices later.

Let’s be clear, no one in this forum, me as a nobody certainly not, have the power to move share price for a large cap stock like Supermax, not to mention Top Glove or Harta. Collectively analysts, fund managers and company directors may have some power. But in the long run they too succumb to the fundamental forces. Long term stock investment is not a popularity contest. Graham says it’s a weighing machine. I think acceptance of diverse range of opinions certainly help one to coolly judge what is the real weight in the investment!

(part 1)

@pjseow,

< 25% or 30% net profit margin assumption>

Supermax achieved net profit margins of 4%, 7%, 8%, 16%, 44%, 60%, 54%, 53% in the last 8 quarters. The high net margin is a recent phenomenon. When it normalizes, I doubt it could sustain at even 25% on long term basis.

Yes, Supermax has own brands. But many other established consumer brand owners don’t get 25%. Pre-pandemic, for the last 10 years, both Carlsberg and Heineken Malaysia were 11% to 14%. Nestle Malaysia 10% to 13%. The median net margin for Supermax was about 10%.

To come up with a long term 25% net margin, you need to give very compelling arguments what are the sudden increase in Supermax business moats such that it can deter competitors from eating away its very rich margin.

If Supermax net margin is to revert back to 10%, its stock valuation would look very different.

@pjseow,

<48 billion capacity assumptions>

Just like Intco Medical, Supermax is very aggressive in its capacity expansion plan. Based on Note 3b of its latest quarterly report, it plans to add 22.25 billion capacity to existing 26.17 billion, brining it to a total of 48.42 billion.

At the same time, other players like Top Glove will add another 38 billion by 2022, not to mention Intco which despite share price crash still has close to RM5 billion net cash to fund expansion.
Either glove players collectively delay & slow down their expansion plan (Top Glove already made adjustments), or the ASP will drop faster.

@pjseow,

<ASP assumption>

I think the basis of RHB long term ASP is dubious. Let me quote the rationale stated in RHB report “We expect USD40.00 to be the long-term ASP for nitrile gloves. As the US plans to build its own gloves manufacturing plants, we estimate cost of production to be USD40.00. This should set the long-term global nitrile gloves price. When ASPs drop below USD40.00, US producers will stop producing and, in the long term, ASPs should revert back to USD40.00.”

I wonder if RHB analyst really believe his own argument that the global nitrile glove price be determined by the production cost of inefficient new player in US? This is like saying global crude oil price should sells at USD70 per barrel because that is the production cost of US shale oil producers. Obviously a flawed argument.

In fact RHB has contradicted its own argument in its Top Glove report today. RHB has lowered Top Glove’s blended ASP, including the long term ASP, based on argument that Top Glove could not assess the US market. But didn’t just 4 weeks ago RHB still maintain that US producers cost set the global price?

I’m more comfortable with your USD27 ASP assumption. But do note historically ASP is on downtrend. Based on Harta annual reports, it predominantly nitrile glove blended ASP has declined from about USD39 in 2008 to around USD20 pre-pandemic.

Any argument that ASP should be higher because of higher labor/ materials/ other input costs would only work in the very long term, especially if there were excess capacities in the next few years where stronger players try to drive new players to the ground.

@pjseow,

I refer to your comment on Jun 10, 2021 10:35 AM.

It’s good that you put some numbers around for meaningful discussion. You’ve put forward two scenarios based on Supermax’s long term, normalized PAT.

In your first scenario, PAT = 37 x 48 x 0.8 x 4.13 x 0.3 = 1760 millions. The key assumptions are
- long term blended ASP = USD37 (assumed by RHB)
- 48 billion capacity (Supermax projects capacity increase from 26.2b to 48b by 2022)
- Net profit margin of 30%

In your more conservative second scenario, PAT = 27 x 48 x 0.8 x 4.13 x 0.25 = 1070 millions
- long term blended ASP = USD27
- Net profit margin is 25%

I’ll go over those assumptions in the next few comments Feel free to disagree. Hopefully that help us to get a better picture.

@Pjseow,
You’ve mentioned in earlier comments that CNY appreciation, supposedly cheaper NBR and gas price in Malaysia etc will favor Malaysian producers.

As mentioned before, when ASP is high, when even new entrants could recoup investment within 12 months, not to mention profit margin at 50%, the impacts from all the above factors are at the margin at best.

CNY doesn’t meaningfully dent profit unless it strengthens by 20%-30% this year. If one truly believes in this possibility, should quit gloves and trade in forex instead.

Yes, Malaysia has an established NBR supply chain. But note the key producers are international firms like Korea Kumho, LG Chemical. They can have plants in Malaysia and also elsewhere. LG has a plant in Ningbo China. Intco’s own 500,000 metric ton NBR plant is under construction. It's not clear to me who will eventually has the upper hand. While China may be disadvantaged in natural rubber, it is not lack of expertise in the petrochemical industry.

Yes, Malaysia is a net exporter in oil & gas, if that is your point. But it doesn’t mean local glove makers get subsidized raw materials or energy. Besides per its annual report, Intco’s main power source is actually coal, which is a cheaper source of energy.

But as mentioned, all these factors are quite insignificant in the current context of high ASP. When everyone makes easy money, they have the cash to continue expansion.

Yes, these factors are more relevant in the long term. However, by the time when they start to bite Chinese competitors (assuming they do), the ASP would have already normalized to a level that hurt many producers, Malaysian included. When that day comes, I have no doubt Malaysian Big Four will still survive. But the super normal profits would have long gone.

The key argument in all my comments above is, an investment into glove stock doesn't just buy into next 12 months profits, but also 2nd, 3rd and years beyond that.

Question is have these been considered in the valuation?

@Investoz88,
You’ve misunderstood my position. My only exposure to Chinese A-shares is through a CSI300 ETF. Intco Medical is not even part of the index. I’ve always wished Malaysian companies and the country well. I’m not here to cheer nor talk down companies just because I own/ don’t own certain shares.

However, the love for the country doesn’t mean we need to support specific Malaysian stocks. In fact, looking more closely, I believe most people become cheer leaders for the sake of their pockets rather than being patriotic (this is just a general statement not intend to anyone specifically).

Anyway, all attempt of cheering/ talking down glove stocks in this forum is just time wasting. The major Malaysian glove stock shares in circulations are into billions. To impact market price there must be transactions up to millions or dozens of millions of shares a day. And even could be futile. Recall Top Glove attempt to shore up its share price through SBB? The point is money managers who buys and sells in millions have no interest nor time to investment advice from forum users like you and I.

So why do I write long comments? It’s just a way for me to organize and put forward my investment thoughts. I’m not here to seek anyone's agreement. Instead I enjoy reading dissenting which could reveal flaws in my thinking. That is value to me.

I want to say again I'm a believer in Malaysian glove industry. There are quite a few well run local companies. This is also a growth industry. However, good companies bought at unattractive price isn’t a good investment. I monitor Intco only because it could affect supply, and therefore ASP, and in turn the Malaysian glove stock valuation.

Into as a share is not a good investment. But one has to differentiate between the share price and the company. The crash in Intco share price has no impact to the company itself in the near term. Not until it has to raise new capital.

But Intco company is in good financial health. Consider two factors
(1) It holds net cash of ~CNY7.5 billion, or ~RM4.9 billion. This is more than Top Glove net cash at RM2.8 billion, or Hartalega at RM2.3 billion. Assume CNY109 for capex of 1,000 piece, a net cash of CNY7.5 billion can pay for close ~70 billion piece new capacity.

2) Its current capacity of 45 billion piece p.a. will continue to churn out gloves in coming months, when ASP is still relatively high, and when Malaysian producers experience setback due to reduced workforce size during FMCO. The new cash earned at high margin provide more ammunition for further expansion.

Could their numbers be fake? Well, I’ve watched Chinese companies long enough to know multiple past scandals (though the same also happen in Malaysia). But I will consider the following factors in Intco's favor:

(a) It’s easy for companies to fake earning, but not so easy to fake cash.

(b) The last 12 months free cash flow of Intco = CNY11,390 million (operating cash flow) – CNY4,864 million (investment) = CNY6,526 million.
So, unlike say Serba Dinamik which have consistent negative FCF, this company is currently a cash cow (other Malaysian glove makers too)

(c) Frost & Sullivan confirmed it’s now the second largest glove producers in the world. While I’m skeptical of Frost’s future ASP projection, I think they would do a good job in reporting historical matter.

Down the road Into may trip due to its overly aggressive expansion. But until ASP normalizes, Intco will continue to be a spoiler for other players through more supplies and lower prices. Like it or not, that’s how the market economy functions.

Glove stocks may be attractive at current price. But one can only come to the conclusion after cool headed considerations of all factors, including competition.

Now more people are interested in IFRS17 after a round of education by limyuwei. Several related questions were raised at STMB AGM today, including one by MSWG.

Last Sat The Edge reported that IJM, PLUS and Ekovest are also interested in highway trusts.

Highway trust is like a magic bullet. There is no more toll hike for road users. Government avoids compensation due to toll freeze. Yet concessionaires can get the full value. Everyone can be happy as long as road users don't notice that toll concessions have been extended.

As of end Feb 2021, traffic volume at LDP and Sprint was at 90% and 70% of pre-MCO levels. Should expect these two months to be even worse.

Sutp, I see your point.

Note under the same page
Total Debt (mrq) = 292.58M
Total Cash (mrq) = 7.79B, or 7,790 million

Under the tab Financials -> Balance Sheet -> Quarterly,
Shareholders’ equity (‘000) = 13,113,604, or 13,114 million

Therefore, MRQ D/E = 293/13114 = 2.2%. The website display is misleading.

In fact the company has a net cash of 7,790 – 293 = CNY7,497 million.

Sutp,
Thanks for pointing out Mahsing investment cost is only RM41 (~USD10) per 1,000 piece capacity.

This is actually my point. If ASP remains just USD10 (for Mahsing) or USD 16.8 (for Intco) above their production cost, they recoup their investment in 12 months. Profits can be ploughed back for further expansion.

Given the rather low investment cost and ease of expansion, there are two possibilities. First is ASP comes down a lot faster than predicted by Frost & Sullivan and many analysts. This will discourage further capacity expansion as you’ve mentioned.

The second possibility is ASP remains sufficiently high in the near term. The resulting profit will cover investment cost in months rather than years. The supernormal profits provide bullets to aggressive producers like Intco to continue expansion. The end result is even more capacity comes online by 2022. That could bring down ASP even more, albeit one year later

In either scenarios ASP will still normalize faster than the five year projected by Frost & Sullivan.

I don’t think Intco’s debt to equity ratio is 2.2x. Different financial websites may quote different figures which can be misleading. I check Into’s submitted annual report for 2020.

http://vip.stock.finance.sina.com.cn/corp/view/vCB_AllBulletinDetail.php?stockid=300677&id=6954106

归属于母公司所有者权益合计 (Shareholders’ equity) = CNY 9,344 million

短期借款 (short term borrowing) = CNY 22 million
长期借款 (long term borrowing) = CNY 109 million
应付债券 (bonds) = CNY 121 million
Total debt = 22+109+121 = CNY252 million

Debt to shareholder equity = 252/ 9,344 = 2.7%

Other measures for financial health:
利息保障倍数 (interest coverage ratio) = 299.33
EBITDA全部债务比 (EBITDA to total debt) = 243.65%.

In other words, with debt to EBITDA ratio of 0.41X, it only takes 5 months of 2020 EBITA to fully repay total debt. So I think it has a very strong balance sheet, at least up to recent moment.

(... continued)

I’ve read the ASP projection by RHB analyst. I think it is based on dubious logic. Let me quote its latest report on Supermax (same logic also applies to its other glove reports):

“We expect USD40.00 to be the long-term ASP for nitrile gloves. As the US plans to build its own gloves manufacturing plants, we estimate cost of production to be USD40.00. This should set the long-term global nitrile gloves price. When ASPs drop below USD40.00, US producers will stop producing and, in the long term, ASPs should revert back to USD40.00.”

It makes little sense that if US production cost is USD40, the global ASP should then be sold at USD40 or higher. In an equilibrium state, the price floor should be set by the lowest cost producers. Before the equilibrium state is reached, price could well fall under the production cost. A good example is last year WTI price fell far below the US shale producer cost (at one point spot price was negative!), driving many to bankruptcy.

Granted gloves are now considered strategic in US. The US government would support local glove producers. But the support can be in the form where federal agencies are mandated to buy supplies from US producers at a higher price than the market, which is actually supported under current federal laws. But for the large majority of private sector users, they will still buy at the market price, the lower the better. US private sectors will revolt if they are forced to pay foreign supplied gloves at a high price say USD40 set artificially by the cost price of US inefficient producers.

This is why I can be skeptical of analyst projection. Too many are engaged in backward engineering of their calls and then pick convenient excuses as supporting facts.

Last, I don't mean to discourage the glove investment thesis by you or anyone else. I just hope that by arguing for the opposite, just like you arguing for the positive side of the thesis, we help one another reduce confirmation bias and make a better decision. This discussion has been a pleasure!

Pjseow, thank you for sharing your calculation.

I agree Supermax should command a higher ASP because of its ODM model. However, the ODM model also incurs higher sales & distribution cost. Note that pre-pandemic Supermax has lower operating margin and net margin when compared to Harta.

My RM10b for 100b piece capex estimate for Top Glove is a rough number. But it’s based on Top Glove own press release during the latest quarter. In page 2 it states that
“To this end, the Group has earmarked RM10 billion for CAPEX over the next 5 years from FY2021 to FY2025, which will increase its current production capacity by about 100 billion pieces of gloves to a total production capacity of over 200 billion pieces of gloves.”

https://www.topglove.com/App_ClientFile/7ff8cb3f-fbf6-42e7-81da-6db6a0ab2ef4/Assets/Quarterly%20report/Top%20Glove%202QFY2021%20Press%20Release.pdf

Chinese Yuan has strengthened since May 2020. But US QE lifts all boats, Malaysian Ringgit included. While Malaysian mishandling of pandemic (which also impacts our glove producers vis-à-vis the Chinese) and poor fiscal health could weaken the Ringgit, a USD60-70 crude oil price provides good support.

Having said that, I think exchange rate doesn’t play a big role in this context. We are talking about the difference between current operating margin of close to 70% versus pre-pandemic level of 10+%. Forex could at most make only a few percent differences. Besides there is capital control in China, and government intervenes to prevent sharp appreciation/ depreciation. Four years of Trump’s actions have not succeeded in pushing up the currency beyond what the Chinese policy maker has allowed it to go.

On gas price. I know Malaysian glove producers use natural gas in the manufacturing heating process. But cheapness is actually relative. Recall in 2019 glove makers actually complained sudden increase in gas price by Gas Malaysia.

Actually this is not the first time I read about Malaysian advantage in cheap gas as compared to the Chinese. However, do Chinese glove producers used gas like their Malaysian counterparts? I actually doubt so.

Refer to Intco annual report. It mentions
能源方面，公司所需的主要能源为煤炭，已为所有营运中的生产基地取得了能耗指标，并在安庆（安徽）及岳阳（湖南）生产基地投资热电联产项目，加强公司在能源消耗方面的成本控制。

http://vip.stock.finance.sina.com.cn/corp/view/vCB_AllBulletinDetail.php?stockid=300677&id=6954106

In other words, the main energy usage by Intco is coal. It also has energy production JV to control costs. While coal is dirty, it is much cheaper than gas. That is also true in Malaysia, which is why we still commissioned the last coal-fired power plant this year, and coal plants will only start phasing out by 2030. Yes, China will also phase out coal under its net zero policy. But China is a leader in renewable energy, where production cost keeps plummeting.

Anyway, like exchange rate, I don’t see the energy cost plays a big factor in the ASP/ production competitiveness in the next few years.


(to continue next)

Pjseow, I’ve put in all I know about glove industry in my many exchanges with Ben Tan earlier, which you also joined occasionally.

I’ve been a believer in glove secular growth long before the pandemic. I must admit that I’m underweight in glove now. I closely follow the development in order to rebalance at the right time.

Unfortunately, I don’t have a crystal ball either. As I explained before, from the lessons learned from other industries, I’m doubtful of Frost & Sullivan ASP projection. It assumed a gradual ASP decline which remained elevated up to 2025, and that contradicts experiences elsewhere.

You’ve put forward good arguments on why glove is not like agricultural products. When ASP is depressed, incumbent glove producers can restrain capacity expansion plan (they did in the past) or scale back capacity utilization.

Let’s examine the logic in more details. First, unfortunately the relative ease to adjust output level is a double-edged sword. It also means it's relatively easy to expand capacity, for newcomers too. That is why I believe ASP will normalize faster than Frost & Sullivan has projected.

Of course, the ability to restrain output could help putting a floor to the ASP. The nitrile glove ASP level per 1,000 pieces between 2015-19 was around USD23. Incumbent producers made money at this level. Supermax net margin then was 8% to 12%, and Harta was 15% to 18%.

At this level, many smaller new entrants will struggle. But they won’t throw in the towel immediately. Some have actually been in the business for a long time and were acquired by other non-glove listed companies. With access to capital, these “new” players can still survive a price war for considerable time.

I agree the Malaysian Big Four will weather the storm and even prosper after that. However, the same cannot be said of individual shareholders. It depends on their average entry price. Besides, the share price could depress further should ASP ever falls to the low 20s level faster than expected. That will test shareholders’ conviction and emotional strength.

Now bring China into the picture. As mentioned before, previously the Malaysian Big Four had tacit understanding to restrain capacity expansion when demand was weak. Not so easy now with new big players in the form of Intco and Blue Sail. It is just like OPEC + Russia have more challenges maintaining price level when shale producers disrupted the equilibrium.

It would help if Malaysian Big Four are still the most efficient producers. But they may no longer be. Labor related benefits are already rising to fend off sanction threat by CBP and the like. Locally the dire state of government finance does not help as people start clamoring for windfall tax.

On the other hand, Chinese producers like Intco is every bit as efficient as the Malaysian Big Four. In 1Q2021, the operating margin of Supermax, Hartalega and Intco Medical are 68.5%, 68.2% and 65.7% respectively.

https://finance.yahoo.com/quote/7106.KL/financials?p=7106.KL
https://finance.yahoo.com/quote/5168.KL/financials?p=5168.KL
https://finance.yahoo.com/quote/300677.SZ/financials?p=300677.SZ

The Chinese receives strong local government support. I’ve shared this example before. When Intco signed an agreement with Jiangxi 彭泽县 county, the local government was responsible to deliver 800 acres of land priced at only CNY40,000 (RM25,000) per acre. In comparison, last year Harta paid RM 263 million for 38 hectares of land at Sepang, or RM2.77 million per acre. In other words, Harta’s land cost is more than 100 times of Intco.

http://www.szse.cn/disclosure/listed/bulletinDetail/index.html?05bdcdcb-ca2c-4db4-9e07-741fded2df81

I’ve done some calculation comparing the Capex per 1,000 pieces. Intco budgeted CNY5 billion for the Jiangxi 彭泽县 county project, for an annual capacity of 45.75 billion according (refer Feb 2021 announcement). That is equivalent to Capex per 1,000 pieces of CNY109.29 or USD16.81 (at exchange rate of 6.5).

As a comparison, To Gloves announced target of 100 billions capacity with RM10 billion investment, i.e. per 1,000 pieces Capex is at RM100 or USD25 (assume exchange rate of 4), much higher.

Based on the disclosed information, I have to conclude that the currently still high ASP is actually dangerous for Malaysian producers. Say ASP is maintained at USD60 for a while longer. Based on 1Q21 net profit margin of 55%, by selling every 1,000 pieces Into can record a net profit of USD33. It can pay for new capacity of 2,000 pieces per annum! Or sell 1 piece can fund capacity for 2 more pieces!

Intco’s stated aim is to expand fast and grab market share. It will expand like crazy as long as it has the funds. It's a proxy to China's supply threat. While I'm unable to forecast the ASP, the development there could offer hint on the future ASP trend.

RM5 cash per share, or about RM1.6 billion cash. It sits in Hong Leong Bank, earning peanuts for HLIND shareholders. But it is a cheap and stable source of funding for HLBANK shareholders.

You have to be a HLBANK shareholder too to enjoy the full benefit of the cash!

Sutp, thank you for your blog which is based on data and analysis. I'm sure any readers will learn something regardless of their position.

The fortune of glove stocks will largely be determined by the ASP trend in coming quarters. The ASP trend is in turn decided by the supply-demand dynamic.

As a rule of thumb, a supernormal profit situation cannot last for long without protection from high entry barriers such as regulation, high IP content, high upfront investment or network effect. Unfortunately the incumbent glove companies do not have such protections. Their key advantage is in efficiency. In other words, through economy of scale and accumulated past knowledge, they can produce at lower unit cost and crush new rivals through competitive pricing.

Therefore it's not a surprise that before the pandemic, Supermax has only modest operating margin of 10% to 13%, and net margin of about 10% for most of the last decade (but last 12 months was about 70% and 50% respectively). Even Hartalega operating margin is in the range of 20% and net margin in mid teens. I expect when ASP fully normalizes, margin will revert to pre-pandemic level, if not lower. Any excess profits would be competed away either by incumbents' own capacity expansion or by new capacity from rivals. The question is how long the process will take.

You mentioned Frost & Sullivan report. Frankly I'm not too convinced with their ASP projection. I note that Frost & Sullivan is not a disinterested party. It was appointed by Top Glove as the industry consultant for Top Glove's Hong Kong listing. I've come across many Frost & Sullivan reports used by other company IPOs in a variety of industries. I have yet to come across one report where its projection has undermined the company IPO attempt.

The said Frost & Sullivan Report can be found in page 96 in the HKEX listing document below. The projected ASP (per 1,000 pieces) for nitrile glove is USD85.1 in 2021, USD53.5 in 2022, USD35.1 in 2023.
https://www1.hkexnews.hk/app/sehk/2021/103230/documents/sehk21022601984.pdf

I agree forecasting beyond a year is difficult. But I have doubt in Frost & Sullivan because their projected ASP decline is too gradual. In their projection, ASP will not even return to the 2015-2019 historical average of USD23 five years from now! Given that glove sector has a low barrier of entry, I will expect excess supply to reach the market much sooner than Frost & Sullivan has thought.

This is the economic principle of free market economy at play. The same pattern has happened many times in other industries like solar panel, oil, steel, and more recently face masks. (Perhaps many Malaysians will also be surprised to learn that global vaccine production capacity was 3 billion pre pandemic, but is projected to reach 11 billion by end of 2021, and over 20 billion by end of 2022!)

For that reason, in order to understand opportunities of Malaysian glove sector, I watch Chinese producers closely. There are a few listed glove makers there. By now most people will be familiar with Intco Medical.

As of 2019, Intco Medical annual capacity was only 19 billion pieces, of which only 5 billion pieces were in nitrile gloves. By now its capacity has reached 45 billion pieces, of which 21 billion are in nitrile gloves. In has leapfrogged competitors to become the world second largest producer.

Refer to the company response to investor on May 7 below. Intco expects new production lines at Anhui and Jiangxi provinces to double its nitrile glove capacity by end of Q3. It expects annual capacity to reach 120 billion by Q2 of 2022. If the projection is right, Intco could have easily close the global glove shortage gap as projected by MARGMA (I'm also not sure how robust is MARGMA forecast methodology).

http://irm.cninfo.com.cn/ircs/company/companyDetail?stockcode=300677&orgId=9900032727

The NBR capacity constraint is being addressed too. In Aug 2020 Intco invested in a project with 50 million ton NBR capacity to be completed in 15 months. A phase 1 installation of 30 million ton capacity is on going according to its announcement to the stock exchange. The announcement also mentions that currently the NBR shortages situation have been addressed as many domestic NBR producers have expanded production.

http://static.cninfo.com.cn/finalpage/2021-04-19/1209718506.PDF

As a check point, I want to watch whether Intco can deliver the doubling of its nitrile glove capacity by Q3 this year. If t does, the Frost & Sullivan ASP projection will be in serious trouble. The Malaysian glove stock valuation may have to adjust accordingly based on a lower ASP.

How important are agencies like NPG to the growth of Allianz life insurance? I ask because the agency glamorous image, while helping recruitment, is at odd with the conservative & reliable insurance image projected to customers.

Could there be some inherent risk?

Slide 7 shows the core profit before tax (which strips out the effects of fair value loss). For the past 5 quarters, the core PBTs are
1Q2021, RM130.7m
4Q2020, RM192.2m
3Q2020, RM176.0m
2Q2020, RM206.5m
1Q2020, RM116.2m

While core PBT increased 12% YoY, it declined 34% QoQ. Is this good or bad? I wonder if insurance business has strong seasonality effect, where results tend to be stronger towards the year end?

Market share for General Insurance is maintained at 13.3% (No 1). Life increase from 7.7% to 8.8% (but position dropped from 5th to 6th)

On the life side, Annualized New Premium continues to grow. ANP for the past 5 quarters:
1Q2021, RM171.3m
4Q2020, RM167.7m
3Q2020, RM150.7m
2Q2020, RM90.8m
1Q2020, RM122.6m

However I don't understand how to relate the new business value of RM82.6m to the ANP of RM171.3m. Appreciate if anyone can explain.

*** from above ***

It only becomes a concern if inflations morph into the 3rd scenario which is above 4%. If that happens (current market consensus is it won’t), the Fed’s ability to rein in inflation will be questioned. To retain its credibility, the Fed will have to tighten forcefully, potentially triggering a recession. This will be bad for equity.

Of course, it will be a catastrophe if US goes back to its double digit inflation days (scenario 4). Foreign creditors will see their US Treasuries holdings evaporate in value. The USD reserve currency status will become shaky. With the fiat currency in turmoil, physical gold will be a very sought-after asset.

However, the reality today is US is still in scenario 1 (which is 2% or lower inflation). 2021Q1 core PCE (a preferred measure of inflation by Fed) is only 1.5%
https://fred.stlouisfed.org/series/BPCCRO1Q156NBEA

We’re only taking about entering scenario 2 (2% to 4%) territory. I think it’s a bit premature to worry about scenarios 3 or 4.

I agree the velocity of money is picking up. But take a look at this velocity of M2 Money Stock chart from St. Louis Fed.
https://fred.stlouisfed.org/series/M2V

I have two observations:
(A). The velocity is only picking up now, from a very low base. The current situation is actually just a reflation. There is no sign high inflation or overheating.

(B) The velocity of money has been dropping steadily over the past 20 years. Even after 4 rounds of QEs since 2009, with trillions “printed”, the velocity of money is still trending downward. This is a strong evidence that there are larger deflationary forces at work. That's why deflation rather than inflation has been a greater enemy in the last decade.

It’s difficult for me to talk about risk of inflation without quantifying the inflation. So I shall discuss 4 different inflation scenarios:
1. 2% or below
2. 2% to 4%
3. 4% to high single digits
4. Double digits

As can be seen from the chart below, core inflation (which excludes the volatile energy and food prices) have been trending downwards, another sign of structural deflationary forces at work. In the past decade, there were more years where inflation was below 2% than years above 2%.

https://tradingeconomics.com/united-states/core-inflation-rate

That’s why Fed wants to pursue a more “robust” inflation. As the new Fed policy now targets an “average” 2% over a period, the Treasury market expectation for inflation 5 years from today is at 2.37%

I noted this is at the lower end of the 2% to 4% range. I think it's very acceptable. The stock market could tolerate it.

*** continue next ***

Hi Ben, thanks for your reply.

I didn't read Part 1 of your article earlier until you pointed out above. I just read up and commented. We could continue our discussion there if you wish to.

Hi Ben, let’s see if I get your central idea in this article.

You mentioned the “unrealized monetary value depreciation”. This was the result of Fed money printing (and more importantly government handing out cash directly to people, meaning printed money won't just sit idly as bank reserves)

You mentioned that “inflation can only get realized when countries start decisively going out of the pandemic”. The key evidence is high personal saving rate is at a record high. When the saving gets spent down as economy normalizes, inflation could follow because lots of money would chase after limited goods and services.

I agree that the high personal saving now would contribute to inflation later. However, I believe the the impact is modest and only temporary. For the rest of this comment I would focus on the personal saving.

Below is the data on US personal saving in absolute term (which should match your chart in percentage term), as published by the St. Louis Fed.
https://fred.stlouisfed.org/series/PMSAVE

There are a few key data points which I would refer to later:
Feb-2020 (eve of Covid-19 outbreak in US): USD1.4 trillion personal saving
April-2020: USD6.4 trillion saving
Nov-2020: USD2.1 trillion saving
Jan-2021: USD3.8 trillion saving
Feb-2021: USD2.5 trillion saving
Mar-2021: USD3.0 trillion saving.

For perspective, the total US personal income in 2020 is about USD20 trillion. Therefore, throughout the last 1 year, the saving rate fluctuated between 1 to 4 months of personal income.

There are two spikes in the personal saving chart. The spikes correspond to the first two rounds of stimulus passed by the US governments.

Under the first round of CARES Act most tax paying adult received up to USD1,200 per person. There were also increased unemployment benefits. They were largely responsible for the first spike that peaked in Apr 2020. Notice the USD6.4 trillion personal saving in Apr 2020 got spent down to only USD2.1 trillion by Nov 2020. It didn't cause any inflation concern (not a surprise given the weaker economy during the pandemic)

The second spike in personal saving up to USD3.8 trillion in Jan-2021 corresponded to Trump’s second stimulus bill in Dec 2020. It came with a smaller USD600 stimulus cheque per person. That is why the spike is smaller. The personal saving got spent down to USD2.5 trillion by the next month. Again the spending down did not create high inflation.

The third spike in personal saving is building up now. It is largely the results of Biden’s USD1,400 per person stimulus cheques that started flowing out since Mar 2021. Although the April data has not been published, I expect a new height would be reached in April.

Given the economy is much stronger now, the spending down of this third spike in personal saving could be more inflationary. But not much more. More importantly it won’t last. There is no more stimulus cheques! (The other USD2.3 trillion infrastructure bill currently under negotiation is another matter, which can be discussed separately)

In other words, despite the incredible spikes in personal saving rate as shown in your chart, the impact to overall inflation has been really minimal. We’ve already seen two rounds where a few trillions USD were spent down, topped up and spent down again without overheating the economy. Throughout the pandemic last year US CPI never exceeded 2% (only now it was at 2.6% based on latest Mar-2021 data)

Yes, most people agree that US inflation would pick up in the coming months. But the contribution from the trillions of personal savings would be limited and only transitionary.

This is not the usual one to one chess. It's a multiple player simultaneous chess. That's why it's hard. One can either make a side bet or be a spectator.

Not fake news. This is just the opening move of a new chess game. The last game lasted over a year with no winner.

EPF has several hundreds billions invested in local equity, restricted to about 200 companies. Some funds are managed by external managers which may have different strategies. So it's not a surprise to see EPF everywhere.

Not sure how EPF views Litrak. But personally I see Litrak as quite defensive at prevailing price. It has limited downside and offers stable dividends until concessions expire. It complements more risky holdings in a portfolio. However I don't expect much capital appreciation.

Ben, thanks for your article on the important topic of inflation outlook.

My view is the inflation expectation in US has gone up mainly due to optimism about reopening of economy. 45% of US population has received at least one jab, way higher than many have expected just a few months ago. Daily confirmed cases have dropped from a peak of 25k to less than 5k now.

https://ourworldindata.org/covid-vaccinations
https://ourworldindata.org/coronavirus/country/united-states

Higher inflation expectation is also encouraged by the Fed with its plenty of patience in holding off rate hike. In Aug 2020 the Fed has announced that instead of targeting 2% inflation, it would target inflation that AVERAGES 2% over time.

While the Fed is silent on how long is the average duration, most people believe the Fed would be sanguine to let inflation runs to say 3% in the coming quarters to compensate for the shortfall in earlier period. This could help to put the economy on a firmer footing. This would reduce deflationary risk due to frequent undershooting of target in the last decade.

Besides a little push on the wage increase helps to reduce income inequality in the US. Inequality has been feeding the dangerous populist sentiments and creating a fertile ground for demagogues like Donald Trump.

Yes, there is a risk that the Fed monetary policy, coupled with Biden's expansionary fiscal policy, could bring back double digit inflation like what happened in the 70’s.
https://tradingeconomics.com/united-states/inflation-cpi

But so far there is little evidence of wage-price spiral that was necessary for persistent high inflation. Higher wages is the key to high inflation given close to 80% of the US economy is contributed by services. As long as wage growth remains moderate, as many expect it to be, the commodity price rise in crude oil, copper, lumber and so on is likely to be transitionary. Besides, technological advances are deflationary in nature given it replaces manpower.

I note that not even Larry Summers, who has strongly criticized Biden’s stimulus, has boldly predicted the comeback of high inflation. Summers has covered himself with plenty of ifs.

In fact if one were to believe in the market verdict, participants in the Treasury market bet with their money that the US inflation rate 5 years from now is 2.3%

https://fred.stlouisfed.org/series/T5YIFR

Of course, a 2% to 3% inflation rate in US does not provide comfort for Malaysians if we experience much higher inflation.

Looking at Malaysia past situation, normally the risk of high inflation comes from sharp depreciation of the Ringgit, especially during a financial crisis which leads to capital flight.

That’s why I don’t agree with your view that a person living in Malaysia should focus his investment in Malaysia. I believe a healthy dose of diversification out of Malaysia is important. Not necessarily just US, or China for that matter. For example, a typical retailed investor may invest in good track record unit trusts that invest in the region or even globally. Better still, dollar cost averaging into low-cost ETFs that track US, European and AP market.

But there is a more important decision than selecting which share market, which sector or even which stocks. A well thought through asset allocation plan is crucial to help investors ride through all market conditions. So to me the most important decision is the percentage allocation into cash, equity (foreign and local), bonds, real estate and even precious metals.

Take three typical scenarios that associate with the inflation rates:
1) Deflation (negative inflation) – as experienced by Japan in 90s and 2000s, or by HK in late 90s and early 2000s. Government bonds will outperform (but this does not apply to developing country government bonds given the tendency of capital flight). Cash is an alternative option

2) Mild inflation – like most of the years in US from 80s and now. Actually S&P 500 return since 1980 is about 100 folds!

3) High inflation – Not just bonds and cash, but stocks will suffer too, as most companies cannot pass on cost increase fast enough. It will be even worse during stagflation, where companies also suffer from weak demand. When there are fears about debasement of fiat currencies, I believe gold will make a comeback. Gold has not only been tested in the 1980s high inflation period, but also in many war periods centuries ago.

As for cryptocurrencies, I believe it is an expression of easy liquidity today. When there is a systemic risk that the world is falling apart (though very unlikely in my view), individuals as well as country central banks will prefer to hold physical gold rather than Bitcoin, Ethereum, not to mention dogecoin, as they all rely on a functionating Internet to verify transactions!

Of course it's good for the 43% shareholder Gamuda. It's their proposal!

As for the rest, it depends on individual entry price and the final offer price. A 4.5 offer should be good enough for anyone who bought at 3.7 last week, right?

It reminds me of a tale from a Chinese idiom. The owner wanted to ration the food supply to his monkeys. So he tried to strike a deal by offering the monkeys 3 fruits in the morning and 4 in the evening. The monkeys protested.

But the owner had good knowledge of financial engineering. So he next proposed 4 fruits in the morning and 3 in the evening, which made the monkeys happy and accepted the better offer.

Motorists don't want to pay for higher toll. So the government tells concessionaires not to raise toll.

But the government is short of money to compensate concessionaires. Gamuda the concessionaire also needs money to fund its Penang Transport Master Plan project.

So Gamuda has come up with a "clever" financial engineering so that everyone can have the cake and eat it too!

Toll will be frozen. In return the government needs to offer longer concession period (like PLUS). And instead of a government buyout, a non-profit Highway Trust will raise money by issuing bonds to buy highways from Gamuda and Litrak minority shareholders. To sweeten the deal, the government also needs to provide tax exemption.

In a nutshell, it's to take advantage of the current low interest rate environment by swapping the more expensive equity ownership (since cost of equity is higher) with the cheaper bond (as cost of debt is lower). The government does not fork out a single cent but just use its power to sweeten the deal.

I recall in 2019 Gamuda accepted the valuation at RM5.2

Given current concessions are shorter by 2 years, dividends has been paid out during the interim, and the temporary traffic reduction due to the pandemic, logically it should worth less now. I think RM4 plus should be fair? Probably at the lower end of RM4?

Let’s digress a bit. Yes, I also read about Prof Jomo’s remark to impose windfall tax on industries that greatly benefit from the Covid-19 crisis. No doubt it will impact glove stock share price if the government were to take his advice. May be there will be some sort of compromise later, like another round of contribution by the large glove makers to relieve the pressure.

Windfall tax will not doubt hurt Malaysia’s image. The country has been lagging behind regional peers in wooing foreign investors. It will also deter local investment. However, to put things in perspective, Malaysia will not the first countries to impose such a tax. In fact within Malaysia the glove industry will also not be the first to “suffer”. Utilities and palm oil producers have paid/ been paying windfall tax.

In fact, I consider it’s even more unfair for palm oil producers, many of them are struggling, to have to share their “windfall” whenever CPO price merely exceeds RM2,500 per MT (RM3,000 in East Malaysia). This so-called windfall levy on palm oil companies is based on selling price rather than profit. As a result, even loss-making palm oil companies have to share their “windfall”. If the tax has to be imposed, it should be on a real “windfall” situation, i.e. that is currently enjoyed by glove companies.

There are two common arguments against imposing windfall tax on glove companies. First argument is glove is not commodity like palm oil. There are many different types of gloves like surgical, cleanroom and so on. There are also branded and OEM. However, on the other hand, unlike say electronic products, there are only so many types of gloves. So, I believe this is mere technical issue that could be resolved, even if not very satisfactorily.

A better argument is a windfall tax will defer glove producers from further investment, and may even drive them to invest abroad. That’s why I think the windfall tax will have to be designed in a clever way to encourage continuous domestic investment. For example, part of the tax should be exempted if investment in Malaysia is above certain threshold. This will encourage glove companies to invest their profits but discourage it from splashing on dividends or stock buybacks.

The next question is that, if government discourage dividend when glove companies have record profits, who will want to invest in glove company stocks? The share price will sink. But actually this doesn’t really matter from the economy stand point. The glove shares are currently traded in the secondary market (Bursa). No matter how high or low the share prices are, it is not going to increase or decrease company capital which is needed for investment.

It only matters when companies want to raise new fund through IPO or placement or right issues. But with record profits it is very unlikely that leading Malaysian glove companies need to raise fresh capital in the next few years. At least not in Malaysia. The secondary listing by Supermax and TG are to take place outside Malaysia anyway.

I suppose many glove investors won’t like my view. In a nutshell what I want to say is I agree that windfall tax should never be imposed in an ideal world. However, Malaysia is far from ideal, and windfall tax already exists today and get imposed on the wrong targets. So I think a carefully calibrated windfall tax on glove companies is not necessarily a bad idea, especially if it can relieve the pressure on public finance and offer respite to palm oil companies.

Ben, thanks for your analysis. Thank you for the effort in keeping everyone informed on the latest development.

I agree that Supermax statement on the ASP drop is not very clear. But since it’s part of the press statement I don’t expect detailed elaboration. However, analysts who attend the post result briefing should clarify and report accordingly.

Taking a step back, I see the market sell off as a sign where investors believe ASP has reached a turning point sooner than expected (though Harta may have 1 more quarter). Just a few months ago, the market consensus was ASP would remain elevated throughout the 2021, perhaps with only gradual decline in second half of 2021. A drop of 15% to 25% in the first quarter has badly dented analyst forecast for 2021. That’s why in today research reports on Supermax analysts slashed revenue, earning, cashflow and the resulting TP.

Supermax press release also mentions about large-scale increase in public listed Chinese rivals. Although it doesn’t name them, the high-profile ones are Intco Medical, Blue Sail Medical and Zhonghong. Actually Intco Medical also had a record revenue and profit in Q1 2021. Q1 revenue of CNY 6,735 million was 38% higher QoQ. Operating margin at 66% is on par with Malaysian glove producers.

Intco is still aggressive with its expansion plan. A subsidiary is building a Nitrile Butadiene Rubber facility with a capacity of 500,000 metric tons in Anhui province. The company announced that the first phase with 300,000 metric tons of NBR is already under installation. Intco also projects another 120 billion pieces of glove capacity come online by Q2 of 2022.

However, like Malaysian glove producers, Intco share price has weakened since the last few months (from the height of 280 to 160). Currently Intco is only valued at a TTM PE of about 5 times. So both the largest (TG) and second largest (Intco) glove makers in the world are now selling at 5 times!

In a sense that may be good news for Malaysian producers. It means Intco will face challenge in raising large amount of capital in Hong Kong. Actually, I suspect TG also faces the same challenge. TG recent announcement to halve the size of its HK listing is not so much due to consideration of not diluting Malaysian investors (if so why go ahead in the first place), but probably because TG bankers have difficulty securing enough interests from new investors.

If my guess is right, that will actually be favorable for leading Malaysian players for they can continue to expand and defend their market share using internally generated funds. That is the plan of Hartalega and Supermax as they only give out meagre dividends, preferring to plough their profits for expansion and defense against the Chinese.

Just an side note.

Ping An Insurance (HKEX stock code 2318) diluted EPS for past 4 quarters is CNY 8.11, or HKD 9.73. The closing price today is HKD82.1, translating into a TTM PE of only 8.4 times. This is commonly viewed as the best managed insurance company in China -- impressive growth (although growth has flattened during pandemic; ROE ~20%.

The situation of Malaysia and China may not be comparable. However I wonder for an international investor would Ping An be relatively more attractive?

Any comment yuwei?

@limyuwei, thanks for sharing HLA business performance.

Slide #16 shows the EV, which is an information not provided by Allianz. Do you have any comment on the EV and NBEV by HLA? In your view how does HLA perform vis-à-vis other insurers?

Slide #17 mentions HLA focuses on no-par and investment-linked products as they have higher NBEV margin. Can you explain why such products have higher margin? What is the situation at Allianz?

The concessionaire of the Maju Expressway has deferred its bond coupon payment.

It was reported that
""The Covid-19 pandemic and resultant MCO slashed the average daily traffic of the Maju Expressway by 39.1% to only 88,970 vehicles in 2020 (2019: 145,987 vehicles). This in turn severely weakened the earnings and cash flow-generating ability of MESB, the concessionaire of Maju Expressway"

https://www.theedgemarkets.com/article/highway-operator-mex-ii-defers-bond-coupon-payment

This news is negative to highway concessionaire companies. Although LDP and Sprint may fare better, and Litrak has a stronger balance sheet, it would still be impacted by low traffic at least in the short term.