Rubber Gloves - More Upside from Earnings Growth!

Rubber Gloves - More Upside from Earnings Growth(finally !!!)
from KENANGA

We maintain our OVERWEIGHT rating on the rubber gloves sector. Rubber glove stocks under our coverage have performed well YTD, led by KOSSAN (+30%), SUPERMX (+26%), HARTALEGA (+23%), and TOPGLV (+21%). Nevertheless, we believe they still have further upside moving into 2Q15. The stage is set for rubber gloves makers to post decent-to-solid quarterly earnings growth over the next few quarters. Our investment case is based on: (i) resumption of earnings growth in coming quarters, underpinned by new capacity expansions matched and fueled by sustained demand for rubber gloves, led by nitrile gloves, (ii) favourable USD/MYR exchange rate, and (iii) the sustained low raw material prices especially latex. We expect glove makers to announce good sets of 1QCY15 numbers due to the commencement of new capacity starting from Jan 2014 and a favourable forex rate. As an indication, the recently announced Top Glove’s 2Q15 results which topped expectations were boosted by the strengthening of US dollar against MYR. In the meantime rubber glove players indicated that customers have been found for their new plants’capacities. Our Top Pick is HARTALEGA with a TP of RM9.50. We continue to like HARTALEGA for its: (i) highly automated production processes model, (ii) solid improvement in its production capacity and reduction in costs leading to higher margins compared to its peers, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position. We also have OUTPERFORM calls for KOSSAN (TP: RM6.68) and SUPERMX (TP: RM2.75).

Mixed bag of 4QCY14 results. Results of the glove makers from the 4QCY14 results season were mixed. Both Supermax and Hartalega posted results which came in below expectations. However, Kossan Rubber came in within but Top Glove topped expectations. Hartalega’s results were lower due to higher-than-expected operating expenses arising from new recruitment of labour for the incoming NGC project. Supermax saw lower-than-expected sales volume and start-up costs incurred in new plants. Kossan interestingly saw a 7% QoQ volume growth driven by maiden contribution from additional new 5 lines in Plant 1. However, the best performer was Top Glove in its recently announced 2Q15 results which topped expectations, due largely to an 8% strengthening of US dollar against the RM.

New in-coming capacity to drive quarterly earnings growth in FY15. Concerns of oversupply appear to have dissipated as earlier highlighted. In fact, in-coming new supply had been slower-than-expected. However, after a year of slowdown in most of 2014, all four players namely Hartalega, Kossan, Top Glove and Supermax have started commissioning their new plants gradually in end 4QCY14, albeit at a slower pace. As such, the slower-than-expected ramp-up in new production capacity further reinforces our positive outlook on the sector by allaying concerns on competitive pressure and oversupply issues. Apart from favourable forex, we expect new capacity to drive earnings growth of rubber glove stocks under our coverage over the next few quarters. Hartalega’s NGC plant has commissioned production in end Dec CY14 and currently with six running production lines. We expect Kossan to register solid growth in both revenue and earnings for 2015 with additional capacity of 6b pieces of gloves added after the full completion of three plants with 17 double-former high speed technological advanced production lines running in full force. We understand that customers have been secured. This brings the three new plants’ installed capacity to 22b from 16b per pieces of gloves per annum. On Supermax, we understand that two lines, from the new plants namely Lot 6059 and Lot 6058, are expected to start commissioning soon. From our channel checks, demand for nitrile gloves is strong.

Weakening of MYR vs. USD is short-to-medium-term positive to rubber glove players. Taking a que from Top Glove’s recent 2Q15 results, we expect other glove makers to report good sets of 1QCY15 numbers underpinned by the strengthening of USD against MYR. YTD, the USD had risen by 7% against the RM (USD1 = MYR3.69). Generally, a weakening Ringgit is positive for glove makers. Since sales are USD-denominated, theoretically, a depreciating ringgit against the dollar will lead to more revenue receipts for glove makers. Ceteris paribus, a 1% decline of RM against USD will lead to an average 1%-2% increase in the net profit of rubber glove players. However, we believe the impact from currency movements to glove players’ earnings is neutral over the long-term. This is because glove players typically hedge the currency on a consistent basis, hence in theory any negative or positive impact will be neutralised over time.

We like KOSSAN, maintain OUTPERFORM and TP upgrade to RM6.68. We are raising KOSSAN’s TP from RM6.00 to RM6.68 by upgrading our PER from 16x to 18x (at +2.0 SD above its historical forward average) as its prospect is enhanced by the new production lines that could potentially lead to higher margins. We believe KOSSAN’s new gloves production lines could potentially lead to higher margins from improvement in productivity and efficiency as the lines are designed to focus on larger orders with fewer clients (compared to previous production scheduling model) for a single product type and specification, thus reducing idle downtime from frequent machinery setting adjustments to accommodate diverse specifications. This could lead to an output of 35,000 pieces of gloves per hour, which is higher than its existing average production line speed of 29,000 gloves per hour, a robust 20% enhancement. Its current production style comprises shorter production lines catering to a large customer base with diverse products, which reduces reliance risk on few larger clients. However, such an arrangement also limits margin expansion due to more downtime on frequent machinery setting adjustments.

Maintain OVERWEIGHT. Our TOP PICK is HARTALEGA with an OUTPERFORM and TP of RM9.50. We raised Hartalega’s TP to RM9.50 from RM8.20 based on higher FD CY16 PER of 24 compared to 21x previously (at +2.0 SD above its historical forward average) due to its solid management and its ability to consistently remain head and shoulders above its peers in terms of better margins, solid improvement in production capacity and reduction in costs. We like HARTALEGA for its: (i) highly automated production processes model, (ii) solid improvement in its production processes and reduction in costs leading to higher margins compared to its peers, (iii) innovation in producing superior quality nitrile gloves, and (iv) positioning in a booming nitrile segment with a dominant market position