TOP GLOVE CORPORATION BHD
BVA.SI
Rubber Gloves – Malaysia - Take Chips Off The Table
- The sector has had a good run and we believe it is time to lock in profits. We reckon that downside risks are burgeoning and there is no leeway for letdowns.
- We are also turning bearish on the back of rising concerns over unsustainable premium valuations (+2SD above 5-year forward mean PE). Hence, the crowding into this space is a good opportunity to sell on strength. In a tactical move, we downgrade our sector call to UNDERWEIGHT from MARKET WEIGHT.
WHAT’S NEW
No room for disappointment.
- As the share prices of major rubber glove players have made new highs, we believe the market is fundamentally underpricing risks such as:
- strong currency headwinds that may eat up profits (sharp US dollar depreciation in previous cycle led to earnings contraction of 15-30% q-o-q),
- potential supply recovery in the Chinese vinyl glove space, and
- unprecedented sales volume, which could unwind on possible inventory build-ups.
Overshooting valuations, turning bearish…
- While these new share price highs were inspired by a combination of overhyped optimism and hope of the current scarcity situation lengthening into the future, we are turning bearish on the glove sector. This is premised mainly on the back of mounting concerns over unsustainable premium valuations.
…and making a tactical move; downgrade to UNDERWEIGHT.
- Cumulatively, glove makers have seen their share prices rise by 110% since the start of May 17. The sector currently trades at 27x 2019F EPS, which is more than +2SD above its 5-year forward mean PE.
- Valuations are at all-time high and the sudden crowding into this space represents a good opportunity to sell on strength, in our opinion.
- We are moving our sector recommendation to a tactical UNDERWEIGHT from MARKET WEIGHT.
ACTION
Top Glove: Downgrade to SELL with an unchanged target price of RM8.00 based on 18x 2019F PE.
- It is the second best performing glove stock under our coverage. Now, we reckon valuations have run ahead of fundamentals and we advocate to take profit.
- Although Top Glove is looking at more inorganic growth opportunities, future M&A initiatives should be smallish seeing that the acquisition of Aspion would have already stretched net gearing to 0.6x.
Hartalega: Re-iterate SELL with an unchanged target price of RM8.04 based on 24x 2019F PE.
- The highly-anticipated new anti-microbial gloves (AMG) may face some competition, no thanks to Unigloves and BioCote, as they have both collaborated to launch Fortified (a similar functional product to AMG) in Europe earlier this month. Hence, we believe Hartalega has somewhat missed the first-mover advantage in this region.
Kossan: Downgrade to SELL with an unchanged target price of RM7.18 based on 18x 2019F PE.
- Despite being a laggard in the glove manufacturing space, the stock still gave investors a handsome capital return of 50% over the past nine months. Similar to Top Glove, we recommend taking some chips off the table primarily on valuation grounds.
- We believe upside is limited from current share price level given the lack of fresh catalysts.
ESSENTIALS
Currency headwinds may eat up profits.
- Seeing that the US dollar has been depreciating against the ringgit (-13% since Jan 17 to ~RM3.90/US$ currently), we are wary of corporate earnings possibly falling short of expectations. For example, in the previous cycle when the US dollar weakened sharply vs the ringgit by more than 10% in a short period of time (from Dec 15 to Jun 16), the headline earnings generated by glove makers were lacklustre, contracting by 15-30% q-o-q for two consecutive quarters.
- Collectively, their market capitalisation fell by 35%.
Potential recovery in Chinese vinyl glove industry…
- We expect the shutdown of Chinese vinyl glove companies to be temporary as this was led by the government’s antipollution drive.
- To our understanding, they are allowed to go live again if their production method is changed to using gas instead of coal previously; however, the former method is more expensive by about 20-30%. Hence, this is not something structural such as the oversupplied steel and coal sectors in China, which required de-capacity campaigns.
…fuelled by price-sensitive F&B customers.
- Assuming a full cost pass-through from higher energy expense, we estimate that vinyl glove is still cheaper vis-à-vis nitrile ones by approximately 10-20%.
- Generally, end-users of this product are from the F&B space, whom we believe to be more price sensitive. Hence, this may prompt an appetite switch back to the less expensive glove offering. Consequently, we are concern the situation may reverse and hurt Malaysian rubber glove players.
Robust demand may be aided by inventory build-up activities…
- The Association of Natural Rubber Producing Countries (ANRPC) reported the world supply-demand position for latex to be in a slight oversupply condition in Dec 17, with the rubber inventory in Qingdao (main raw material source for China’s tire output) still at relatively high levels. Hence, we believe the robust glove demand could also partially be accompanied by some inventory build-up activities where customers are taking advantage of the current weak raw material price environment.
…in anticipation of higher raw material prices.
- We expect latex prices to gain some traction from current level of below RM5.00/kg to a range of RM5.00-5.50/kg over the next couple of months.
- Firstly, the International Rubber Consortium Ltd has agreed to withhold 350,000MT of natural rubber exports until Mar 18. Also, we observed good financial showing from the likes of Caterpillar Inc and Komatsu Ltd, suggesting a demand recovery for global heavy vehicles (note that the tires used here contain more latex input vs those for passenger vehicles). Lastly, there is the seasonal wintering period from February to May.
Unprecedented volumes could unwind on inventory build-ups.
- In general, there is a healthy price correlation between latex and nitrile (at 75% with a p-value of
Calm before the storm.
- Although the existing earnings trend does not display any signs of weaknesses, we are vigilant on potential threats contributing to profit disappointment.
- Over the next 1-2 quarters, healthy forward orders in hand along with positive ASP revision should lend support to decent earnings expansion. However, the weak US dollar is not encouraging and is likely to eat up a portion of their bottom-line. The current quarterly earnings run rate projected by the street over the next two quarters is RM303m308m.
- This is 5-7% higher than 3Q17’s performance, and we reckon consensus could be overly optimistic, suggesting some downside risk.
Chan Jit Hoong CFA
UOB Kay Hian
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http://research.uobkayhian.com/
2018-01-29
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