Separating the wheat from the chaff


  • Corporate News
  • Saturday, 16 May 2020

AN air of cautiousness permeates the minds of most investors when it comes to the economy and companies’ outlook.

There is also the worry of a second wave of the Covid-19 outbreak.

Yet, the stock market seems all charged up when it comes to stocks that are seen to be beneficiaries of the pandemic or at least those that claim to be.

Most of the companies whose shares have been actively bought over the two weeks are healthcare-related companies. While rubber gloves stocks have already been sought after by investors since the outbreak, they continue to attract buyers. But the euphoria seems to have spread to periphery players, all jumping on the Covid-19 bandwagon.

These are the makers of face masks, hand sanitisers, personal protective equipment (PPEs) and hospital beds among others.

Some technology counters are also on the uptrend, helped on by the fact that the major tech companies in the United States are driving up markets there as the pandemic has led to higher usage of digital technologies.

But among this group of companies, rubber glove manufacturers stand out. Leading the charge is Top Glove Corp Bhd, the world’s largest producer of medical gloves, which now commands a stratospheric price earnings (PE) multiple of 70 times.

But another glove maker seems to have outpaced Top Glove, namely Hartalega Holdings Bhd, whose PE has hit 75 times, leading to its market capitalisation surpassing that of Top Glove (see table).

Then there is HLT Global Bhd, a small cap whose shares have more than doubled just over the last week. It doesn’t even make gloves. It is a glove-dipping line manufacturer, which has also announced a venture to distribute Covid-19 rapid test kits around the world. It now commands a PE multiple of 50 times.

But can these valuations be justified?

In comparison, Malaysia’s largest lender, Malayan Banking Bhd (with market capitalisation of RM83.4bil) is trading at a PE multiple of a mere 10 times.

In the United States, Facebook Inc trades at 25 times earnings. Wouldn’t investors be better off by taking positions in such leading companies? Or will rubber glove makers really see a significant rise in profits to justify such high valuations?

One concern is, at such high values, all the upside in earnings could already been factored in. Others doubt that profits will climb manifold, considering that as rubber glove makers the world ramp up production, supply will catch up with demand and cap product prices, and in turn margins.

But there are those who reckon that rubber glove makers are in a once-in-a-life-time upswing, that will see their profits double or more.

Phillip Capital Management Bhd chief investment officer Ang Kok Heng says earnings of rubber glove companies will surge from higher demand and increased capacity will give them better economies of scale.

Average selling prices (ASPs) have risen by more than 10% given that delivery lead times have extended from the usual one to two months in February, to the current lead time of up to 11 months. Another factor boding well for rubber glove manufacturers, says Ang is the slump in raw materials prices following lower demand for rubber as a whole and lower crude oil price.

UOB Kay Hian notes that latex prices have declined by almost 10% in the first quarter of the year. Nitrile prices are 8% down. Both are the main raw materials for rubber gloves.

Every 1% drop in raw material costs could boost earnings of glove makers by between 1% and 4%, UOB Kay Hian opines.

All eyes will be on the profit numbers for the first calendar quarter of 2020 by the Malaysian listed rubber glove makers which should be out soon.One former fund manager who is an active investor today, points out that it is currently a sellers’ market where rubber gloves are concerned.

“There are more ad hoc customers and with the tight supply condition, buyers are jockeying for allocation and pushing up ASPs. Buyers are restocking, following concerns of a second wave of Covid-19 cases. They are also worried about longer delivery times. All this means demand will likely outstrip supply at least over the medium-term, ” says the former fund manager.

Former investment banker Ian Yoong says his channel checks indicate that some local rubber glove manufacturers are asking for deposits when orders are taken – a first as far as Malaysian rubber glove manufacturing goes.

Singapore-listed glove maker Riverstone Holdings Ltd, with roots in Malaysia, reported a 54% jump in its first-quarter results announced earlier this week.

In Thailand, Sri Trang Gloves Thailand, the country’s biggest producer of medical gloves, last month filed for an initial public offering to raise funds to increase production capacity. The company reportedly said it is seeing substantially increased demand for its products as a result of the pandemic.

It should be noted though that it is the medical rubber glove makers who are most likely to be seeing the full benefits of the pandemic, as opposed to industrial glove makers and other supporting players in the chain.

High demand: Latex gloves on hand-shaped moulds moving along an automated system on the production line at a Top Glove factory. The company commands a stratospheric PE multiple of 70 times. — BloombergHigh demand: Latex gloves on hand-shaped moulds moving along an automated system on the production line at a Top Glove factory. The company commands a stratospheric PE multiple of 70 times. — Bloomberg

Jumping on the bandwagon

Since the Covid-19 outbreak, a flurry of listed companies have jumped on the bandwagon, rushing to make announcements that their business has some link to the new behaviour of the masses and as such should benefit.

But a few pertinent questions need to be raised. Are these stocks merely enjoying hype-driven interest or are their underlying businesses really enjoying robust sales which in turn should translate into significantly increased profits?

Underlying all of this, is this crucial fact: many of the products seeing a spike in demand, do not have high entry barriers. Low cost producers from China predominantly, are likely to flood the market with their low-priced alternatives, which will push pricing down.

Face masks are a good example.

The South China Morning Post recently reported that China has stepped up its capacity to produce face masks by more than five-fold in the month of March – a manufacturing feat that’s fanning concerns about a glut when infection cases taper off.

According to the report, total daily capacity in China rose to 110 million in the month of March alone from about 20 million in February, with 3,000 new entrants.

China made half of the global output of masks last year and this figure may be as high as 85% in 2020, reports indicate. Then there is an issue on the quality of face masks that are being flooded into the market. Do they meet the stringent medical standards needed for hospitals to buy?The production frenzy has come on the back of an equally rapid increase in prices of face masks across the region and beyond, fuelled by panic buying mostly.

Locally, SCGM Bhd, a plastic product manufacturer, has diversified into the production of medical protective equipment, such as medical face shields and face masks.

This week, lingerie manufacturer Caely Holdings Bhd said it is branching out into the making of fabric protective masks and PPE in an agreement with another listed company, Ni Hsin Resources Bhd. More announcements are likely to be made.But some warn there would be an overcapacity when demand eases. Moreover, the profit margin in this business is also said to be thin.

The pandemic has also raised the profile of a few listed companies producing and distributing chemicals used for personal care and cleanliness such as sanitisers and disinfectants. These are Hexza Corp Bhd, Samchem Bhd and Hextar Global Bhd.

The stocks have had a low profile until recently, and are generally tightly held by their major owners.

Nova Wellness Group Bhd, which is generally known for selling dietary supplements and food and skin care products, is seeing sales of its hand sanitisers up since Covid-19.

The company reportedly has plans to launch new healthcare products to go with its hand sanitisers.

An analyst notes that Apex Healthcare Bhd, has seen demand for its hand sanitisers and face masks soar.

Similarly, the analyst says UWC Holdings Bhd and Supercomnet Technologies Bhd are also enjoying increased demand in the devices and components they supply for Covid-19 testing.

Bioalpha Holdings Bhd has seen an increase in the sales of its immunity products such as vitamin C and “tiger milk mushroom”. Sales at its Constant Pharmacy outlets are also on the uptrend, managing director William Hon tells StarBizWeek. This week, Widad Group Bhd announced it has signed a collaboration with Stoika Sdn Bhd to enter the building disinfectant business under its facilities management segment.

Last month, Permaju Industries Bhd inked a deal to bottle and distribute a Hong Kong firm’s sanitiser product for the South-East Asian market.

In the technology space, Green Packet Bhd stands out. As part of its “We Are Ready” campaign, Green Packet launched its flagship proptech application, KipleLive that aims to help Malaysian businesses to embrace the new norm. Notably, the company’s artificial intelligence thermal scanner has already been deployed in many government buildings, schools, retail, and corporate towers.

And they are targeting to help schools, factories, and hospitals to better manage their resumption and operations with this solution. The company has also launched an enhanced KiplePay e-wallet version to help companies especially food vendors, restaurant owners and retailers get back into operations by offering affordable digital solutions, ranging from an e-commerce platform to online payment systems for those looking to digitally transform their business.

According to Yoong, the stock market is currently dominated by retail players focused on listed companies that are seen as beneficiaries of Covid-19. But to separate the wheat from the chaff, some age-old pointers are good to be used.

One is profit margins.

While a company may have been earning a decent margin from a product like hand sanitisers, that may not sustain in the longer run, as multiple companies have jumped into the market.

Creador founder and CEO Brahmal Vasudevan says it is hard to see these companies actually doubling their profits.

“Sure, there has been some boost in sales but that is being evened out due to the overall softening of demand. In fact, I think only a very few companies will do better than what they are doing, with the exception of say rubber glove and hand sanitiser makers, but that too the improvements will not be that big, ” he tells StarBizWeek.

Industry experts also point out if a cure or a cost-effective vaccine is found, valuations of rubber glove players will be deemed excessive. That said, it’s still anyone’s guess how long this pandemic will last.

More important than earnings are free cash flow from operations, Yoong adds.

“Institutional funds are less optimistic given the possibility of a global recession, ” he says,

Article type: metered
User Type: anonymous web
User Status:
Campaign ID: 18
Cxense type: free
User access status: 3
   

Did you find this article insightful?

Yes
No

100% readers found this article insightful

Across the site