Rubber glove sector
Upgrade to overweight: We have upgraded our recommendation on the rubber glove sector to “overweight” from “neutral” on the back of robust demand growth expectations for financial year 2019 (FY19).
According to the Malaysian Rubber Glove Manufacturers Association, the rubber glove industry has been growing at an average of 8% to 10% for the past 25 years, and we expect this to continue in FY19.
The expected robust growth is underpinned by an expanding global healthcare sector as well as increased awareness of the importance of hygienic practices throughout the industry, especially in emerging markets such as India and China.
Currently, glove consumption per capita for emerging markets such as India and China is still low at around two to six gloves compared with about 100 to 280 gloves for developed countries.
Positively, we believe nitrile-based rubber (NBR) prices will continue to decline due to falling prices of butadiene, which is an input cost for nitrile gloves.
As NBR is a key input material for nitrile gloves, this is beneficial to the Big Three producers (Top Glove Corp Bhd, Kossan Rubber Industries Bhd and Hartalega Holdings Bhd) as lower NBR prices will widen the margins for nitrile rubber gloves.
We reckon that there could be some pressure on margins for FY19 stemming from an influx of glove supply from the big three producers. FY19 will see an enlarged supply of gloves by 14%, although the expansion will come at a gradual pace.
As this exceeds the organic demand growth expectations of 8% to 10%, we opine that the average selling price (ASP) will be slightly weighed down initially. It will take six to 12 months for demand and supply to reach equilibrium.
Although the big three producers benefit from a weaker ringgit as exports make up most of the sales, we believe the recent strengthening of the ringgit against the US dollar has been minor as the rubber glove players will be able to pass on the cost to their customers via an upward ASP revision.
Based on our sensitivity analysis, a 1% strengthening of the ringgit against the US dollar will impact the bottom line by roughly 1% for the big three producers. Our house projection of the US dollar-ringgit rate is 4.04 to 4.06 for end-2019.
All in, we opine that the recent selldown of rubber glove stocks has been unfounded as the sector’s fundamentals and growth prospects remain solid.
The headwinds for the sector such as concerns about overcapacity and strengthening of the ringgit are not new, and we believe that among the largest rubber glove producers, the Big Three are capable of weathering them.
The downside risks which may prompt us to review our call for the sector include a sudden supply glut stemming from other glove makers (such as in China), triggering a price war that crimps margins, as well as the inability of glove makers to pass on the rising cost.
Our top picks for the sector are Top Glove (“buy”; fair value [FV]: RM6.52) and Hartalega (upgraded to “buy” from “hold”; FV: RM5.88).
We like Top Glove for: i) its expansionary plans; ii) its focus on and continual efforts in improving quality and operational efficiency; and iii) its position as the largest rubber glove manufacturer.
We like Hartalega due to its: i) foresight and execution; ii) its visible capacity expansion; and iii) its ability to develop proprietary technology which translates into greater operating efficiencies. — AmInvestment Bank, Jan 11