UG Healthcare Corp - RHB Invest 2018-04-24: Riding On Global Demand Growth

UG Healthcare Corp - RHB Invest 2018-04-24: Riding On Global Demand Growth UG HEALTHCARE CORPORATION LTD 41A.SI

UG Healthcare Corp - Riding On Global Demand Growth

  • We are positive on the long term global demand growth for gloves – demand has been rising at a 5.7% CAGR over the past 12 years. Our expectations of an appreciating USD vs MYR would also indicate an improved earnings outlook for glove manufacturers. 
  • UG Healthcare is increasing its annual production capacity by 21% y-o-y to 2.9bn units by Jun 2018, which would contribute to higher FY19F revenue and earnings. 
  • We initiate with a BUY recommendation, and Target Price of SGD0.32 (60% upside), which is 14x FY19F EPS, a discount to the peer average of 25x.



Dynamics positive for rubber glove manufacturers. 

  • RHB’s economics team expects USD/MYR to average 4.05 in 2H18 and 4.10 in 1Q19. This is mainly driven by the view that inflation could surprise on the upside, resulting in higher- than-expected interest rates that could benefit the USD. 
  • The glove sector is a key beneficiary of a stronger USD, as c.100% of sales is USD-denominated. 
  • UG Healthcare, which derives two-thirds of its revenue in USD (with another quarter from GBP and one-eighth from CNY), would be one of the beneficiaries.


Minimal impact expected from potential US-China trade tussle.

  • Malaysia is the world’s leading supplier of medical rubber gloves, satisfying c.65% of global demand. In 2017, the US and China respectively accounted for c.28% and 5% of Malaysia’s total value of rubber products exported. As both are net importers of medical rubber gloves from here, we do not expect their trade tariffs to have a significant impact on demand for such gloves.


UG Healthcare is raising its annual production capacity to 2.9bn units by Jun 2018.

  • Expectations are for global glove demand to rise 6-8% pa going forward. UG Healthcare is expanding its capacity by 21% y-o-y to 2.9bn units pa by Jun 2018. This would allow for more production flexibility (for both existing and new facilities), and thus improve UG Healthcare’s overall production efficiency. 
  • Management expects annual production capacity to rise further to 3.2bn units by Jun 2020 – and this would require continued capex over the next 2-3 years.


Soft raw material prices are positive for margins.

  • Latex prices have fallen from > MYR8.00/kg in Jan 2017 to the current MYR4.30/kg level, and this has helped to lower production costs.


Initiate with BUY recommendation.

  • UG Healthcare trades at a FY19F (Jun) P/E of 8.6x. This is sharply lower than the peer FY19F average of 25x. We believe its production growth strategy could bring its P/E closer to its peer average. 
  • Our Target Price of SGD0.32 is 14x FY19F EPS, and close to the DCF-derived fair value of SGD0.31. We ascribe a lower target P/E (vs peers), as UG Healthcare’s smaller capacity justifies a P/E discount.
  • Key risks include higher gas and raw material prices, which could narrow margins.



INVESTMENT MERITS


Riding on expanding global glove demand. 

  • Data from the Malaysian Rubber Gloves Manufacturers Association (MARGMA) shows that global glove demand has risen from to 201bn pieces in 2017 from 103bn pieces in 2005, representing a 12-year CAGR of 5.7%. The industry expectation is for future growth of 6-8% pa.

Malaysia recorded a 4-year 11.3% CAGR in exports of rubber gloves. 

  • Data from the Malaysian Rubber Export Promotion Council (MREPC) points to close to 10% annual growth in Malaysian exports of rubber gloves. We believe continued healthcare demand for gloves would drive this growth trend for the next few years.

Driving the rubber gloves export growth is synthetic rubber (SR) gloves. 

  • SR gloves exports from Malaysia surged by a 17.6% CAGR over the past four years (higher than overall Malaysian gloves exports CAGR of 11.3% over the same period). SR gloves are seen as the growth segment going forward, as healthcare workers prefer such gloves. 
  • As only 35-40% of UG Healthcare’s glove production is of nitrile gloves (with the balance being latex), there is room for significant growth ahead, in our opinion.

More manufacturing capacity by 4QFY18… 

  • At the end of FY17 (Jun), UG Healthcare achieved its planned production capacity of 2.4bn gloves pa from its two plants at Senawang, Seremban, Malaysia. The construction of the third manufacturing facility commenced in late 2017. 
  • The initial production capacity of 500m pieces (from three lines) in the third manufacturing facility is expected to come onstream in 4QFY18. Another 300m pieces (from two lines) in the third manufacturing facility are to come onstream later.

… resulting in efficiency improvement. 

  • Current capacity utilisation is 65-70% (based on 2.4bn gloves pa capacity). The third manufacturing facility allows UG Healthcare greater flexibility in the production of its extensive range of products eg less downtime (for instance, two days) from switching from one type of glove to another type. 
  • UG Healthcare currently has three products, demand for which justifies running non-stop production – but has no capacity to do so presently. 
  • Management aims to run production non-stop for these three products when new capacity comes onstream in May or Jun 2018. With the new capacity, there would be increased efficiency and volume also in the 1.6bn-capacity second manufacturing facility.

Key growth over the next two years would come from emerging markets. 

  • The developed markets, on the other hand, are saturated, and UG Healthcare would need to market more aggressively to gain market share.
  • 70% of sales are its own brand and sold through its own network, whereas 30% are as an original equipment manufacturer (OEM) for third parties where the company does not have a network, eg Japan and Canada.

Fall in latex prices has helped to lower production costs. 

  • UG Healthcare buys raw materials such as natural latex and nitrile at spot price, and does not hedge its prices. 
  • To illustrate, UG Healthcare fixes the price in April, for example, and buys latex. The latex is then delivered in May or June. The company buys wet latex, which cannot be stored for more than three weeks (unlike dry rubber, which can be stored longer). As latex prices have fallen from > MYR8.00 per kg in Jan 2017 to the current MYR4.30/kg level, this has helped to lower production costs. However, the rise in nitrile prices has an offsetting effect. 50-55% of UG Healthcare’s costs are from raw materials (comprising nitrile and latex).

Impact of recent rise in gas prices is limited. 

  • As gas accounts for a relatively small 15% of total costs, the recent rise in gas prices would have a limited effect on total costs.

Renegotiation of ASP is done when input costs change. 

  • If raw material prices eg those of latex or nitrile rise, UG Healthcare would engage customers to renegotiate on ASP. This helps to keep margins relatively stable, although there is a lag effect of 3-4 months. 
  • End-customers, such as hospitals and dental practices, usually review prices every 6-12 months.


VALUATION


Most of UG Healthcare’s peers are listed on Bursa Malaysia. 

  • The average forward P/E of peers (mainly Bursa Malaysia-listed glove manufacturers) is 25x, sharply higher than UG Healthcare’s 8.6x (based on RHB’s FY19 earnings forecast). As UG Healthcare is a small player vs its peers (evident from its much smaller market capitalisation), we believe it should trade at a lower target P/E than its peers. Our UG Healthcare Target Price of SGD0.32 is pegged to 14x FY19F EPS.
  • The Bursa Malaysia-listed peers have recorded strong share price gains over the past 12 months, and we see the likelihood of UG Healthcare playing catch-up as a laggard, as the global demand/supply factors apply across all glove manufacturers.



DCF-derived fair value of SGD0.31. 

  • We checked our P/E derived Target Price with our DCF- derived fair value of SGD0.31. It was obtained using the following parameters:
    1. Terminal growth rate of 2.7%;
    2. CoE of 7.9%, which factors in a risk-free rate of 2.4%, equity risk premium of  7.7%, and beta of 0.71;
    3. Capital structure with debt of 41% and equity of 59%.
  • Considering historical global rubber glove demand growth of 5.7% CAGR (from 2005 till 2017 data), our terminal growth rate of 2.7% is seen as a plausible assumption. Whilst global demand growth could be around mid single-digits for the next few years, we expect this to slow to low single-digits in the longer horizon, as the market matures.


KEY RISKS

  • The main risk would be rising raw material prices. Latex is a key cost component. If latex prices rise, UG Healthcare’s margins could be temporarily squeezed until ASPs are repriced with customers by up to 3-4 months later.


FINANCIALS


Strong 2QFY18 net profit growth. 

  • UG Healthcare recorded 2QFY18 revenue and net profit growth of 19% and 75% y-o-y respectively. Production volume grew, due to the ramp- up in new production lines that came on-stream at the end of Jun 2017. 
  • The company also recorded higher ASPs for its proprietary brand of products. 2QFY18 gross profit margin was 17.8%, up from 2QFY17’s 14.6%.

Good 1HFY18 operating cash flow. 

  • There was an improvement in net cash used in operating activities. For  1HFY18,  net  cash  from  operating  activities  was  SGD2.6m  vs a deficit of SGD1.9m for 1HFY17.

Stronger FY19 net profit expected, due to higher production volume. 

  • On the back of higher costs, we believe 2HFY18 y-o-y net profit growth would be slower.
  • We expect FY19 earnings to be stronger, on increased output – assuming 2.9bn pieces pa capacity for FY19, and capacity utilisation that is close to 70%.

Distribution business could expand. 

  • For UG Healthcare’s distribution business, besides selling its own manufactured products, it also distributes products made by others. These include products that it cannot manufacture. UG Healthcare is looking to focus more on its distribution business in Brazil, China, Europe and the UK.


COMPANY BACKGROUND

  • In 1989, UG Healthcare commissioned its first manufacturing plant in Seremban and also established a US distribution platform. In 2013, production commenced at its second manufacturing plant. From 2014 onwards, UG Healthcare further established its downstream distribution presence in Beijing, Baoding, Chengdu and Suzhou, as well as Brazil.
  • UG Healthcare’s main competition is at downstream distribution, where its distribution companies compete with other distributors for end-users of disposable gloves.

Upstream manufacturing

  • UG Healthcare produces gloves according to the demand and orders received from its own distribution companies, as well as from other distributors marketing and selling its proprietary UniGloves range of disposable gloves.
    • It is also the OEM for end-users’ brand names if the quantity is sizable;
    • It outsources generic products to other OEM players to produce its UniGloves brand to meet demand for the products.

Downstream distribution

  • Here, UG Healthcare:
    • Formulates and rolls out marketing strategies and campaigns best applicable for the particular markets in which it operates;
    • Provides consultation services on hand protection solutions and products;
    • Caters for after-sales support.

End-users (customers)

  • UG Healthcare’s end-users include:
    • Healthcare providers such as hospitals, dental clinics, nursing homes and hospices;
    • Manufacturers such as those in the automotive and electronics industries;
    • Life sciences players such as laboratories and manufacturers in those industries;
    • Food and beverage processors;
    • Beauty hair salons and tattoo studios.


Key Milestones


Upstream manufacturing

  • 1989 - Commissioned first manufacturing plant in Seremban; Commenced production of 1st natural latex examination gloves
  • 1992 - Produced 1st powder-free natural latex examination gloves
  • 1996 - Become a member of MARGMA
  • 1998 - Developed 1st nitrile examination gloves; Launched an extensive range of coloured, scented and coated examination gloves
  • 2013 - Commenced production at the second manufacturing plant
  • 2017 - Commissioned third manufacturing plant

Downstream distribution

  • 1989 - First foray into the international market; Established US distribution platform
  • 1990 - Incorporated Unigloves Artz in Germany; Developed German distribution platform
  • 1997 - Incorporated Unigloves USA
  • 2000 - Established Unigloves UK to cater to UK and other European markets
  • 2002 - Established Unigloves Shanghai
  • 2012 - Established presence in Nigeria
  • 2014 onwards - Established presence in Beijing, Baoding, Chengdu and Suzhou, as well as Brazil


Accreditations

  • 1997 - Certified  by the TUV Cert Certification Body of Rheinich Westfalischer TUV for ISO 9002 / EN ISO 9002 / MS ISO 9002, for the manufacture and supply of natural latex examination gloves
  • 2000 - Obtained Standard Malaysian Glove (SMG) certification from the Malaysian Rubber Board for powder-free gloves
  • 2003 - Certified for ISO 9002 / EN ISO 9002 / MS ISO 9002 for the manufacture and supply of both natural latex and nitrile powder and powder-free examination gloves
  • 2005 - Obtained SMG certification from the Malaysian Rubber Board for powder gloves
  • 2009 - Obtained ISO 13485:2003 and ISO 2001:2008 certified by URS:UKAS.





RHB Invest | http://www.rhbinvest.com.sg/ 2018-04-24
SGX Stock Analyst Report BUY Initiate BUY 0.32 Same 0.32



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