CIMB Research overweight on glove makers, likes Kossan, Supermax

Supermax to benefit from weak Ringgit

KUALA LUMPUR: CIMB Equities Research retains its overweight recommendation on the glove makers sector and believes the recent selldown provides investors the opportunity to accumulate glove stocks which have structural positive long-term prospects.

In its research report issued on Friday, it said its top picks in the sector are Kossan and Supermax.

“At current levels, we estimate that the sector is trading at 24.1 times one-year forward price-to-earnings (P/E), near its three-year historical mean (24 times). 

“We believe that glove counters deserve to trade higher given its: i) businesses’ defensive nature, ii) inelastic global demand for gloves and iii) robust EPS growth (three-year EPS CAGR of 20.4%),” it said.

However, the downside risks are stiffer-than-expected pricing competition and/or sharp strengthening of ringgit vs. US$.

CIMB Research said year-to-date, collective market cap of glove counters under its coverage declined 16%. This is on the back of concerns over potential pricing competition from more aggressive capacity build-up in 2019. 

It estimates the sector’s capacity to rise 17.8% in 2019F to 142.9 billion gloves per annum vs. 13.1% in 2018.

It explained that while headline numbers exhibit aggressive capacity build-up in 2019, investors should take into account three factors: i) new capacity is commercialised on a gradual basis,
ii) glove makers decommission older plants with new capacity acting as replacement capacity, and iii) glove makers can delay additional capacity to prevent a supply glut.

“This was witnessed in 2016, when pricing competition was only evident for two quarters (Q2 to Q3 of 2016),” it said.

“We believe that Malaysia’s global market share will grow beyond the current 63%. This is owing to Malaysian glove makers’ higher efficiencies and better economies of scale (larger capacity). 

“This should allow Malaysian glove makers to capture a bigger piece of our estimated global glove demand growth of 8.5% to 268 billion gloves in 2019F,” it said.

CIMB Research although China and Thailand glove producers are also expanding their capacity, this is unlikely to be a major threat to Malaysian glove makers. 
Its channel checks reveal that: i) most of this expansion replaces less efficient and older production capabilities (20 to 30 years old), as well as ii) Malaysia glove makers’ technological advances being meaningfully ahead of other countries.

The research house was not overly concerned about the recent strengthening of ringgit vs. US$ (YTD:+1% and +2% since Dec 1, 2018) and cost hikes (0.7% higher gas cost and 10%
minimum wage hike). 

“In our view, this will be more than offset by the recent weakening of raw material prices (45-50% of total production cost) such as nitrile butadiene prices (-13% on-quarter in 4QCY18) and ongoing cost efficiency efforts.

“For every 1% weakness in US$ against the ringgit, we estimate that net exposure to glove makers’ earnings is only 0.5%-0.6%. This does not take into account the cost pass-through mechanism that allows glove makers to share cost savings/increases,” CIMB Research pointed out.