Glove Manufacturers - DBS Research 2020-03-09: Stock Up Selectively


Glove Manufacturers - Stock Up Selectively

  • Rate of Covid-19 infection globally ex China has surged, despite slowing in China.
  • Share prices of rubber glove manufacturers have tracked the major swings in infection rate.
  • Manufacturers on course for record earnings; although valuations are at higher end.
  • We advocate investors be selective; our preferred plays: Riverstone (SGX:AP4) and Kossan Rubber on relative valuations.

Rising infection rate ex China.

  • The number of new Covid-19 cases in China have been on a declining trend since 19 February 2020. However, the rate of infection in the rest of the world has accelerated since then, especially in Korea, Italy and Iran.
  • On 7 March, there were 4,055 new cases globally. Cases outside of China accounted for more than 95% of all new cases.

Share price moves in tandem with daily cases

  • The experience from SARS and H1N1 indicates that rubber glove manufacturers saw an improvement in sales volumes and margins during the outbreak of both viruses. For the Covid-19 outbreak, the share price of rubber glove manufacturers has tracked the major swings in the rate of infection. While the new type of coronavirus was identified on 7 January 2020, the rate of infection has increased gradually ahead of the Chinese New Year holidays.
  • Share prices of the rubber glove manufacturers registered a small spike on 28 January when market trading resumed after the CNY holidays. Riverstone share price recorded the strongest daily increase of 19.6%, followed by Top Glove share price (+8.3%), Kossan (+5.5%) and Hartalega (+3.6%).
  • Meanwhile, rubber glove manufacturers’ share price recorded a decline on 19 February when the daily cases registered a daily decline of 72%. The daily new cases dropped from 1,852 on 18 Feb to 516 on 19 Feb. Top Glove's share price led the daily decliners by sliding 3.9%, followed by Hartalega (-3.1%), Kossan (-2.5%) and Riverstone share price (-1.0%).

Additional orders arising from Covid-19.

  • According to Top Glove (SGX:BVA)’s founder and executive chairman Tan Sri Dr Lim Wee Chai, the group has seen a surge in glove demand, especially from China, Hong Kong, Singapore and Taiwan. Total sales orders received from China are expected to be more than double that of usual sales orders. During their recent results announcement, Kossan and Hartalega also said that they have seen higher orders increase due to the Covid-19. In general, delivery takes a month from the placement of an order.
  • The Malaysian Rubber Glove Manufacturers Association (MARGMA) stated in a press release on 28 January 2020 that China has requested for urgent shipments and rubber glove players have ramped up their production to meet the request.

Anticipate better upcoming quarter results.

  • Rubber glove players Hartalega and Kossan reported better q-o-q results in 4QCY19 (September-December 2019) on the back of higher sales volume, while their ASP was rather flat q-o-q. While Top Glove’s upcoming 2QFY20 results announcement (December 2019- February 2020) is unlikely yet to see material increases arising from the Covid-19 outbreak, we expect the trend of higher sales volume from developing markets to persist, especially for nitrile gloves.
  • On the back of higher sales and stable average selling price (ASP) environment (vs a declining trend in the last few quarters), gross margin for Riverstone should at least maintain at the 4Q19 level of 20.4%, which is higher than the 20.1% in FY19. We expect ASP for both HC and CR to be more stable now, as raw material prices and other costs items such as labour and utilities are not expected to see a steep increase.
  • According to MARGMA, global demand for rubber gloves is expected to grow by 32bn pieces (12% y-o-y) in 2020, excluding the additional orders arising from Covid-19. Meanwhile, the upcoming 1QCY20 results (January-March 2020) for Kossan and Hartalega could point to the onset of additional demand arising from Covid-19.

Top pick: Riverstone on relative valuations

Prospects of higher demand likely to support valuations.

  • The sector’s PE is now at +2SD of its mean PE (from the period of SARS outbreak till now). The experience from SARS and H1N1 indicates that rubber glove players saw an improvement in sales volumes and margins during the outbreak of both viruses .
  • We believe the prospects of higher demand are likely to keep the sector’s multiples above its mean levels. Our preferred stocks are Riverstone and Kossan for their relatively more attractive valuations.

Riverstone Holdings (SGX:AP4) (BUY, Target Price: S$1.34)

  • We maintain our BUY call and Target Price of S$1.34, pegged to 20x FY20F earnings. This is equivalent to c.34% discount to peers. We expect Riverstone to move in tandem with its larger peers, which are trading at an average of 31x CY20F earnings.
  • Riverstone has received more enquiries on its healthcare (HC) gloves and face masks that the group produces for its cleanroom (CR) customers, though face masks, together with other cleanroom products, only account for 1-2% of total revenue. Only one out of its five manufacturing plants is in China that contributed only 5% of total FY19 revenue, based on the location of customers, and 3% based on the location of assets.
  • HC gloves account for c.50% of the group’s total revenue and c.30% of group earnings, as the margins for HC gloves are lower than CR. We are optimistic that Riverstone can continue to generate higher volumes for both the HC and the high-margin CR gloves. Butadiene prices, the key raw material for nitrile glove, have stabilised, which represents the most ideal situation for Riverstone.
  • While Covid-19 could provide a near-term boost, the HC segment remains competitive in the longer run in view of the huge number of players in this segment. Thus, Riverstone is shifting its focus to the CR segment, where it is the industry leader with about 40-50% market share. For the more competitive HC division, the focus would be on niche products, e.g. double colour or double gloves, that can command higher margins and to differentiate itself from the many players in this space. The stock is supported by a strong balance sheet with net cash position.
  • See Riverstone Holdings Share Price; Riverstone Holdings Target Price; Riverstone Holdings Analyst Reports; Riverstone Holdings Dividend History; Riverstone Holdings Announcements; Riverstone Holdings Latest News.

Kossan (BUY, Target Price: RM5.60)

  • We maintain our Target Price for Kossan at RM5.60, based on 27x FY20F EPS. This is equivalent to +1 SD of its 5-year mean. We are expecting net profit to grow at a 3-year CAGR of 8.5% over 2018-2021. Kossan is currently trading at 24x CY20 EPS. This is at +0.7 SD of its 5-year mean PE or at +1.2 SD of its 10- year mean.
  • Our utilisation rate assumption of 80% indicates that there is room for Kossan to increase production. Based on our sensitivity analysis, every 1% increase in utilisation could increase Kossan’s net profit by 1.5%. Every 1% improvement in net margin could increase Kossan’s net profit by 10.5%. During the H1N1 pandemic, Kossan’s net profit margin improved to 11-12% (4Q19 net margin: 10.7%).
  • Kossan’s key markets are the US, Europe and Scandinavian countries. The group owns a manufacturing plant in Dongguan, China. However, the China plant is not involved in glove manufacturing. This plant undertakes secondary and value-added processes on the gloves produced in Malaysia.
  • The output of the plant is mainly for electrical and electronic industry use. We reiterate our BUY call on Kossan.

Top Glove (SGX:BVA) (HOLD, Target Price: RM5.70)

  • We maintain our Target Price of RM5.70, based on a CY20 PE of 30x. The ascribed PE is based on +1SD of its 5-year mean. Top Glove is trading at 26x CY20 EPS. We maintain our HOLD call as we believe the positives have already been priced in given its rich valuation.
  • Top Glove has announced that it had reached a final settlement agreement with Adventa Capital (and related parties) over the acquisition of Aspion for RM245m. To recap, Top Glove sued Adventa to claim back at least RM715m for Top Glove’s purchase of Aspion. Despite the settlement value being only 34% of the claim amount, the settlement allows Top Glove to focus on its businesses and put an end to the legal distraction. Meanwhile, the proceeds can help to improve Top Glove’s cash position that can be tapped for future expansion.
  • Factoring in the settlement, the acquisition price comes to RM1.1bn. Aspion has achieved a small profit before tax of RM5m in 1QFY20, compared to loss of RM4m in FY19.
  • Assuming an annualised net profit of RM20m for FY20, the implied PE for the acquisition works out to 55x. The Aspion acquisition provides Top Glove with additional capacity of 4.7bn pieces. This increased Top Glove’s capacity by 9% to 57.2bn. Together with its new lines, Top Glove is now operating at 85% utilisation, providing it with capacity to ramp up production to meet the increased demand.
  • (Using the latest FX rate of 1 RM to 0.3309 SGD, we derive target price of 1.89 in SGD term)
  • See Top Glove Share Price; Top Glove Target Price; Top Glove Analyst Reports; Top Glove Dividend History; Top Glove Announcements; Top Glove Latest News.

Hartalega (FULLY VALUED, Target Price: RM5.05)

  • We maintain our Target Price for Hartalega at RM5.05, pegged to 34x CY20F EPS. This is equivalent to +1 SD of its 5-year average. Its valuations are stretched at 43x forward PE, which is near to +2.0 SD of its 5-year mean PE or +1.5 SD of its 10-year mean.
  • Hartalega has been focusing its business in developed countries since inception, although in recent years it has started to foray into emerging markets. Most of Hartalega’s revenue is derived from developed countries such as North America, Europe and Australia (82% of total FY19 revenue). Asia (excluding Malaysia) only contributed 14% of FY19 revenue. Hartalega set up a subsidiary in China in 2013 to distribute gloves as it believes that the per capita consumption of gloves in China is likely to increase. In view of its lofty valuations compared to its peers, we maintain our FULLY VALUED call.
  • See attached PDF report for peer comparison table. 

Malaysian Research Team DBS Group Research | Siti Ruzanna Mohd Faruk DBS Research | Lee Keng Ling DBS Research | https://www.dbsvickers.com/ 2020-03-09
SGX Stock Analyst Report BUY MAINTAIN BUY 1.340 SAME 1.340