Rubber Gloves – Malaysia - UOB Kay Hian 2020-05-27: Overweight The Sector On Better ASP & Demand Visibility


Rubber Gloves – Malaysia - Overweight The Sector On Better ASP & Demand Visibility

  • We upgrade the sector to OVERWEIGHT as we turn more bullish on significantly uptrending ASPs and demand.
  • Despite possible vaccine discoveries in the near term, scaling up manufacturing capacity to achieve global herd immunity could take 12 months in the best-case scenario. This underlines our expectation of demand being sustained in 2021.
  • Valuations have yet to fully factor in an impending and sustained earnings surge.
  • Top pick: Top Glove (SGX:BVA).


  • Close to 300 vaccines and treatments in the pipeline but success rate is 10% or less. The COVID-19 pandemic has brought about an unprecedented urgency to develop a vaccine or treatment. To date, based on Milken Institute, there are 111 vaccines and 197 treatments in the pipeline to treat and prevent COVID-19. The critical mass of vaccines and treatments is imperative, given the success rate of the candidates is typically 10% or less based on preclinical studies through clinical trials to licensure, according to a study by Boston Consulting Group (BCG).
  • Possible discovery of a vaccine or treatment over next 1-2 quarters... At this juncture, there are two vaccines and six treatment drugs at Phase III of clinical trials. Phase III is the last stage prior to the drug being approved, provided it has proven safety and efficacy. Thus, it may be possible for a breakthrough vaccine or treatment in the next 1-2 quarters.
  • …but will take 12-18 months to achieve global manufacturing scale needed for herd immunity. However, once a vaccine is successfully validated, it must be produced at a scale that can enable herd immunity. BCG estimates this translates into coverage of more than 60% of the world’s population, which would require up to 5b doses for a vaccine. The production needed to reach such a global manufacturing scale would take for at least 12 to 18 months or 2Q-4Q21. 2Q21 is the best case timeline estimated by BCG.
  • ASPs have surged against backdrop of demand spike. Delivery lead times have extended to 11 months from the usual 30-45 days. ASP revisions have varied across all the producers, however they are broadly expected to continue to rise until end-20. That said, 3Q20 ASPs appear to have taken a significant step change q-o-q relative to 2Q20’s q-o-q mid-to high-single-digit growth.


  • Upgrade to OVERWEIGHT from MARKET WEIGHT. We turn more bullish on the sector as ASPs surge past our expectations. Aside from that, we believe elevated demand could be well sustained up till 2Q-4Q21, underpinning our 2021 earnings outlook. We believe profit taking upon discovery of a vaccine may be too premature. A more reflective measure is potential shortening of delivery lead times and sharp ASP reversions. However, glove usage is likely to remain widespread until a vaccine and/or treatment production achieves global manufacturing scale in 2Q-4Q21 in a best-case scenario. Our upgrade to OVERWEIGHT is premised on:
    1. multi-fold valuation gain have yet to fully factor in the impending earnings surge over the quarters ahead;
    2. sustained glove demand over 2021; and
    3. scarcity of safe haven earnings growth (2-year earnings CAGR of 43% in 2019-21) as most other sectors face multitude of headwinds.
  • Our top pick for the sector is Top Glove (SGX:BVA).
  • Aside from our BUY on Kossan, a high proportion of OBM sales and the possession of its own distribution positions Supermax as a forefront beneficiary of the surge in glove ASP.
  • ASP base expectation: Peak in late-20 to early-21 before trending downwards gradually. Overall, our base assumption is for ASPs to peak in late-20 to early-21 before gradually trending down across 2021. However, given the low base in 1Q20, we expect average ASP to grow y-o-y in 2021. Instances of a second wave of COVID-19 infection or overall emergency restocking have prompted elevated demand. For example, despite China containing COVID-19 by early-March, some glove producers are still receiving double the usual orders.
  • Bumper year for 2020 but post previous outbreaks, volume growth have averaged only -1%. The Malaysian Rubber Glove Manufacturers Association (MARGMA) expects industry volume to grow to 345b pieces in 2020 (from 298b), a surge from the average 10- year growth of 8-10%. Notably, in post-pandemic periods, volumes contracted only 1%. We believe demand growth is supply-capped, arising from producers operating at already maximum utilisation rates. Thus, it is possible for an overspill of demand into 2021-22.
  • Still unable to meet demand despite capacity surge. Ytd, the Big-3 producers have their expansion plans intact. We expect capacity additions of close to 7%, 10% and 19% for Hartalega, Kossan and Top Glove respectively. Other producers such as Sri Trang, Riverstone, Comfort Gloves and Rubberex are expected to see a capacity addition of 23% and all producers would collectively add 17% to total capacity for 2020. While it outstrips historical demand growth of 8-10%, it coincides well with the surge in demand. However, it falls considerably short of meeting demand, as reflected by delivery lead times of 11 months.
  • Raw material prices continue to trend lower. Going forward, operating margins could be aided by a slump in raw material prices. Latex prices have declined 9.5% from 1Q20, given soft latex demand (30% of demand is derived from rubber tyres). Meanwhile, nitrile prices are 8% lower in May. According to our calculations, every 1% drop in raw materials costs could boost earnings by 1-4%. That said, we do not expect any cost savings pass through, seeing the imbalance in demand-supply dynamics.
  • Potential upside from our RM/US$ assumption. We have a RM4.30/US$ assumption for 2020-21. However, should the ringgit depreciate further from our assumption, our calculations show that every 1% depreciation of the ringgit vs the US dollar could beef up glove makers’ earnings by up to 4% (this excludes the shared cost savings mechanism with customers which will consequently moderate any significant gain in margins).

We have revised our earnings forecasts and assumptions based on our more bullish outlook for the sector.

  • We expect ASPs to peak in late-20 to early-21, followed by a gradual downtrend over the rest of 2021. However, given that ASPs were not inflated in 1Q20, we expectASPs to remain higher y-o-y in 2021.
  • ASPs across the three producers vary because of:
    1. their different year ends;
    2. how ASPs trended over 2019 in relation to the respective glove companies’ year-ends; and
    3. the varying ASP locked in for the respective companies.
  • The economies of scale are not fully realised as we expect glove companies’ effective tax rates (Top Glove: 13%, Hartalega: 21%, Kossan: 19%) to normalise closer to the corporate tax rate of 24%. This arises due to the bumper year in earnings against the companies’ unchanged capital allowance.
  • Based on our revised ASP assumptions, we raise Top Glove’s FY20-21 net profit forecasts by 55% and 118% respectively; and Hartalega’s FY21-22 net profit forecasts by 5% and 71% respectively. We had earlier factored in our more bullish outlook into Kossan’s earnings.

Top Glove Corporation (SGX:BVA) (BUY/Target: RM14.72).

Kossan Rubber Industries (KRI MK/BUY/Target: RM10.00).

  • Our recommendation and target price are maintained as we had previously factored in our more bullish assumptions into Kossan’s valuations. Our target price is based on 23x 2020F PE, or +1SD of its 3-year mean PE. This factors in the attractive 2-year earnings CAGR of 69% over 2019-21).
  • We believe consistent execution and growth, backed by its Bidor development, could eventually translate to a multi-year earnings compounder for Kossan. Therefore, we believe its valuations should narrow closer to that of Hartalega and Top Glove.

Hartalega Holdings (HART MK/HOLD/Target: RM10.24).

  • Upgrade to HOLD from SELL with a higher target price of RM10.24 (from RM7.36). Our target price is based on 45.0x 2021F PE, or its +2SD of its 3-year forward PE mean. The premium can be justified by Hartelega’s strong operating efficiency under ordinary circumstances and innovation ahead of peers. Aside from that, the Next Generation Manufacturing Complex (NGC) 2.0 provides visibility over medium-term growth.
  • Nevertheless, our HOLD call is premised on Hartalega’s valuations being priced in at this juncture, which limits potential price upside. Entry price is RM9.00.


  • Discovery of a vaccine and/or treatment could cause negative newsflow, however, as we have previously highlighted, scaling of global manufacturing to achieve herd immunity may take 12 months and beyond. Aside from that, peak mass testing may translate into lower glove demand as well.
  • Downside risks are spikes in raw materials costs, a strengthening ringgit, sharp ASP reversion and COVID-19 outbreak among the production workforce. Upside risks are supply disruption to the broader industry and a strengthening US$.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-05-27
SGX Stock Analyst Report BUY UPGRADE HOLD 4.79 UP 2.010