Productive 1Q for rubber glove sector, strong outlook ahead

KUCHING: The rubber glove industry is expected to remain resilient moving forward backed by ongoing demand, the possible increase in the cases of H7N9 bird flu virus China and the defensive and captive earnings stream nature of the industry.

Outlining this, the research arm of Kenanga Investment Bank Bhd (Kenanga Research) said the just concluded results season of the first quarter of 2013 (1Q13) as reported by public-listed Malaysian rubber glove companies was within expectations.

Sales volume within sector largely grew year on year (y-o-y) across all the companies, led by Kossan Rubber Industries Bhd (Kossan), up 23 per cent y-o-y, Hartalega Holdings Bhd (Hartalega), up16.9 per cent y-o-y, Supermax Corporation Bhd (Supermax) up 8.1 per cent y-o-y and Top Glove Corporation Bhd (Top Glove) up 20 per cent y-o-y.

The increases were due to capacity expansions as well as higher demands fueled by the lower ASPs (average selling prices) due to the easing input of raw material prices.

“Looking at the 1Q13 results, Kossan and Hartalega were the most resilient in combating the minimum wage policy implemented on January 1, 2013. Top Glove and Supermax were, however, slightly impacted by the minimum wage.

“Interestingly, the margins of Kossan and Hartalega have been resilient, which demonstrated their ability to pass the cost through to counter the higher cost from the minimum wage,” Kenanga Research noted in a sector update yesterday.

Supermax registered a weaker 1Q financial year 2013 (FY13) profit before tax margin of 11.5 per cent compared with 12.6 per cent in 4QFY12 while Top Glove which reported its 2QFY13 (December 2012 to February 2013) results last month, was hit by a RM8 million increase in salaries due to the effect of the minimum wage.

The research team was not overly concerned of further margin erosions as an estimated three to five per cent increase in the ASPs which was announced in January 2013, would take effect from the second quarter onwards.

“In addition, these players have invested in the automation and computerisation of their manufacturing processes and have gradually reduced their reliance on manual workers to further minimise the adverse effect of the minimum wage policy.

“Some of the automations put in place include the automated mechanical stripping system (removing gloves off hand moulds) and glove puller and stacker system.

“The benefits from automation will, however, take some time to flow through to mitigate the effects of the minimum wage policy,” Kenanga Research reckoned.

The research team believes that the rubber glove players may face higher production costs emanating from the persisting high energy prices as the government has raised the gas price by seven per cent to RM16.07 per million British thermal units since June 2011 and raised the electricity tariff rate by eight to 10 per cent.

The hike in energy prices was expected to be in line with the government’s subsidy rationalisation programme but the research house is not overly concerned on the potential hikes since energy cost makes up only eight to nine per cent of the production cost.

It also believes that the average 10 per cent demand per annum for rubber gloves over the next few years is still intact, with overall demand expected to be led by natural rubber gloves although synthetic rubber gloves had consistently been taking up the former’s market share.

It chose Kossan as the top sector pick (with a target price of RM4.88 per share) due to the latter’s undemanding valuation with the stock trading at just 9.1-fold its 2014 earnings per share (EPS) or at a 38 per cent discount to its larger peers like Top Glove’s 14.2-fold and Hartalega’s 13.9-fold for 2014.

In addition, the company is gradually raising its dividend payout ratio, having recently declared a final seven sen tax exempt dividend.

This brought its total full-year FY12 dividend per share to 12.5 sen, implying a 38 per cent payout ratio – well ahead of its less than 20 per cent payout ratios in the past three years.

Third is the fact that “Kossan is not just a rubber glove play but a bet on its TRP (technical rubber products) division, which is growing strongly at a rate of more than 20 per cent quarter on quarter at the pre-tax profit level over the past few quarters.”