Rubber Gloves – Malaysia - UOB Kay Hian 2020-04-09: Shelter Amid An Array Of Gloom

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TOP GLOVE CORPORATION BHD (SGX:BVA)

Rubber Gloves – Malaysia - Shelter Amid An Array Of Gloom

• We maintain MARKET WEIGHT on the sector as our base-case earnings growth appears to support elevated valuations amid depressed valuations in the broader market.
• Potential sell triggers would include peak valuations (+2SD), shortening of delivery lead times and minimal infected cases. However for now, earnings should be well sustained for the next two quarters.
• Top pick: Kossan.

WHAT’S NEW

PPE demand spikes up to 17x higher.

• The Covid-19 outbreak has driven up demand for personal protective equipment (PPE). Based on a survey of 1,600 US hospitals, released by healthcare consulting company Premier, demand for PPE has surged to between 3.3-17.0x higher than the typical burn rate for PPE equipment such as N95 masks (17.0x), face shields (8.6x), isolation gowns (5.0x) and surgical masks (3.3x). While it did not specify gloves, the Covid-19 outbreak has inadvertently resulted in a demand surge for gloves as well.

Bumper year for 2020 but post previous outbreaks, volume growth has averaged 1%.

• Malaysian Rubber Glove Manufacturers Association (MARGMA) expects Malaysia 2020 industry volume to grow by 13-18%, a surge from the average 10-year growth rate of 8-10%. Our industry assumption of 15% is largely in line with overall expectations. However, in periods post the past three outbreaks (SARS: 2004, H5N1: 2008 and H1N1: 2011), y-o-y growth averaged 1%.
• For now, we maintain our forecast of 7% industry growth for 2021 until we obtain greater visibility over the containment of COVID-19.

ASPs have surged against the backdrop of demand spike.

• Our channel checks suggest ASPs have surged by 3-5% since March as demand has far outstripped supply. Despite China already containing the outbreak domestically, glove producers are still receiving 2x the usual orders. Supply is constrained as reflected by elevated utilisation rates (~95%) and lengthening delivery lead time to 120 days from the usual 30-60 days.

ACTION

Maintain MARKET WEIGHT.

• There is potential further upside depending on the length of the outbreak beyond our base assumption to our healthy two-year earnings CAGR forecast of 15.2% over 2019-21. However, we maintain MARKET WEIGHT on the sector as:
  1. sector valuations are currently trading at 29.9x, close to the +1SD to the PE mean of 30.4x,
  2. easing of outbreak would result in an eventual oversupply, leading to a de-rating in the sector,
  3. PE valuation differential between the glove sector to the broad market has widened from 8.0x to 15.2x,
  suggesting that there is deep value in the broader market.
• We think valuations should be well sustained over the next two quarters; however the aforementioned factors imply that the return-to-risk appears fair at this juncture. Top pick for the sector is Kossan.

Vaccine discovery may be too premature for profit taking.

• Depending on the severity of the outbreak, profit taking upon discovery of vaccine may be too premature. During H1N1, valuations continued to climb nine months after vaccine discovery, in tandem with q-o-q profit growth. We believe a more reflective measure is potential shortening of delivery lead times and decline of infected cases as potential red flags to waning demand.
• Apart from that, potential peak valuations that we have highlighted may be indicative of a sell trigger as it factors in +2SD valuations against aggressive incremental demand.

Kossan Rubber Industries (BUY / Target: RM6.22).

• Maintain BUY with a target price of RM6.22. Our target price is based on a PE peg of 25x, to factor in the attractive earnings growth (2-year earnings CAGR of 20% over 2019-21). Over time, the earnings growth coupled with consistent execution should reinvigorate Kossan’s valuations.
• The potential re-rating should narrow its discount to Top Glove and Hartalega, which we think should be trading at 26.0x and 33.0x PE respectively.

Top Glove (SGX:BVA) (HOLD / Target: RM6.05).

• Our target price is based on a PE peg of 26.0x 2020F PE, a premium to the Big-3 PE mean of 24.0x.
• While we continue to like the glove sector amid the COVID-19 outbreak, we believe Top Glove’s valuations have well priced in its near-term outlook amid an unprecedented sell-off in the broader market.
• We believe Top Glove’s premium of 26.0x to the sector PE mean is fair given it is a component in the FBMKLCI Index and therefore deserving of a slight premium to the sector.
• Entry price is RM5.50.
• 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 Holdings (SELL / Target: RM5.85).

• Our raised target price is based on a PE multiple of 33.0x to 2020F PE. It is a slight premium to 5-year forward mean but a premium to its peers, which have historically traded at an average of 24.0x. The premium can be justified by Hartelega’s strong operating efficiency and innovation ahead of peers.
• Nevertheless, our bearish call is premised on Hartalega’s lofty valuation (42.7x CY2020 PE) which limits potential price upside. Entry price is RM5.20.

ESSENTIALS

EBITDA margins receive double thrust.

• As we head into 2Q20, operating margins should improve further, aided by a slump in raw material prices. Although it is the wintering season (Feb – May), we expect latex prices to decline given latex demand softness (30% of demand is derived from rubber tires). Prices are currently 7% lower vs 4Q19’s average while February nitrile prices were 6% lower and are expected to fade further as it is a crude oil by-product.
• Furthermore, the ramp-up in utilisation rates to ~95% from ~85% should realise enhanced economies of scale. Apart from that, should the US$/RM forex rate strengthen by 1% from our US$4.30/RM assumption, it could translate into +2% in earnings.
• For FY20, we expect industry core margins to grow by 1.8bps to 12.7%, given the uptrending ASPs and favourable raw material prices. This is underlined by our base assumption of two quarters of super-normal profit backed by the surge in demand tied to the COVID-19 outbreak.

Upside of 13% and 25% to FY20 earnings forecast should outbreak be extended to 3Q and 4Q respectively.

• With our base assumption of a severe outbreak over two quarters, it underlines our FY20 industry earnings growth of 25% and 6% for FY20 and FY21 respectively. We have projected flattish earnings growth for FY21 as we expect margins and volume to normalise, following high inventory built up in FY20. Our FY20 earnings represent mild upside of 5% to consensus estimates.
• That said, our FY20 earnings could be further adjusted upwards by 13% and 25% should COVID-19 see an extended breakout till 3Q20 and 4Q20 respectively.

RISK

• Downside risks are spikes in raw material costs and strengthening RM.
• Upside risks are roader industry, pandemic outbreaks and strengthening US$.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-04-09

SGX Stock Analyst Report HOLD MAINTAIN HOLD 2.010 SAME 2.010