TOP GLOVE CORPORATION BHD (SGX:BVA)
RIVERSTONE HOLDINGS LIMITED (SGX:AP4)
Malaysia Glove Sector - Washout Earnings, But The Worst Is Yet To Come
- We expect glove stocks' earnings to decline further as demand-supply dynamics remain imbalanced. However, downside is increasingly limited with some producers already falling into losses. Against this backdrop, sector valuations are trading close to -1 standard deviation of the pre-pandemic 5-year P/E mean. Hence, the reward-to-risk payoff appears balanced at this juncture.
- Maintain MARKET WEIGHT.
Glove stocks' downside increasingly limited and priced in.
- Current ASPs are close to US$23/’000 pieces. While the slide appears to have steadied, it represents an additional quarter of soft fundamentals. This is amid rising cost, primarily with the minimum wage (+25% in May) taking full effect in 3Q22. This is partially offset by nitrile and latex costs declining marginally vis-à-vis 2Q22 by 3-4% q-o-q.
- Smaller glove producers have fallen into operational losses and no meaningful capacity addition is expected over the immediate term, with utilisation rates at sub-optimal levels. We believe there is further earnings downside but it is increasingly limited and priced in.
Glove stocks' 1Q22 results round-up.
- Sector earnings came in below expectations. This was due the deep imbalance between demand and supply, which weighed heavily on ASPs amid rising cost. Supermax was further weighed by its sales ban by the US Customs and Border Protection (CBP), which also affected its Canada sales.
- The sector’s top-line contracted 12.9% q-o-q off a 17% decline in ASPs but volume sales recovered 5% as supply chain issues eased. The sector registered EBITDA and PAT margins of 14.4% and 0.5% respectively. Had it not been for Hartalega’s backloaded tax expense (attributed to the prosperity tax), the sector would have realised an adjusted PAT margin of 10.3%.
- Pre-pandemic (2019) EBITDA and PAT margins were 17.5% and 10.2% respectively.
We do not foresee meaningful capacity addition over the immediate term.
- However, our sales volume growth for the Malaysia Big-4 glove producers is 5.9% and 15.1% for 2023 and 2024 respectively (2022F: -9.5%). This will be driven by higher utilisation given that utilisation for 1Q22 was close to only 60%; optimal range is between 80-90%.
- Existing hospitalisation cases attributed to COVID-19 cases appear to be picking up, which should aid demand. However, demand and ASPs should not go into a tailspin, unlike during the height of the pandemic, with customers fully aware of their bargaining power.
Index exclusion on the horizon for Top Glove
- Top Glove (SGX:BVA)’s market capitalisation of RM8.0b, which ranks it 39th on the FBMKLCI Index. It is at risk of being excluded from index in its review in November should its ranking remain below the 35th spot. Hartalega has a market capitalisation ranking of 34th position. QL Resources and AMMB are in queue to be index replacements.
- Apart from that, should Top Glove’s 15-month timeline to resolve its US CBP ban be an indicator, Supermax could potentially resolve theirs sometime by end-22.
Smaller producers fall into operational losses, a precursor to its larger peers.
- In 1Q22, small-cap public listed companies experienced deep operational losses at -10.3%, a far cry from pre-pandemic operational margins of 6.8%. Malaysia’s Big 4 producers remained comfortably profitable with operational margins of 15.0% (pre-pandemic: 18.1%). This is well ahead of China producers with 3.4% operational margins and a PAT margin of 0.8%.
- However, the upcoming quarter will see a further deterioration. Such operating conditions are not viable over the medium term. Hence, it could lead to a few tangible inflection points, namely:
- new entrants exiting the industry,
- gradual recovery of utilisation rates to optimal levels, and
- resumption of capacity addition.
Glove sector valuations close to -1 standard deviation of 5-year pre-pandemic mean.
- Existing sector valuation at 21.8x suggests there remains some downside, given that it is above the 5-year P/E mean of 16.9x. The rolling average has been distorted with downward bias over the past 2 years with glove companies trading at 3-4x P/E. Hence, if sector valuations were to be compared to pre-pandemic conditions, 21.8x P/E is close to -1 standard deviation of its 5-year mean of 21.6x. Hence, downside ahead has been factored in to a certain extent.
Maintain MARKET WEIGHT.
- Small-cap glove producers have fallen into operational losses. We believe China producers could be one quarter away from the same predicament, with them registering EBITDA margin of 3.4% on average in the recent quarter. These indicate that the industry is nearing the bottom given the unsustainability of such operating conditions.
- Due to the temporary nature of bottoming of the sector and long-term structural growth that the industry offers, investor interest may be swiftly piqued to bottom fish.
- Meanwhile, current valuations are trading close to -1 standard deviation of its 5-year pre-pandemic P/E mean. The reward-to-risk payoff appears balanced. That said, we advocate investors to accumulate on potential significant weakness given that earnings could undershoot expectations.
Philip Wong
UOB Kay Hian Research
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https://research.uobkayhian.com/
2022-07-20
SGX Stock
Analyst Report
0.30
DOWN
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0.800
SAME
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