We are maintaining our OVERWEIGHT rating for the rubber gloves sector. Rubber glove stocks under our coverage have performed poorly YTD, led by TOPGLV (-13%), SUPERMX (-11%), HARTALEGA (-10%) and KOSSAN (-9%), but we are not perturbed and expect the sector to recover and even outperform in subsequent quarters. This is based on our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply demand equilibrium and ultimately dispel market skepticism of a potential oversupply situation. We expect earnings growth to resume in subsequent quarters, underpin by: (i) new capacity expansion fueled by sustained demand for rubber gloves, led by latex gloves, although nitrile gloves, which have been consistently taking up the former’s market share, will continue to show better growth prospects, (ii) the weakening of the Ringgit against the US dollar, which is positive to rubber glove players, and (iii) the sustained low raw material prices. Our TOP PICK is SUPERMX. We like Supermax because: (i) it is trading at 11.4x FY14E EPS (30% discount to the sector average) compared to an average 15% net profit growth over the next two years; and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax eliminates some uncertainty and helps lends credibility to its business model and management. SUPERMX is trading at 11.4x FY14 earnings while KOSSAN is trading at 14.7x FY14 earnings. We believe the valuation gap should narrow when we consider that SUPERMX’s capacity and net profit are at levels similar to KOSSAN. We also have OUTPERFORM calls for KOSSAN (TP: RM5.13) and HARTALEGA (TP: RM8.21).

Sell-off on rubber gloves stocks unjustifiable. Although rubber glove stocks under our coverage have performed poorly YTD 2014 led by TOPGLV (-13%), SUPERMX (-11%), HARTALEGA (-10%) and KOSSAN (-9%), we are not perturbed and expect stock prices to Outperform again in subsequent quarters. The optimism is based on our analysis that the slower-than-expected new capacity expansion should help keep supply-demand in equilibrium and ultimately dispel market skepticism of an oversupply situation. Following the dismal Top Glove recently announced 2Q14 results, share prices of rubber gloves stocks under our coverage have fallen by between 6-11%. Recall Top Glove’s poor set of results were dragged down by its low-margin latex based products with intense competition as well as its low utilisation rate averaging 72%. However, from our channel checks, we gather that players like Hartalega and Kossan is presently operating at full capacity. Hence, we do not expect Top Glove’s poor set of results to spill over to other rubber glove players under our coverage.

Oversupply concerns appear overplayed. Tell-tale signs of oversupply concerns appear overplayed considering that capacity expansion of the four rubber gloves under coverage are expected to be delayed and staggered. Kossan’s 5b pieces capacity will only gradually be ramped up starting from Mar 2014 (1st plant) and the other two plants will commence in May-Jun 2014 (net increase in new capacity for 2014 is 2.5bn pieces). Supermax’s new plant with an estimated 5.3b pieces will only start ommercial operations end 2Q 2014 with an estimated net incremental increase of 2.5b pieces. Top Glove is scalling back and only expects 2b pieces new capacity by end 2014. Meanwhile, Hartalega’s NGC plant is only expected to commence commercial production by 4Q 2014 with a net incremental increase of 2.0b pieces by end 2014. If we sum this up the new capacity is only about 9b pieces which is only 56% of new world demand (if we take global demand at 160b pieces of gloves and assuming a 10% growth, new demand is expected at 16b pieces) which accounts for less than 60-65% of Malaysia market share globally (bearing in mind all the four players under our coverage accounts for an estimated average 90% of production in Malaysia). Separately, from our channel checks, we gather that players like Kossan and Hartalega have reached peak capacity for the Jan-Mar 2014 quarter volume sales (please refer overleaf for details).

Mixed bag of results. Rubber gloves stocks under our coverage delivered a mixed bag of results in 4QCY13. Kossan and Hartalega came in largely within our and market consensus expectations. However, Supermax and Top Glove came in below both our and market consensus expectations. Supermax’s 4Q/FY13 results were hit by an unexpected fire at its Alor Gajah plant leading to a temporary loss of production output. Similarly, Top Glove recently released 2Q14/1H14 results, which came in below expectations at 40-41% of both our and the consensus full-year forecasts due to: (i) losses from its China operations (vinyl division) amounting to RM10.6m, (ii) margin pressure from intensifying competition and inability to implement full cost pass through and (iii) forex losses.

No worries on potentially higher energy cost going forward. Ceteris paribus, the recent hike in electricity tariff is expected to hit rubber gloves players’ earnings by 2-3%. However, we are not overly concerned since rubber gloves players generally were able to pass on the cost increase judging from past experience during electricity and natural gas tariff hikes. Electricity cost accounts for an estimated 20-30% of fuel costs which in turn make up 10% of total production costs of rubber gloves players. Natural gas accounts for the remaining 60-70%. From our observation, earnings of rubber gloves players were not impacted from the hike in gas and electricity tariff back in 2011.

Maintain OVERWEIGHT. Our TOP PICK is SUPERMAX with an OUTPERFORM and TP of RM3.80. We like Supermax because (i) it is trading at 11.4x FY14E EPS (30% discount to the sector average) compared to an average 15% net profit growth over the next two years; and (ii) we believe the re-emergence of EPF as a substantial shareholder of Supermax eliminates uncertainty and lends credibility to its business model and management. We maintain our OUTPERFORM calls on KOSSAN (TP: RM5.13) and HARTALEGA (TP: RM8.21) and MARKET PERFORM on TOPGLVE (TP: RM5.58).

Source: Kenanga