By Sherilyn Goh
Amidst weak sentiments in the local market aggravated by declining oil prices, the rubber glove sector has proven its resilience by continuing to deliver sustained margins. How long will it benefit from current market circumstances?
Sector background: Driven by increasing global demand, which has seen export volume of rubber gloves increasing year after year, aggressive expansion plans are in place with no signs of slowdown in operation. The utilisation rates of local rubber glove manufacturers Hartalega, Kossan, and Top Glove stood at 87%, 85%, and 75-80% respectively.
Export volumes for both natural rubber and synthetic rubber gloves have also been on an upward trajectory, paving way for growth in the sector.
One should, however, take note that in recent years, export volumes of the higher margin synthetic rubber have outpaced that of natural rubber (56:44 in first quarter of calendar year 2015 or 1QCY15), due to the increasing popularity and demand for the former in the US and the EU region.
Among its peers, Top Glove has the largest exposure to natural rubber gloves, which constitute more than 60% of its sales mix.
Export volumes of the natural rubber variant, however, is expected to be supported by increasing demand from emerging markets such as Brazil and China.
It is expected that by 2017, supply for synthetic rubber gloves from key manufacturers will hit 31.1 billion pieces per annum, while its demand is projected to grow at 15% amounting to 32.3 billion pieces per annum between 2015 and 2017.
As it stands, glove usage per capita in the US stands at 166 pieces, about 33 times higher than that in Asia (five pieces), presenting glove manufacturers with enormous opportunities in the event of a step up in healthcare standards in emerging markets mandating the use of rubber gloves.
What analysts think: Analysts are mostly upbeat on the outlook for the rubber glove sector, reaffirmed in the growth in earnings estimate for financial years 2015/2016 (FY15E/FY16E) to 3.3%/7.3%, at a point when corporate results announcements for 2QCY15 came mostly below expectation.
In line with this, TA Securities is recalibrating its industry price-earnings (PE) multiple for rubber glove sector to 20 times, up from 18 times previously, premised upon its defensiveness amidst lacklustre market sentiments.
According to the research house, the industry’s focus on the nitrile (synthetic gloves) wave will continue to be the impetus to fuelling earnings growth for the industry in the near to medium term.
In terms of valuation, Hartalega and Kossan are prescribed a premium, maintained at 25% due to their earnings growth potential, high return on equity, and positive outcome from optimising their energy efficiency.
Top Glove, on the other hand, is expected to trade at targeted industry PE multiple of 20 times due to its latex heavy mix. Supermax is accorded a 40% discount due to various implementation issues.
“We upgrade our recommendation on the rubber sector from ‘neutral’ to ‘overweight’. We are positive on the sector’s ability to withstand the global economic turbulence.
“Buy Hartalega, Kossan, and Top Glove. Hold Supermax,” said TA Securities.
Of all the glove makers, Top Glove emerged as a top pick for AllianceDBS Research, who revised upwards its target price to RM9.15, from RM6.95 previously, premised on the fact that Top Glove’s valuation is cheaper relative to its peers, Kossan and Hartalega.
Top Glove’s rising cash pile, according to the research house, also provides scope for higher dividends, with potential upside in earnings.
While nitrile glove demand is expected to outpace natural rubber glove demand, AllianceDBS argued that natural rubber glove makers will be better positioned to capture currency gains, as its nitrile counterparts will likely compete away the currency gains because of the need to deploy new capacities.
The research house also forecasted that earnings before interest and taxes per 1,000 (Ebit/k) gloves will increase by 46% year-on-year to RM10.28 in FY15E on the back of stronger US dollar and productivity gains.
“Thereafter, we expect Ebit/k gloves to grow by 5%/0% in FY16/17E. There is potential for earnings upside if Top Glove continues to register last quarter’s profitability of RM11.17 Ebit/k gloves.
“The share price could rerate towards our RM9.15 target price as the street upgrade forecasts and the market realises Top Glove as a cheaper play on the currency tailwind. Our target price is based on 18 times CY16 PE,” wrote AllianceDBS Research in its report published on Sept 2, 2015.
Peer comparison:
StockStalk: While the recently-concluded corporate results announcement were generally seen as “weaker than expected”, with earnings of listed companies for 2QCY15 falling mostly below expectations, there was one exceptional story – the rubber glove sector which emerged as the biggest winner.
While being a washout quarter for most others, with the FBM KLCI having traded at a 9.6% discount to consensus target of 1,775, 2QCY15 saw market consensus revising their FY15E/FY16E earnings estimates for the rubber gloves sector higher by 3.3%/7.3%.
A beneficiary of the weakening ringgit, export-oriented glove stocks have seen their competitiveness propped up in the current market environment. Attesting to the sector’s resilience, the average beta of key rubber glove players is relatively low, currently standing at 0.5.
The current circumstances encompassing the strengthening US dollar against the ringgit, low raw material costs, and intensifying competition have led to declining average selling prices (ASPs), which is estimated to have decreased 5% to 10% year-on-year for both Hartalega and Kossan. Manufacturers have, however, offset the decline in ASPs via the higher quantity of gloves sold.
The hike in natural gas tariffs effective July 1, which saw prices increasing by 10.3% to RM21.80 per one million British thermal units is also likely to result in the additional costs being passed on to customers, albeit not with immediate effect.
It is estimated that manufacturers will have to increase ASPs by 1% to mitigate a 10% hike in gas tariffs. Assuming that no cost is passed through, the glove makers will see their earnings impacted on average by 6%.
While downward pressure on the ringgit is set to persist, the rubber glove sector is likely to remain attractive against a volatile market environment in months to come. Time to take your gloves off and get your hands on these stocks while they trade below fair value, perhaps?
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Important Note and Disclaimer: This article should NOT be taken as a cue to either buy or sell the stock. The intention is to highlight the key factors you might want to think about before plunging in or scrambling out. While KINIBIZ makes every endeavour to ensure facts are right and opinion is fair, no liability can be assumed for anyone relying on this information. In other words let the buyer (or seller) beware — a reflection of Bursa Malaysia, we say.
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