Gloves. In the pink of health. OVERWEIGHT (maintain) SECTOR UPDATE. 7 March 2014 KDN: PP 10251/07/2013 (032736)

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1 Gloves OVERWEIGHT (maintain) Absolute Performance (%) 1M 3M 12M Kossan Hartalega Supermax Top Glove Source: Bloomberg Before After Rating TP (RM) Rating TP (RM) Kossan BUY 5.08 BUY 5.08 Hartalega ADD 7.75 ADD 7.75 Supermax ADD 3.25 ADD 3.25 Top Glove ADD 6.48 ADD 6.48 Source: Affin Note: summary of our recent rating and TP changes In the pink of health All still intact Results from the recently concluded 4Q13 earnings season were commendable, with all the Big 4 glove manufacturers (Top Glove, Supermax, Kossan and Hartalega, combined 60% global market share) under our coverage performing generally within our and consensus expectations. On a yoy basis, earnings grew across the board, led by our top sector pick, Kossan which saw earnings expand by a robust 39% yoy in 2013, to a new record high of RM141m. Overall, we attribute the Big 4 s healthy results to: 1) robust sales-volume growth backed by healthy capacity expansion; 2) favourable raw material costs and; 3) an overall enhancement in operating efficiencies brought by managements initiatives in improving the automation process in their respective production facilities. Demand to remain resilient Deemed as a staple product within the healthcare industry, we believe that demand for rubber gloves will continue to remain resilient. We gather from the Malaysia Rubber Glove Exports Council (MREPC) that global demand and consumption (barring any viral outbreak) will continue to grow by around 8% to 10% annually at least over the near term. Herein, we think that the assessment is realistic judging from the recent historical demand trend, spurred by rising healthcare reforms globally. In addition, we gather that global population is increasingly becoming more hygiene conscious, and some have even set more stringent requirements on the quality of gloves used while others are encouraging more healthcare centres to use them. All in, we think that the global demand will continue to grow, in tandem with world population growth, and spurred along by an increase in usage at healthcare centres globally. Low and stable latex price bodes well for the sector Aside from the robust demand growth that would ensure manufacturers organic growth, glove manufacturers have also benefited from low raw material costs. Despite the wintering period currently (which falls typically from February to April annually), and a surge in the production of automobiles in China, the latex price has continued to head south, declining by 26% yoy and 13% YTD. We believe this is due to the ample supply of latex from countries such as Vietnam and Cambodia. Both countries had ventured into the rubber plantations industry back in , and their plantations are now in their prime age following the initial gestation period. Therefore, we believe latex output from these countries will continue to increase going forward. [Note that: 1) the latex price is the sector s key growth driver which makes up 55-60% of the glove manufacturers production costs; and 2) China s automobile (tyre) industry is the largest latex consumer, absorbing about 70% of the global latex output]. Mandy Teh (603) ssteh@affininvestmentbank.com.my Maintain Overweight on the sector. All in, we reiterate our OVERWEIGHT rating on the rubber gloves sector. Our positive view on the sector is backed by: 1) a low and stable latex cost; 2) resilient demand from both developed and developing economies due to improving health awareness and more stringent regulations; 3) improving production efficiencies boosted by manufacturers efforts on plant automations; and 4) stable US$ against RM that would help to spur the nation s export market. Our top sector pick (and only BUY-rated name) remains Kossan (KRI MK, BUY, RM5.08), on its more balanced product mix and attractive valuation (0.59x PEG ratio for 2014E), relative to peers. Key risks would be: 1) a sharp spike in latex price; and 2) stiffer-than-expected price competition, leading to margin erosion. Fig 1: Valuation matrix for glove companies Stock Rating Sh Pr TP Shares Mkt Cap Year Core PE (x) EPS growth (%) EV/EBITDA P/B ROE (%) Net Div Yield (%) (RM) (RM) out (RMm) End CY14 CY15 CY14 CY15 (x) (x) FY14 FY15 FY14 FY15 Kossan BUY ,903 Dec Top Glove ADD ,649 Aug Supermax ADD ,915 Dec Hartalega ADD ,116 Mar Simple average Source: Bloomberg, Affin forecasts Important disclosures at the end of report Page 1

2 Recession proof industry demand should remain resilient Volume demand grew exceptionally strong during viral outbreaks The total global consumption of examination and surgical gloves in 2012 stood at 160bn pieces (+16% yoy), according to data from MREPC. Over , global glove consumption has grown at a CAGR of 9.3%. We gather that global demand for glove had grown exceptionally strong during the multiple virus outbreaks in the 21 st century. To recap, the 2003 SARS outbreak which began in Guangdong, China resulted in a strong +23% yoy surge in gloves demand to 84bn pieces in This was followed by the H5N1 bird flu in 2008 which began in West Bengal India, a year during which glove demand surged by +13% yoy to 122bn pieces. During the H1N1 flu pandemic in 2010, which started in China, gloves demand surged by +13% yoy to 144bn pieces. Demand boost from growing healthcare awareness Overall, we believe gloves demand - deemed as a staple product within the healthcare industry will continue to grow in tandem with world population growth and increasing healthcare centres globally. In a base year scenario assuming an absence of new viral outbreaks, we expect glove demand to remain resilient, growing at a healthy rate of 8-10% p.a. This is due to: 1) improvement in healthcare awareness globally; 2) increase in healthcare reforms with more stringent regulations around the world following the H1N1 scare; and 3) improved affordability as selling prices decline in tandem with lower raw material cost. We gather that some countries have also stipulated more stringent requirements on the quality of gloves used while others are encouraging more healthcare centres to use them, especially in developing countries where the practice of glove usage is still minimal. Fig 2: Global annual demand for gloves Fig 3: Global demand (LHS) and growth (RHS) Source: MREPC, Affin forecasts Source: MREPC, Affin forecasts Excellent prospects in the two most populated countries According to the Malaysian Rubber Board (MRPEC), there is a clear disparity in annual per capita consumption of gloves between the developed countries (US: 149 pieces, EU27: 98 pieces) and the two most populated but developing countries, namely China (4.8 pieces) and India (4.0 pieces). We believe that increasing hygiene levels by both individuals and governments will gradually lead to higher glove usage over time. In fact, the rubber glove industry is eyeing the Chinese and Indian markets, where the anticipated demand (should their governments start to enforce the use of examination gloves) would increase by 2-3x that of current world demand of c.163bn pieces. Important disclosures at the end of report Page 2

3 Fig 4: Gloves import to USA Demand for nitrile gloves is growing, at the expense of latex ones While demand for gloves should remain strong backed by the previouslymentioned reasons, we think that nitrile gloves will continue to see growth outpacing that of natural rubber gloves. This is mainly due to the growing incidence of latex allergy among medical professionals, and in the general population. Hence, use of natural rubber gloves has increasingly been replaced by nitrile ones. Since 2008, the nitrile glove industry has grown at a CAGR of 12%, while that for natural rubber has been heading south. Besides, we also gather from MREPC that imports of nitrile gloves from the world s largest glove user, the US, has grown by a 22% CAGR over the past 10 years since 2003, while imports of natural rubber gloves have conversely declined over the years. Fig 5: Gloves export from Malaysia Source: MREPC, Affin Source: MREPC, Affin Hartalega and Kossan should be key beneficiaries from rosy nitrile demand In light of the rosy demand for nitrile gloves, we note that both Hartalega and Kossan are the key beneficiaries backed by their respective product mix. (See Fig 6). This has also helped to explain their commendable earnings growth as compared to the other two large manufacturers, whose product mix are still skewed towards NR gloves. Fig 6: Big 4 s latest product mix (2013) Source: Companies, Affin Fig 7: Big 4 s earnings ( ) Source: Companies, Affin Important disclosures at the end of report Page 3

4 Low and stable latex price should bode well for sector : Benign speculative activities on latex Aside from the rosy demand growth, glove manufacturers have in recent times also benefited from low raw material costs. Looking back at 2012, it was a year of two halves for the rubber gloves sector. The sector s key cost driver, namely the latex price, has been on a roller-coaster ride, soaring in 1H12, and having peaked at an all-time high of RM7.93/kg in February 2012, before trending down in 2H12. This was largely due to high speculative activities in 1H12 by traders, the sharp volatility in latex prices (which are highly correlated to global crude oil prices) and the surge in vehicle sales in the preceding year. In 2013, latex price continued to decline and average RM5.69/kg (vs RM6.72/kg in 2012). Fig 8: Latex price vs crude oil price Fig 9: China s automobile production Source: Bloomberg, Affin Source: China Association of Automobile Manufacturers, Affin Latex price is to stay at prevailing low level Despite a further surge in production of automobiles in China, which grew by +14.8% yoy in 2013 (2012: +4.6%), the latex price has continued to trend down, declining to RM4.61/kg in February 2014 vis-à-vis RM6.23/kg recorded in February We attribute this to the ample supply of latex, typically from countries such as Vietnam and Cambodia (note that these two countries ventured into the rubber plantations industry back in and we continue to expect stronger latex production volumes from these two countries going forward as their rubber plantations enter their prime age). Important disclosures at the end of report Page 4

5 Smaller pricing mismatch between nitrile and latex Generally, we believe that the: 1) ample supply of latex; 2) weak global market sentiment and; 3) the switch in customer preference from natural rubber to nitrile gloves will continue to ensure that the latex price remains favourable. In tandem with the lower latex prices, the price premium (between the two raw materials) for latex over nitrile, has narrowed to 26% from 56% over the same period last year. Notwithstanding the smaller price differential, we understand that demand for nitrile gloves remain robust. Margins are expected to stay healthy Overall, we expect a low latex cost environment and the manufacturers continuous push towards greater plant automation to continue to contribute positively to margins and the bottomline. (Note that latex price is the sector s key cost driver, making up 55-60% of the glove manufacturers production costs). Operating margins for glove manufacturers have been improving since 2Q12 and this trend should continue, as we believe their latex price will stay at prevailing low levels of c.rm /kg. So long as the latex price movement is not volatile and remains within a reasonable level, operating margins should remain steady (greater plant automation and cost pass-through should alleviate the effects of higher labour and energy costs). Fig 10: Latex price vs nitrile price Fig 11: Price disparity gap between the two commodities Source: Bloomberg, Affin Source: Bloomberg, Affin Important disclosures at the end of report Page 5

6 Valuations & Recommendation Maintain OVERWEIGHT Given the inherent demand for rubber gloves in the healthcare industry, and coupled with more stringent healthcare regulations, we remain positive on the long term prospects for the sector. Strong underlying demand typically spikes up whenever there is a viral outbreak (such as SARS and H1N1 scare, as well as H7N9 and H10N8 presently in China). Embedded in our forecast is an annual global gloves demand growth of 10%. We continue to like all the four gloves companies under our coverage and remain upbeat on their respective prospects given: 1) an improving product sales mix through the sales and manufacturing of higher quality gloves; 2) capacity expansion; 3) plant automation; 4) favourable raw material cost; and 5) their strong position as the largest glove producers globally with a combined global market share of 60%. We reiterate our OVERWEIGHT rating on the glove sector. Forecasting a double-digit earnings growth for the sector in We are forecasting average earnings growth of 17% and 14% for the sector in 2014 and 2015, respectively, with the highest growth led by our top sector pick, Kossan (+27% yoy). We like Kossan the most due to its favourable position, whereby all its production lines are highly versatile and interchangeable. This means minimal downtime in switching from natural rubber to nitrile gloves and vice versa depending on customers need. Also, this provides the manufacturer with some flexibility in adjusting ASPs whenever the cost of production increases. Possible downside risks Key risks to the sector are: 1) a sudden spike and increased volatility in the latex price due to stronger-than-expected demand for natural rubber from China s auto industry; 2) margin erosion from stiffer-than-expected pricing competition (strong pipeline of capacity expansion) and; 3) a significant appreciation in the RM/US$ exchange rate thereby dampening the manufacturers top line growth (since sales are denominated in US$). Cost-pass-through shouldn t pose a problem On a separate note, we believe that the 17% hike in electricity cost effective in January 2014 will be passed on to customers. We also expect an announcement on a gas tariff hike soon (Malaysia has delayed five scheduled bi-annual gas tariff hikes, currently at RM16.07/mmbtu). Nonetheless, we are confident that the higher gas cost could be passed on to customers, as in the past. Note that the manufacturers have managed to pass on the higher labor cost from the minimum wage policy effective in January 2013 through selling-price adjustments, with plant-automation initiatives, both of which have helped lift operating margins. Fig 12: RM/US$ exchange rate Fig 13: General cost breakdown for glove manufacturers (2013) Source: Bloomberg Source: Companies, Affin Fig 14: Valuation matrix for glove companies Stock Rating Sh Pr TP Shares Mkt Cap Year Core PE (x) EPS growth (%) EV/EBITDA P/B ROE (%) Net Div Yield (%) (RM) (RM) out (RMm) End CY14 CY15 CY14 CY15 (x) (x) FY14 FY15 FY14 FY15 Kossan BUY ,903 Dec Top Glove ADD ,649 Aug Supermax ADD ,915 Dec Hartalega ADD ,116 Mar Simple average Source: Bloomberg, Affin forecasts Important disclosures at the end of report Page 6

7 Kossan Sector: Rubber Gloves KRI MK 6 March 2014 BUY (maintain) Price Target: RM5.08 ( ) Price Performance 1M 3M 12M Absolute +7.3% +23.2% % Rel to KLCI +5.7% +20.9% % Stock Data Issued shares (m) Mkt cap (RMm)/(US$m) 2,903.2/891.8 Avg daily vol - 6mth (m) wk range (RM) Est free float 37.9% BV per share (RM) 1.11 P/BV (x) 4.05 Net cash/ (debt) (RMm) (4Q13) (36.7) ROE (2014F) 19% Derivatives Nil Shariah Compliant Yes Key Shareholders Kossan Holdings 51.2% Kumpulan Wang Persaraan 5.6% Invesco HK Ltd 5.0% EPF 5.0% Earnings & Valuation Revisions 14E 15E 16E Prev EPS (sen) Curr EPS (sen) Chg (%) Prev target price (RM) 5.08 Curr target price (RM) 5.08 Source: Affin, Bloomberg Mandy Teh (603) ssteh@affininvestmentbank.com.my Rock-solid and still our top favourite 2013 was a new profit record Our top sector pick, Kossan (KRI) recently reported a new record high earnings in 2013, with core net profit soaring by 39% yoy to RM140.6m. This was mainly driven by a respectable growth in volume sales of its speciality glove products which typically fetch higher margins. Besides, KRI also managed to turn around its clean room gloves division, posting a +79% yoy growth in revenue and a PBT of RM1.6m vis-a-vis a pretax loss of RM1.2m in Taken together with a favourable product mix, KRI's 2013 EBITDA margin expanded by +2.9 ppt to 18.4%, its highest level since More balanced product mix should put KRI in a better position We remain upbeat on KRI s prospects and believe that KRI is in a position to benefit from any shift in glove demand trend since its production lines are highly versatile and interchangeable. This means minimal downtime in switching from natural rubber to nitrile gloves and vice versa depending on customers need. Also, this will provide some flexibility to the manufacturer in adjusting its selling prices (ASPs) whenever the cost of production increases. Following the +16% increase in electricity tariff, management guided that they have raised their ASPs by around 1% effective in January 2014 to compensate for the tariff hike. All in, we believe that KRI is faring better in adjusting its ASPs as compared to TOPG (ADD, TP RM6.48), judging from its track record in raising ASPs, where KRI successfully passed on cost from the minimum wage hike in January Possible ventures to Indonesia or Vietnam Apart from its enviable production lines, we are also positive on KRI s strategic capacity expansion and diversification into technical rubber products (TRP), surgical and cleanroom gloves that enables KRI to widen its customer base. To cater to the increasing demand for its TRP products, we understand that the group is aggressively looking to expand its TRP production facilities. Given the rising cost of production in Malaysia, we do not rule out the possibility of KRI venturing abroad such as Indonesia and Vietnam. Assuming a 15 line plant, we estimate a RM15m contribution to 2015E net profit. Note that revenue from KRI s TRP division has grown by +12% yoy in 2013 to RM161m. Reiterate BUY on KRI We expect KRI to post another solid year of earnings in 2014, backed by: 1) resilient demand growth from the healthcare industry; 2) favourable raw material prices (we expect the latex price to remain low in 2014 due to new onstream supplies from Thailand, Cambodia and Vietnam); 3) KRI s increasing plant automation which should enhance operating efficiencies; and 4) management s efforts in ramping up its special purpose gloves (surgical and clean room gloves which typically fetch lucrative margins). Despite heavily outperforming its peers and the KLCI over the past 3 and 12 months, we continue to see value at current levels. We reiterate our BUY rating on KRI with an unchanged TP of RM5.08 based on a 2014E PER of 18x. Key risks would be: 1) a sharp rebound in key raw material prices; 2) stiffer-than-expected pricing competition; and 3) a sharp depreciation of the US$ against RM resulting in a slowdown in gloves export. Earnings and valuation summary FYE Dec E 2015E 2016E Revenue (RMm) 1, , , , ,939.0 EBITDA (RMm) Pretax profit (RMm) Net profit (RMm) EPS (sen) PER (x) Core net profit (RMm) Core EPS (sen) Core EPS chg (%) Core PER (x) DPS (sen) Dividend Yield (%) Consensus profit (RMm) Affin/Consensus (x) forecasts 1.0 Important disclosures at the end of report Page 7

8 FOCUS CHARTS Fig 1: KRI s sales composition mix (2013) Fig 2: KRI s product mix (2013) Fig 3: KRI s capacity Fig 4: KRI s net profit (LHS) vs EBITDA margin (RHS) ; *note: company guidance Fig 5: KRI s geographic customer mix Fig 6: KRI s 5-year PER average Source: Bloomberg, Affin Important disclosures at the end of report Page 8

9 FINANCIAL SUMMARY - Kossan Profit & Loss Statement Key Financial Ratios and Margins FYE Dec (RMm) E 2015E 2016E FYE Dec (RMm) E 2015E 2016E Total revenue 1, , , , ,939.0 Grow th Operating expenses (1,044.0) (1,068.8) (1,254.2) (1,414.1) (1,541.9) Revenue (%) EBITDA EBITDA (%) Depreciation (45.1) (51.6) (65.2) (68.3) (71.9) Core net profit (%) Amortisation EBIT Profitability Net interest income/(expense (6.4) (7.2) (6.7) (6.9) (8.8) EBITDA margin (%) Associates' contribution PBT margin (%) Others Net profit margin (%) Pretax profit Effective tax rate (%) Tax (33.7) (37.9) (45.4) (59.7) (73.9) ROA (%) Minority interest (2.6) (3.7) (3.3) (4.2) (5.2) Core ROE (%) Net profit ROCE (%) Dividend payout ratio (% Balance Sheet Statement FYE Dec (RMm) E 2015E 2015E Liquidity Fixed assets Current ratio (x) Other long term assets Op. cash flow (RMm) Total non-current assets Free cashflow (RMm) FCF/share (sen) Cash and equivalents Stocks Asset managenment Debtors Debtors turnover (days) Other current assets Stock turnover (days) Total current assets ,044.0 Creditors turnover (days Creditors Capital structure Short term borrow ings Core ROA (%) Other current liabilities ROCE (%) Total current liabilities Quarterly Profit & Loss Long term borrow ings FYE 31 Dec (RMm ) 4Q12 1Q13 2Q13 3Q13 4Q13 Other long term liabilities Revenue Total long term liabilities Operating expenses (276.4) (281.8) (276.8) (285.1) (280.3) EBITDA Shareholders' Funds ,122.6 Depreciation (11.8) (13.5) (11.7) (12.4) (14.0) EBIT Cash Flow Statement Net int income/(expense (1.7) (1.8) (1.7) (1.6) (2.1) FYE Dec (RMm) E 2015E 2015E Associates' contribution EBIT Exceptional Items Depreciation & amortisation Pretax profit Working capital changes (28.8) (15.1) (48.6) (41.8) (33.4) Tax (10.5) (10.5) (9.9) (11.0) (6.4) Cash tax paid (33.7) (37.9) (45.4) (59.7) (73.9) Minority interest (1.0) (0.8) (0.6) (1.3) (1.0) Others Net profit Cashflow from operations Core net profit Capex (40.0) (70.0) (75.0) (90.0) (75.0) Disposal/(purchases) Margins (%) Others EBIT Cash flow from investing (40.0) (70.0) (75.0) (75.0) (74.0) PBT Debt raised/(repaid) (16.0) Net profit Equity raised/(repaid) Net interest income/(expense (6.4) (7.2) (6.7) (6.9) (8.8) Dividends paid (25.6) (44.8) (57.6) (70.3) (76.7) Others Cash flow from financing (48.0) (41.1) (51.9) (72.5) (80.7) Free Cash Flow forecasts Important disclosures at the end of report Page 9

10 Hartalega Sector: Rubber Gloves HART MK 6 March 2014 ADD (maintain) Price Target: RM7.75 ( ) *fully diluted Price Performance 1M 3M 12M Absolute -3.0% -5.6% +45.6% Rel to KLCI -4.2% -6.4% +27.9% Stock Data Issued shares (m) Mkt cap (RMm)/(US$m) 5,115.9/1,571.5 Avg daily vol - 6mth (m) wk range (RM) Est free float 36.9% BV per share (RM) 1.23 P/BV (x) 5.70 Net cash/ (debt) (RMm) (1Q14) ROE (2014F) 19% Derivatives Nil Shariah Compliant Yes Key Shareholders Hartalega Industries SB 50.4% EPF 6.1% Budi Tenggera 4.9% Earnings & Valuation Revisions 14E 15E 16E Prev EPS (sen) Curr EPS (sen) Chg (%) Prev target price (RM) 7.75 Curr target price (RM) 7.75 Source: Affin, Bloomberg Mandy Teh (603) ssteh@affininvestmentbank.com.my Ultimate beneficiary from the nitrile wave A consistent performer In its latest results announcement, Hartalega (Harta) posted a healthy +8.5% yoy growth in its 9MFY03/14 s revenue to RM827m, thanks to the robust demand for its core nitrile glove products (volume sales grew by a sturdy +17.5% yoy to 8.5bn pieces of gloves), coupled with Harta s healthy capacity expansion. In tandem with higher sales volume, Harta s operating costs also increased, albeit at a slower rate of +7.8% yoy, thanks to: 1) the group s continuous improvement in enhancing production efficiency; and 2) favourable raw material costs. As a result, Harta s 9M14 s core earnings jumped 14.5% yoy to RM194m. Nitrile gloves demand continues to rise and this augers well for Harta Despite the latex price continuing to trend down, leading to a smaller price disparity between latex and nitrile, we gather that nitrile glove demand remains healthy. Usage of nitrile gloves in the US and North America has increased by a CAGR of 22% since This augers well for Harta, which specializes in the production of nitrile gloves. Half of its customers are from these two countries. Capacity expansion is imminent To cope with overwhelming demand, Harta has completed the land filling and road access infrastructure for its latest production facility. Management guided that they are currently building the manufacturing facility, and is confident that the first phase of its Next Generation Intergated Complex (NGC) (equipped with 11 production lines) will be commissioned by April This project is targeted to be completed over the next 8 years (end March 2022), and has been accorded an Entry Point Project (EPP) status under the government s Economic Transformation Programme (ETP). While Harta s current capacity is at 14bn pieces of gloves, management expects the capacity to jump by threefold to 42bn pieces in 2022 when the entire project is fully commissioned. Higher quality gloves should help sustain robust margins Key investor concerns rest with stronger price competition going forward. Nonetheless, we believe Harta will be able to sustain its superior net profit margins at around 22% through the sale and production of its higher margin premium quality gloves. Harta s newest glove invention, COATS (Colloidal Oatmeal Active Therapeutic System) is anti-irritant, antibacterial and is anti-dry dermatitis, which is suitable for consumers in countries where the climate is cold and dry as it has an added moisturising effect. We understand that Harta has secured one big order for COATS over the next 6 months and has received many enquiries. Due to its current capacity constraint, we are positive on demand for COATS going forward. Maintain ADD and TP of RM7.75 On a whole, we remain upbeat on Harta s prospects. Harta s share price has risen strongly (2013: +52%) due to its solid earnings delivery and improved trading liquidity. We maintain our ADD rating and TP of RM7.75. Key risk to our rating lies in stiffer-than-expected price competition as all the glove manufacturers under our coverage are currently ramping up their respective production capacities for synthetic nitrile gloves. Earnings and valuation summary FYE Mar E 2015E 2016E Revenue (RMm) , , , ,472.3 EBITDA (RMm) Pretax profit (RMm) Net profit (RMm) EPS (sen) PER (x) Core net profit (RMm) Core EPS (sen) Core EPS chg (%) Core EPS (sen) * Core EPS chg (%) * Core PER (x) * DPS (sen) Dividend Yield (%) EV/EBITDA (x) Consensus profit (RMm) Affin/Consensus (x) *based on and enlarged share base of 804.6m forecasts Important disclosures at the end of report Page 10

11 FOCUS CHART Fig 1: Harta s capacity growth Fig 2: Harta s capacity from NGC Source: MRPEC, Affin; *note: company guidance ; note: company guidance for FY14-22E Fig 3: Hartalega s net profit (LHS) and EBIT margin (RHS) Fig 4: Harta s product mix (2013) Source: Affin Fig 5: Hartalega s geographic customer mix Source: Bloomberg, Affin Fig 6: Hartalega s 5-yr PER average Source: Bloomberg, Affin Important disclosures at the end of report Page 11

12 FINANCIAL SUMMARY - Hartalega Profit & Loss Statement Key Financial Ratios and Margins FYE Mar (RMm) E 2015E 2016E FYE Mar (RMm) E 2015E 2016E Total revenue , , , ,472.3 Grow th Operating expenses (636.1) (691.1) (784.8) (874.8) (942.0) Revenue (%) EBITDA EBITDA (%) Depreciation (29.0) (34.1) (48.0) (65.6) (78.5) Core net profit (%) Amortisation (0.0) (0.0) EBIT Profitability Net interest income/(expense) (1.7) (0.9) (2.2) (2.9) (3.2) EBITDA margin (%) Associates' contribution PBT margin (%) Others Net profit margin (%) Pretax profit Effective tax rate (%) Tax (57.0) (70.8) (81.5) (95.0) (103.2) ROA (%) Minority interest (0.1) (0.3) (0.1) (0.1) (0.1) Core ROE (%) Net profit ROCE (%) Dividend payout ratio (%) Balance Sheet Statement FYE Mar (RMm) E 2015E 2016E Liquidity Fixed assets Current ratio (x) Other long term assets Op. cash flow (RMm) Total non-current assets Free cashflow (RMm) FCF/share (sen) Cash and equivalents Stocks Asset managenment Debtors Debtors turnover (days) Other current assets Stock turnover (days) Total current assets Creditors turnover (days) Creditors Capital structure Short term borrow ings Core ROA (%) Other current liabilities ROCE (%) Total current liabilities Quarterly Profit & Loss Long term borrow ings FYE Mar (RMm ) 3Q13 4Q13 1Q14 2Q14 3Q14 Other long term liabilities Revenue Total long term liabilities Operating expenses (182.2) (188.3) (192.7) (192.2) (193.1) EBIT Shareholders' Funds Net int income/(expense) (0.2) (0.2) (0.1) (0.1) (0.1) Associates' contribution Cash Flow Statement Exceptional Items (3.3) (6.4) 0.0 FYE Mar (RMm) E 2015E 2016E Pretax profit EBIT Tax (17.7) (18.9) (18.9) (19.0) (16.7) Depreciation & amortisation Minority interest (0.1) (0.1) (0.1) Working capital changes (41.1) 37.7 (77.2) (24.8) (17.7) Net profit Cash tax paid (57.0) (70.8) (81.5) (95.0) (103.2) Core net profit Others Cashflow from operations Margins (%) Capex (35.4) (250.0) (200.0) (300.0) (250.0) EBIT Disposal/(purchases) PBT Others (24.8) Net profit Cash flow from investing (60.1) (203.1) (200.0) (300.0) (250.0) Debt raised/(repaid) (14.3) (12.5) (0.8) Equity raised/(repaid) Net interest income/(expense) (1.7) (0.9) (2.2) (2.9) (3.2) Dividends paid (87.4) (95.0) (186.4) (109.6) (131.6) Others (2.4) Cash flow from financing (95.0) 75.7 (186.0) (69.0) (135.6) Free Cash Flow forecasts Important disclosures at the end of report Page 12

13 Supermax Sector: Rubber Gloves SUCB MK 6 March 2014 ADD (maintain) Price Target: RM3.25 ( ) Price Performance 1M 3M 12M Absolute -3.4% +6.0% +52.6% Rel to KLCI -5.9% +4.2% +31.9% Stock Data Issued shares (m) Mkt cap (RMm)/(US$m) 1,915.2/588.3 Avg daily vol - 6mth (m) wk range (RM) Est free float 52.7% BV per share (RM) 1.38 P/BV (x) 2.04 Net cash/ (debt) (RMm) (4Q13) (154.3) ROE (2014F) 13% Derivatives Nil Shariah Compliant Yes Key Shareholders Dato Seri Stanley Thai 20.4% Datin Seri Cheryl Tan 15.2% Slow and Steady 2013 core earnings grew by 5.9% yoy to RM129m Supermax (SUCB) posted a healthy +13% yoy growth in its 2013 revenue to RM1.13bn. Again, this is due to the resilient demand for gloves, coupled with SUCB s healthy capacity expansion, especially for its nitrile gloves. SUCB experienced a similar favourable operating landscape as Harta, whereby the manufacturers operating cost increased, albeit at a slower rate in tandem with the volume sales. This was mainly driven by: 1) the group s continuous improvement in boosting production efficiency; and 2) favourable raw material costs. Given the higher EBIT margin, up 1ppt yoy to 13.2%, SUCB s 2013 core earnings were lifted by 5.9% yoy to RM129m. Nitrile gloves is the group s key focus for now Management guided that the industry demand for synthetic nitrile gloves remains resilient, particularly for its premium quality range from customers in the US, UK, Canada and Germany. Riding on strong demand, the group is currently fasttracking the construction of new production lines to raise its nitrile gloves production capacity to 12.3bn pieces by 1H14, doubling from 6.9bn pieces currently. This should lead to a significant shift in product mix, with nitrile gloves going from 39% currently to 45%. Despite the rising price competition within the nitrile gloves segment, management is confident in achieving a net profit margin of at least 10% going forward, (2013: 11.4%) brought by: 1) the group s continuous effort in plant automation; and 2) favourable raw material prices in light of the additional latex supply from Vietnam and Cambodia. Green light for Glove City We gather that SUCB s Plant 10 (Lot 6058) is now fully commissioned, and Plant 11 (Lot 6059) will be ready by end-3q14. These two plants will produce an additional 4bn pieces of gloves bringing total production to 23bn pieces in FY14. We have also incorporated a further capacity of 4bn pieces of gloves from Glove City in Recall that SUCB had deferred the construction of its Glove City project for two years pending the ironing out of the terms for its gas supply. This issue has now been resolved and construction work will start soon. It is expected that the 1 st Phase of Glove City (equipped with 30 lines) will be commissioned by 1HFY15. All in, management has allocated around RM100m of CAPEX for for plant expansion, automations as well as refurbishment activities of older lines. Maintain ADD rating on SUCB with TP at RM3.25 All in, we are positive on the resolution of gas supply for Glove City. Importantly, we think that SUCB s current valuation at a 12x 2015E PER is highly attractive, and there is scope for a further re-rating closer to the prevailing industry average of 14x. Maintain ADD with TP of RM3.25, based on a 2014E PER of 15x. Key risk lies in: 1) stiffer-than-expected pricing competiton; 2) delay in its plant expansion; and 3) a sharp rebound in raw material prices. Earnings & Valuation Revisions 14E 15E 16E Prev EPS (sen) Curr EPS (sen) Chg (%) Prev target price (RM) 3.25 Curr target price (RM) 3.25 Source: Affin, Bloomberg Mandy Teh (603) ssteh@affininvestmentbank.com.my Earnings and valuation summary FYE Dec E 2015E 2016E Revenue (RMm) , , , ,419.1 EBITDA (RMm) Pretax profit (RMm) Net profit (RMm) EPS (sen) PER (x) Core net profit (RMm) Core EPS (sen) Core EPS chg (%) Core PER (x) DPS (sen) Dividend Yield (%) EV/EBITDA (x) Consensus profit (RMm) Affin/Consensus (x) forecasts Important disclosures at the end of report Page 13

14 FOCUS CHARTS Fig 1: SUCB s capacity expansion Fig 2: SUCB s core net profit (LHS) and EBIT margin (RHS) ; *note: company guidance Fig 3: SUCB s 5-year PER average Fig 4: SUCB s cost breakdown (2013) Source: Bloomberg, Affin Fig 5: SUCB sales composition on market segment Fig 6: Supermax s sales by region (2013) ; note: for 2013 Important disclosures at the end of report Page 14

15 FINANCIAL SUMMARY - Supermax Profit & Loss Statement Key Financial Ratios and Margins FYE Dec (RMm) E 2015E 2016E FYE Dec (RMm) E 2015E 2016E Total revenue Grow th Operating expenses (850.3) (978.5) (1106.5) (1205.7) (1224.1) Revenue (%) (2.3) EBITDA EBITDA (%) Depreciation (24.3) 0.0 (33.9) (38.8) (41.2) Core net profit (%) Amortisation EBIT Profitability Net interest income/(expense (8.7) (8.8) (9.3) (3.3) (3.3) EBITDA margin (%) Associates' contribution PBT margin (%) Others Net profit margin (%) Pretax profit Effective tax rate (%) Tax (15.9) (25.8) (31.5) (34.5) (35.1) ROA (%) Minority interest 0.3 (0.5) (0.1) (0.2) (0.2) Core ROE (%) Net profit ROCE (%) Dividend payout ratio (%) Balance Sheet Statement FYE Dec (RMm) E 2015E 2016E Liquidity Fixed assets Current ratio (x) Other long term assets Op. cash flow (RMm) Total non-current assets Free cashflow (RMm) (7.2) FCF/share (sen) 15.8 (1.1) Cash and equivalents Stocks Asset managenment Debtors Debtors turnover (days) Other current assets Stock turnover (days) Total current assets Creditors turnover (days) Creditors Capital structure Short term borrow ings Core ROA (%) Other current liabilities ROCE (%) Total current liabilities Quarterly Profit & Loss Long term borrow ings FYE 31 Dec (RMm) 4Q12 1Q13 2Q13 3Q13 4Q13 Other long term liabilities Revenue Total long term liabilities Operating expenses (281.7) (284.7) (292.6) (245.8) (155.5) EBIT Shareholders' Funds Net int income/(expense) (2.0) (2.2) (2.2) (2.1) (2.3) Associates' contribution Cash Flow Statement Exceptional Items FYE Dec (RMm) E 2015E 2016E Pretax profit EBIT Tax (10.5) (4.7) (4.9) (4.1) (12.2) Depreciation & amortisation Minority interest (0.4) 0.0 (0.6) (0.6) 0.8 Working capital changes 17.2 (60.2) (18.6) (31.2) (5.4) Net profit Cash tax paid (15.9) (25.8) (31.5) (34.5) (35.1) Core net profit Others Cashflow from operations Margins (%) Capex (64.1) (85.0) (100.0) (100.0) (100.0) EBIT Disposal/(purchases) PBT Others Net profit Cash flow from investing (64.1) (85.0) (100.0) (100.0) (100.0) Debt raised/(repaid) Equity raised/(repaid) Net interest income/(expense (8.7) (8.8) (9.3) (3.3) (3.3) Dividends paid (17.0) (17.0) (20.4) (23.9) (27.4) Others Cash flow from financing (25.8) (29.7) (27.2) (30.7) Free Cash Flow (7.2) forecasts Important disclosures at the end of report Page 15

16 Top Glove Sector: Rubber Gloves TOPG MK 6 March 2014 ADD (maintain) Price Target: RM6.48 ( ) Price Performance 1M 3M 12M Absolute +7.1% +3.7% +10.5% Rel to KLCI +6.9% +1.3% -3.3% Stock Data Issued shares (m) Mkt cap (RMm)/(US$m) 3,649.0/1,120.9 Avg daily vol - 6mth (m) wk range (RM) Est free float 47.4% BV per share (RM) 2.26 P/BV (x) 2.54 Net cash/ (debt) (RMm) (1Q14) 58.5 ROE (2014F) 13% Derivatives Nil Shariah Compliant Yes Key Shareholders Tan Sri Dato Lim Wee Chai 28.9% Kumpulan Wang Persaraan 6.3% EPF 5.5% Top Glove Holdings 5.2% Matthew International Capital 5.0% Earnings & Valuation Revisions 14E 15E 16E Prev EPS (sen) Curr EPS (sen) Chg (%) Prev target price (RM) 6.48 Curr target price (RM) 6.48 Source: Affin, Bloomberg Mandy Teh (603) ssteh@affininvestmentbank.com.my Haunted by pricing pressure Pricing pressure has hindered TOPG s topline growth The world s largest glove manufacturer, Top Glove (TOPG) continued to register healthy volume sales growth (+10% yoy in 1QFY14) driven by the group s healthy capacity expansion on its nitrile glove production. Notwithstanding the healthy volume growth, TOPG s 1QFY14 revenue was lower yoy (-1.8%) at RM574m. A key reason for this is the sharply lower average selling price (ASP) for its core natural rubber gloves product, which has been declining in tandem with lower latex prices (-11.4% yoy). Furthermore, the continuous switch to nitrile gloves by its key customers has further exerted pricing pressure on its natural rubber gloves product. Thankfully, TOPG s operating cost fell by a sharper 4.5% yoy in tandem with industry trends. As such, TOPG s 1Q FY14 EBIT margin expanded +2.4ppt to 12% while core earnings jumped by 18% yoy to RM50m. Shift focus to Nitrile While the key big markets (eg US, North America and Europe) are shifting their demand from latex-based gloves to Nitrile gloves, TOPG is committed to expanding its production capacity for nitrile. The group aims to expand its total capacity to 46.2bn pieces (from 44bn pieces) from its 2 new factories, namely F27 and F29. Phase 2 of F27, consists of 6 new and highly interchangeable lines which will be commissioned in 2QFY14, producing an additional 0.6bn pieces of nitrile gloves. As for TOPG s F29 plant in Klang, management is confident that the 16 new highly versatile production lines will be commissioned by 4QFY14, producing an additional 1.6bn pieces of nitrile gloves. Notwithstanding the capacity ramp up, plant utilization should stay at 65%, as we incorporate a higher downtime rate as TOPG continues to revamp its production lines and finetune its automation process. RM180m of CAPEX for FY14E Management has allocated a total planned CAPEX of RM180m for FY14E. Among these capex, around RM65-70m of this is allocated for F27 and F29, which includes construction cost and new equipment (robotic arms and auto stacking). An approximate RM70m is allocated for the construction of its Top Glove office tower in Setia Alam; while the remaining RM40m is for land clearing activities, nursery, fittings and planting of young rubber trees in its 40k hectares piece of rubber plantation land in Indonesia. Maintain ADD and TP at RM6.48 While TOPG is the largest glove producer in the world, the manufacturer is our least preferred among its peers at this juncture due to: 1) its unbalanced product mix current product mix still skewed towards natural rubber latex-based gloves which are currently facing strong price competition; and 2) the group s low production utilization rates compared to its peers. We attribute this to TOPG s huge number of old production lines, in which the manufacturer is taking a longer-than-expected time for refurbishment activities. All in, we maintain our ADD rating on TOPG, with a TP of RM6.48 based on a 2014E PER of 18x. Key catalysts would be an improvement in pricing structure moving forward and a faster-than-expected pace in the completion of its refurbishment activities. Earnings and valuation summary FYE Aug (RM'm) E 2015E 2016E Revenue (RMm) 2, , , , ,993.7 EBITDA (RMm) Pretax profit (RMm) Net profit (RMm) EPS (sen) PER (x) Core net profit (RMm) Core EPS (sen) Core EPS chg (%) Core PER (x) DPS (sen) Dividend Yield (%) EV/EBITDA (x) Consensus profit (RMm) Affin/Consensus (x) forecasts 1.0 Important disclosures at the end of report Page 16

17 FOCUS CHARTS Fig 1: TOPG s capacity Fig 2: TOPG s 5-year PER average ; note: 2014F represents company guidance Fig 5: TOPG s customers Source: Bloomberg, Affin Fig 6: TOPG s cost component (1Q FY14) Fig 7: TOPG s product mix (1Q FY14) Fig 8: TOPG s core net profit (LHS) and EBIT margin (RHS) Important disclosures at the end of report Page 17

18 FINANCIAL SUMMARY Top Glove Top Glove: Profit & Loss Statement Top Glove: Key Financial Ratios and Margins FYE Aug (RMm) E 2015E 2016E FYE Aug (RMm) E 2015E 2016E Total revenue 2, , , , ,993.7 Grow th Operating expenses -2, , , , ,586.2 Revenue (%) EBITDA EBITDA (%) Depreciation Core net profit (%) Amortisation EBIT Profitability Net interest income/(expense) EBITDA margin (%) Associates' contribution PBT margin (%) Others Net profit margin (%) Pretax profit Effective tax rate (%) Tax ROA (%) Minority interest Core ROE (%) Net profit ROCE (%) Dividend payout ratio (%) Top Glove: Balance Sheet Statement FYE Aug (RMm) E 2015E 2016E Liquidity Fixed assets ,017.7 Current ratio (x) Other long term assets Op. cash flow (RMm) Total non-current assets , ,070.8 Free cashflow (RMm) FCF/share (sen) Cash and equivalents Stocks Asset managenment Debtors Debtors turnover (days) Other current assets Stock turnover (days) Total current assets , ,178.2 Creditors turnover (days) Creditors Capital structure Short term borrow ings Net gearing (%) Other current liabilities Interest cover (x) Total current liabilities Long term borrow ings Quarterly Profit & Loss Other long term liabilities FYE 31 Aug (RMm ) 1Q13 2Q13 3Q13 4Q13 1Q14 Total long term liabilities Revenue Operating expenses Shareholders' Funds 1, , , , ,845.7 EBIT Net int income/(expense) Top Glove: Cash Flow Statement Associates' contribution FYE Aug (RMm) E 2015E 2016E Exceptional Items EBIT Pretax profit Depreciation & amortisation Tax Working capital changes Minority interest Cash tax paid Net profit Others Core net profit Cashflow from operations Capex Margins (%) Disposal/(purchases) EBIT Others PBT Cash flow from investing Net profit Debt raised/(repaid) Equity raised/(repaid) Net interest income/(expense) Dividends paid Others Cash flow from financing Free Cash Flow forecasts Important disclosures at the end of report Page 18