Rubber Gloves - UOB Kay Hian 2020-12-18: Prospects Are Intact But May Be Weighed By Sentiment

TOP GLOVE CORPORATION BHD (SGX:BVA) RIVERSTONE HOLDINGS LIMITED (SGX:AP4) SRI TRANG AGRO-INDUSTRY PCL (SGX:NC2)

Rubber Gloves - Prospects Are Intact But May Be Weighed By Sentiment

Rubber gloves industry prospects remain intact against the backdrop of undemanding valuations and attractive dividend yields. But we acknowledge:
1. unparalleled valuation surge;
2. yet-to-be ascertained 2022 ASPs; and
3. negative sentiment may prove to be too steep of a speed bump to near-term prospects.
As such, we have trimmed our target prices.
Maintain OVERWEIGHT on the sector as we believe the risk-reward trade-off still remains attractive. Top pick: Top Glove (SGX:BVA).

The glove manufacturing sector has a delivery lead time that stretches for 510 days, or till mid-22. It has been extending from early-March but at a slower rate. In turn, ASPs commanded have been unprecedented, with expectations for it to further uptrend till 2Q21, before seeing some weakness in 2H21.
Meanwhile, spot sales ASPs appear to have reached a ceiling at US$220/’000 pieces. These factors are expected to more than offset the expected surge in nitrile latex cost.
We do not expect industry dynamics to fall off a cliff. But rather, we expect it to take a gradual course of normalisation amid commercialisation of multiple COVID-19 vaccines.

We expect blended industry ASPs to peak in 2Q21, thanks to uptrending contracted nitrile and latex glove ASPs as well as spot sales ASPs. In terms of contracted nitrile ASPs, the industry largely expects it to be sustained at US$80-100/‘000 pieces throughout 2021.
In terms of spot sales, volume as a percentage of overall sales varies across glove producers (Top Glove/ Hartalega/ Kossan/ Supermax: 30%/7-10%/10-15%/10% respectively). Spot sales are extremely lucrative, commanding up to a 50% premium relative to contracted ASPs. But subsequent to 2Q21, blended ASPs may come off due to lower spot sales ASPs and mix. This could signal a peak in terms of quarterly earnings and valuations.

Despite anticipated newsflow over a vaccine discovery, production and mass vaccination, we believe it would take between 12-18 months to achieve global herd immunity. Against this backdrop of better awareness, best hygiene practices and restocking of supply chains, we expect ASPs to peak in 2Q21 and for this to be largely sustained throughout 2021.
Our OVERWEIGHT recommendation is premised on:
1. multi-fold valuation gains yet to fully factor in the impending earnings surge in the quarters ahead;
2. sustained glove demand over 2021;
3. scarcity of safe-haven earnings growth (2-year earnings CAGR of 222% in 2019-21) as most of the other sectors face a multitude of headwinds; and
4. attractive dividend yields, with a possibility of a special dividend.
Our top sector pick is Top Glove. We also like Supermax for its ambitious expansion plans coupled with re-rating catalyst tied to its inclusion into the FBMKLCI Index. Our other buy is rounded up with Kossan, with its appealing valuations.

In terms of valuation, it peaked to 17.8x 1-year forward PE (or > +1 SD of 16.3x) in Jul 10. Peak valuations coincided with peak sector earnings in 2Q10. However, we note that valuations continued to rally well past the approval of the drug vaccine as there was a gestation period for containing the H1N1 outbreak. This had a delayed impact to earnings. However, it is apparent that valuations tracked sector earnings and not the vaccine discovery. Subsequent to the containment, valuations tumbled as the glove industry had a surplus of gloves.

That said, circumstances surrounding the COVID-19 pandemic is distinctively different from that during SARS and H1N1, in the sense that the outbreak is global and highly infectious. These factors have contributed to an unparalleled surge in demand. Therefore, upon the discovery of a COVID-19 vaccine, urgent demand could see a pull-back and possibly impact the premium ASPs commanded by spot sales. However, we envision wider application and awareness of glove usage to sustain overall demand, translating into a gradual moderation of ASPs as supply comes on stream over 2021-22.
In terms of valuations, it has had an unparalleled surge as well and with normalisation of ASPs in 2022 far from certain, the H1N1 precedence may not entirely be fully applicable to the recent COVID-19-driven surge.

Our target price is based on 11.0x 2021F PE, or close to -3.5SD of its 5-year forward PE mean. We believe the valuation should be at a deep discount to its historical PE mean as:
1. it is being pegged to windfall peak earnings;
2. upside to earnings is increasingly being factored in; and
3. the risk-to-reward at this juncture is increasingly pronounced.
That said, our PE peg is reasonable as Top Glove (SGX:BVA) is an established FBMKLCI component index constituent with a sublime earnings CAGR of 450% (FY19-21F). Furthermore, its explosive q-o-q earnings growth over the next two quarters could be supportive of valuations.
See Top Glove Share Price; Top Glove Target Price; Top Glove Analyst Reports; Top Glove Dividend History; Top Glove Announcements; Top Glove Latest News.
See PDF report attached below for summary on Top Glove (SGX:BVA), Hartalega, Kossan & Supermax's earnings assumptions.

Although we do not expect demand to cliff dive upon mass inoculation of the COVID-19 vaccine, the sudden need for gloves may quickly dissipate unexpectedly. This could arise from an unaccounted multiplier effect of demand (single source of demand translating into multiple orders across the supply chain), which may swiftly diminish. Alongside that, the premiums commanded for contracted and spot ASPs;
Nitrile latex cost is expected to peak by 3-4x pre-COVID-19 levels that could curtail earnings if ASPs revert sharply. However, this is in part driven by demand for nitrile gloves. Therefore, any normalisation on glove demand should translate into nitrile latex cost normalising too; and
Further COVID-19 outbreaks in the labour force, disrupting operations.
See PDF report attached below for peer comparison table of glove makers - Top Glove (SGX:BVA), Riverstone (SGX:AP4), Sri Trang Agro (SGX:NC2), Hartalega, Supermax, Kossan, Comfort Glove and Rubberex.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-12-18

SGX Stock Analyst Report BUY MAINTAIN BUY 3.42 DOWN 4.040

BUY MAINTAIN BUY 2.990 SAME 2.990

HOLD MAINTAIN HOLD 1.337 SAME 1.337