Still Riding On Nitrile
Downgrade to NEUTRAL. PER valuations of glove stocks have re-rated significantly from 8-16x (end-2012) to 11-19x presently amid a positive operating environment and superior financials (high ROEs, zero/low gearing). Valuations are fairly reflective of fundamentals at this stage and thus we are downgrading the sector to NEUTRAL from Overweight. Kossan remains our top pick with a higher TP of MYR7.60 (+7%) as we attached a higher PER target of 16x (from 15x), still lower than its peer average of 15.6x. Our HOLD on Hartalega (TP MYR6.71) is maintained but we have downgraded Top Glove to HOLD (from BUY) with a slightly lower TP of MYR6.40 (-5%).
Mild nitrile price competition. Though new supply looks aggressive, near-term price competition is likely to be mild, for new capacity will just about match demand, we believe, with the latter expanding by about 20% YoY. In addition to organic demand growth, nitrile glove sales are also driven by a shift in customer preference from latex powder-free to nitrile gloves. Nitrile glove margins remain superior to those of latex gloves, by >6ppts, due to higher pricing and lower raw material cost.
Hedged against currency volatility. To hedge their USD-denominated receivables against USD:MYR volatility, most glove companies buy forward contracts (which expire in 2-3 months) to sell USD when glove deliveries take place. Hence, glove companies usually do not gain nor lose significantly on USD:MYR volatility.
Muted impact from fuel price hike. We understand that the recent fuel price hike (diesel: +11%) has led to higher transportation costs (+15%) for the glove companies. However, the impact is insignificant as transportation only accounts for 2-3% of total costs, and glove players are not adjusting their ASPs for this.
Hartalega, Top Glove: Less upside. We believe Hartalega’s near-term growth will be limited by its capacity constraint (new capacity to commence in 2015). Meanwhile, Top Glove’s sales volume could be flattish in sequential quarters as we think the higher sales of its nitrile gloves (est. 20% of total sales volume) could be offset by lower sales of latex powder-free gloves (estimated at 20% of total sales volume). We trim our FY8/13-14 EPS forecasts for Top Glove by 5% as we factor in weaker latex powder-free glove sales.
Kossan: A slightly better value proposition. Kossan, an increasingly nitrile-centric glove manufacturer, offers higher net profit growth (3-year CAGR of 16% on capacity expansion of 14% p.a.) at a lower forward PER valuation of 13.9x (vs 15.6x for its peers).
Publish date: 24/09/13