Malaysia Glove Makers - UOB Kay Hian 2021-09-08: Slippery Road To Moderation; Maintain UNDERWEIGHT

TOP GLOVE CORPORATION BHD (SGX:BVA)

Malaysia Glove Makers - 2Q21 Slippery Road To Moderation; Maintain UNDERWEIGHT

The 2Q21 reporting season saw slight sequential growth. It also signifies peak quarterly earnings. The road to moderation appears to be swifter than expected. Furthermore, we believe deferred capacity expansion and sub-optimal utilisation rates may not be fully factored in yet. This underlines possible further downside. We believe sentiment could be further weighed by disappointment to consensus expectations.
Given the downside risks, we maintain UNDERWEIGHT on the sector.

Sector earnings came in largely within expectations. Hartalega and Top Glove (SGX:BVA) came in beyond and below expectations respectively. The former’s earnings were boosted by shipments that had been delayed from the preceding quarter while the latter’s volume sales were affected by its withhold release order (WRO) by the US Customs and Border Protection (CBP).
Sector top-line grew 3.3% q-o-q on the back of volume growth of 8.5% while ASPs declined by 7.0%. Hartalega and Supermax saw output recover, following the COVID-19 outbreak among its labour workforce. Hartalega and Kossan saw higher ASPs in contrast to Supermax and Top Glove as the former’s laggard pricing caught up to the latter.
Sector EBITDA margin softened off lower ASPs amid higher economies of scale and largely unchanged raw materials costs (nitrile: 0.3%, latex: -1.2%).

We now expect normalised ASPs in mid-22 as opposed to 2023 previously. Given that ASPs are no longer as lofty, downside risk from further disappointment is limited. That said, deferred capacity and sub-optimal utilisation rates are possible pressure points to the sector.
Factoring in the softened ASPs alone, our earnings projections already suggest significant downside to consensus expectations. Against this backdrop, there could be further downside to both sentiment and earnings going forward. Given the unfavourable reward-to-risk payoff, we suggest investors to minimise their exposure to the sector.

Throughout the Movement Control Order (MCO), the Big-4 glove manufacturers, with their production footprint primarily located in Klang, Selangor were only operating with a 60% workforce capacity. Subsequent to that, the glove manufacturers had to temporarily halt production altogether during the 2-week Enhanced MCO between 3 to 16 July. (Given that 45% of Top Glove’s production footprint falls outside of Selangor, the EMCO impact was less apparent for Top Glove). It was only in mid-August did new guidelines allow increased operational utilisation. Companies with > 80% of its workforce being fully vaccinated would be allowed to resume 100% of production. From what we gather, this could be achieved by mid-September.
We estimate production output for 3Q21 to be 25% below peak utilisation rates due to the various pandemic restrictions on labour workforce.

Current nitrile ASPs are now close to US$40-45/’000 pieces. It has moderated by close to 12% m-o-m since January. It is expected to moderate by 5-10% m-o-m going forward. This is ahead of our previous expectations of a 5% m-o-m decline. We have now assumed for a 7.5% m-o-m decline. The softening of ASPs is attributed to moderating demand and the influx of supply arising from China.
Production disruption for the Malaysian producers during the MCO was a contributing factor as well, with China producers taking the opportunity to lock in orders with its customers. Based on our new expectations, it translates to an ASP of US$70/23 per 1,000 pieces for 2021 and 2022 respectively and for ASPs to reach pre-COVID-19 levels by mid-22 (from 2023 previously).

Alongside normalising ASPs, we expect sector net profit to grow by 62% y-o-y followed by -82% y-o-y for 2021 and 2022 respectively. Given the sharpness of moderating ASPs and the laggard effect by consensus to factor in downtrending ASPs, this forms downside to consensus earnings expectations relative to ours.
At this juncture, our 2021-23 sector net profit is -4%/28%/34% below consensus projections. Given the significant downside, sentiment may deteriorate as disappointment to earnings are gradually realised.

While ASPs are downtrending below expectations, downside appears increasingly capped. Instead, capacity expansion plans and its subsequent deferment and sub-optimal utilisation rates could represent significant downside to our forecast should industry dynamics moderate too sharply.
For now, 1H22 expansion plans should be intact given the commitment required to plant and equipment suppliers. For now, the Big-4 is anticipated to expand capacity by 28% and 23% for 2021 and 2022 respectively. However, 1H22 year-to-date capacity expansion is 16%. We think it could be representative for 2022 instead of the projected 23% at this juncture seeing that market dynamics are approaching equilibrium by mid-22. This is further compounded by utilisation rates possibly reverting back to 80-85% from near maxed utilisation rates during peak operating conditions last year.
Positively, raw material prices continue to downtrend. Qtd latex and nitrile cost is -19.5% and -8.2% respectively. The end of wintering season has improved supply for latex while normalising demand for nitrile has eased prices alongside glove ASPs but at a diminished rate given that ASPs did not scale the heights of glove ASPs. We continue to expect both nitrile and latex costs to moderate. Nitrile cost remains almost double that of pre-COVID-19 levels.

Sharp deterioration of ASPs following the moderation of COVID-19 cases and cancellation of overlapping orders,
the escalation of forced labour allegations and the potential WRO by US authorities,
spikes in raw materials costs,
a strengthening ringgit, and
the COVID-19 outbreak spreading among the production workforce.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-09-08

SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.20 DOWN 2.020