Rubber Gloves – Malaysia - UOB Kay Hian 2020-07-27: Blockbuster Earnings Growth Yet To Be Fully Priced In


Rubber Gloves – Malaysia - Blockbuster Earnings Growth Yet To Be Fully Priced In

  • Industry outlook has improved further, with higher ASP revisions and spot sales mix. The impact on earnings has yet to be fully factored in by consensus, possibly catalysing valuations ahead. Meanwhile, vaccine discovery could spark kneejerk selling. However, as demand is unlikely to be immediately impacted, it could represent an opportune entry.
  • Maintain OVERWEIGHT on the sector as we believe the reward-to-risk trade-off remains attractive.
  • Top pick: Top Glove (SGX:BVA).

Glove sector industry outlook improves further.

  • The likes of Top Glove, Kossan and Hartalega (Big-3) have revised upwards their ASP guidances for the months of Aug and Sep 20. Meanwhile, Top Glove has raised its spot sales mix to 20-30% from 10-15% previously. However, industry spot sales ASPs remain unchanged at 2-3x contract ASPs.
  • With the higher revisions and spot sales mix, we expect 2020 industry blended ASP to increase by 69% y-o-y (vs 23% previously). Order visibility as reflected by delivery lead time is further extended to 540 days (from 300 days in June). Contracted capacity for 2H21 is almost secured. This suggests new orders being placed may only be received in 2022.

Kossan accelerates capacity expansion.

  • Apart from its higher ASP revision guidance, Kossan has accelerated its capacity addition for 2021 to 35.4b pieces p.a., up 10.4% y-o-y (from 32.0b pieces p.a. and 0% y-o-y growth previously). Apart from that, Kossan and Supermax appear to be on track to be included into the FBMKLCI Index as a component stock during the Nov 20 review. The MSCI review in August is likely to see higher weightage for glove manufacturers as well.
  • Meanwhile, the likes of Top Glove and Supermax have announced a bonus issue, improving liquidity of its shares. Kossan and Hartalega could possibly pursue a similar corporate exercise given the circumstances. For now, dividend payout across the glove manufacturers have been maintained amid the supercycle earnings growth, but we do not rule possible special dividend payouts as only Top Glove has meaningful debt on its balance sheet that could be pared down.

Maintain OVERWEIGHT on glove sector.

  • While the Big-3 has surged to post a gain of 510% ytd, we believe there is further upside. Factoring in recent ASP guidance, higher spot sales mix and accelerated capacity addition, we expect peak earnings to grow by 850% vs 2019. Apart from that, our earnings are 80% above consensus estimates, leaving ample positive surprises over the few quarters ahead. Accordingly, we raised our target prices for Top Glove, Kossan and Hartalega.
  • Furthermore, our normalised valuations based on 2022 suggest there is support to existing valuations. Hence, the reward-to-risk trade-off still appears attractive to us at this juncture.
  • Our top sector pick is Top Glove. We like it for its increasing allocation to spot sales mix coupled with above-industry expansion growth.
  • We also like Kossan as the company:
    1. is a laggard,
    2. is playing catch-up with its peers in its ASP pricing,
    3. has unveiled plans to accelerate capacity expansion, and
    4. is on track to being included in the FBMKLCI Index as a constituent.

Lower-than-usual FDA requirements and accelerated development could result in a COVID-19 vaccine in 4Q20.

  • At this juncture, four vaccines are in Phase III of development, with about 13 more in the pipeline to reach Phase III as well. As three of the vaccines have commenced Phase III in May and July, they are likely to reach conclusion sometime in 4Q20, similar to Murdoch Children’s Research Institute. Based on historical likelihood of vaccine approvals for Phase III candidates, the success rate is 65.9%. Combined with the high success rate of Phase III vaccines for infectious diseases and U.S. Food and Drug Administration’s (FDA) requirement of only a minimum of 50% efficacy, the 17 vaccine candidates in Phase II/III development are well poised to deliver a few alternative vaccines from 4Q20 onwards.

Vaccine discovery is unlikely to dent immediate glove demand…

  • However, we think a vaccine discovery is unlikely to immediately impact glove demand and subsequently ASPs.
    • Firstly, the scaling of global manufacturing capabilities of a vaccine to achieve herd immunity is likely to take 12-18 months to achieve. Locally, Duopharma and Pharmaniaga have been earmarked by the government to pack and fill vaccines locally. Our channel checks suggest that with the available pack-and-fill capacity, it could take up to more than two years before majority of the population is vaccinated. Such instances reinforce our beliefs that commercial scaling and herd immunity could take a year at a minimum.
    • Secondly, global distribution networks could be a bottleneck. Supply chain requirements for a vaccine is highly specialised and complex. Vaccines require constant refrigeration at a narrow temperature band. Thirdly, there could be hesitance from the public to willingly receive vaccination. A vaccine with low efficacy of 50-60% may still undermine public confidence.
  • Furthermore, typical vaccines undergo a timeline of 10-15 years before being approved, unlike the accelerated COVID-19 vaccine candidates. Possible unknown side effects that can only be discovered over time may deter the public from readily accepting a vaccine.

…but likely to spark profit taking.

  • That said, the sheer gains by the glove sector and retail exuberance are likely to spark profit taking or kneejerk selling on the glove sector. Upon such an occurrence, we ascribe investors to consider buying into weakness with our normalised target prices in mind.

Top Glove Corporation (SGX:BVA) (BUY/Target: RM36.90).

  • Our target price is raised to RM36.90 from RM21.90, in tandem with our earnings adjustment is based on 16.0x 2021F PE, or -2.0 SD of its 5-year forward PE mean. (Using the latest FX rate of RM1 to SGD0.3249, we derive target price of 11.99 in SGD term.) We believe valuations should be at a discount to its historical PE mean as:
    1. it is being pegged to windfall peak earnings,
    2. its upside to earnings are being increasingly factored in, and
    3. the risk-to-reward at this juncture is increasingly pronounced given the surge in its share price.
  • That said, our PE peg is reasonable given Top Glove is an established FBMKLCI component index constituent and its sublime earnings growth. High spot sales mix may represent further upside surprise to our earnings. These translate into a 2-year CAGR of 313% (FY19-21F).
  • Furthermore, its explosive q-o-q earnings growth over the subsequent 2-3 quarters should catalyse its valuations going forward.
  • See Top Glove Share Price; Top Glove Target Price; Top Glove Analyst Reports; Top Glove Dividend History; Top Glove Announcements; Top Glove Latest News.

Kossan Rubber Industries (KRI MK/BUY/Target: RM19.40).

  • We raise our target price to RM19.40 from RM10.95 as we raise our earnings and roll over our valuations to 2021. However, we have lowered our PE peg to 18.5x (from 23.0x previously) or -1SD of its 5-year mean PE. We believe lower valuations should be pegged to the super earnings cycle growth. Improved visibility over Kossan’s ASP revision, accelerated capacity expansion and potential inclusion into the FBMKLCI Index are likely to catalyse its valuations once earnings normalise.
  • On a q-o-q basis, 2Q20 ASPs are expected potentially improve by a mid single-digit growth rate. 2H20 is expected to see a steep step change in ASPs. Aside from that, Kossan sees firm demand visibility up till mid-21. It is allocating 15% of volume to meet ad-hoc demand, potentially commanding a premium of 2x usual ASPs. This translates into an attractive 2-year earnings CAGR of 130% over 2019-21).

Hartalega Holdings (HART MK/HOLD/Target: RM19.50).

  • We raise our target price to RM19.50 from RM12.95 as we raise our earnings. Our target price is based on an 29.2x 2021F PE, or its 5-year forward PE mean. The premium that we have attached to Hartelga relative to its peers is justified by Hartalega’s March year-end, capturing suboptimal windfall earnings unlike its peers. Nevertheless, our HOLD call is premised on Hartalega’s already lofty valuations restricting further PE rerating unlike its peers. Entry price is RM17.00.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-07-27
SGX Stock Analyst Report BUY MAINTAIN BUY 7.140 SAME 7.140