Malaysian Gloves Sector

Transcription

1 Asia Pacific Malaysia Healthcare Products/Services (Citi) Company 44 pages Malaysian Gloves Sector In Good Hands: Initiating Sector with Buys on Supermax, Kossan Buy Supermax, Kossan; Hold Top Glove We initiate Kossan and Supermax at Buy/Low Risk with target prices of RM4.95 and RM7.40 respectively, underpinned by earnings growth of 15-24% and ROE of 31%. Top Glove is rated Hold/Low Risk given its lower earnings growth of 10.5% and ROE of 25%. Our 12-month target prices are pegged 1SD/0.5sd above historical means. Catalysts for 3Q10 rerating We believe our preferred glove stocks would see another up-cycle from 3Q10E on: 1) Expected easing of latex prices due to a seasonal rise in rubber production in Aug-Sep; 2) Release of robust 2Q10 results in Aug that point to above-trend margins; and 3) Healthy sales growth. Overall, we see Malaysian glove producers offering good value above-market earnings growth at undemanding valuations, sustainable long-term growth helped by resilient demand, and healthy balance sheets. Fiona Leong Fiona.Leong@citi.com Lawrence Ye lawrence.ye@citi.com Demand has normalized, but still blue skies for some Following A(H1N1)-led consumption growth of 14% in 2009, global demand for examination gloves has normalized. As the industry reverts to average demand growth of 8-10% pa, we see sharp moderation in earnings growth for Top Glove, which competes in the crowded powdered glove segment. But niche players Kossan and Supermax will still enjoy stronger sales growth in 2010, based on our analysis. Headwinds unlikely to cloud earnings outlook The industry faces four key challenges: 1) Overcapacity; 2) Record-high latex prices; 3) RM appreciation; and 4) Cuts in gas subsidies. These headwinds are not new and past experience supports our view that glove producers can and will adjust selling prices to protect profitability. Malaysia s glove industry has pricing power due to its global market dominance (an estimated 65% global market share). Where we could go wrong Our view on Malaysian glove companies could weaken if stronger-than-expected capacity expansion by industry players results in severe overcapacity, latex is in short supply due to a surge in demand from other industries or bad weather conditions, and sharp volatility in latex prices and the US$ that hampers accurate adjustments to selling prices. Figure 1. Malaysia Glove Manufacturers Valuation Metrics Price Target ETR EPS Gth (%) PE (x) PB (x) Div Yld (%) Rating (RM) Price (%) FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E Top Glove 2L Supermax 1L Kossan 1L Source: Citi Investment Research and Analysis estimates See Appendix A-1 for Analyst Certification, Important Disclosures and non-us research analyst disclosures. Citi Investment Research & Analysis is a division of Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Contents Valuation Summary 3 Investment Summary 6 Top picks Kossan and Supermax; Hold Top Glove 6 Risks to our investment view 8 Affordable Recession-Proof Product 9 Necessity for medical practitioners, increased use elsewhere 9 Steady 8-10% pa consumption growth over long term 9 No perfect substitute 13 What makes Malaysia the global leader 15 A quality manufacturer, recognized by MNCs 15 Able to produce comprehensive range of glove products 15 Advantages: Access to latex supplies, support industries 16 Leads in R&D to improve quality, increase efficiency 17 Four Key Concerns Industry overcapacity Record-high latex prices Strengthening ringgit Removal of gas subsidies 24 Production scale to weather volatility in latex prices, ringgit 25 Wide customer base limits risk of pricing pressure 25 Differentiated strategies 25 Top Glove: Volume producer eyeing developing markets 25 Supermax: OBM for additional income, earnings stability 26 Kossan: Medical segment for better margins, earnings stability 26 Top Glove (TPGC.KL) 27 Quants View Glamour 29 Supermax (SUPM.KL) 31 Kossan Rubber Industries (KRIB.KL) 34 Appendix A

3 Valuation Summary Figure 2. Malaysia Glove Manufacturers Valuation Metrics Price (RM) TP ETR Mkt. Cap EPS Gwth (%) PE (x) PB (x) Div Yield (%) ROE (%) Company RIC Rating 27-Jul-10 (RM) (%) (RMm) CY10E CY11E CY10E CY11E CY10E CY11E CY10E CY11E CY10E CY11E Top Glove TPGC.KL 2L , Supermax SUPM.KL 1L , Kossan KRIB.KL 1L , Hartalega HTHB.KL NR 8.20 n/a n/a 1, Latexx Partners LATX.KL NR 3.60 n/a n/a n/a n/a Adventa ADVE.KL NR 3.09 n/a n/a n/a Weighted Average 10, Source: Citi Investment Research estimates and IBES for NR stocks Figure 3. Malaysia Glove Manufacturers P/E vs ROE, CY10E ROE (CY10E) Latexx Partners Hartalega Supermax Kossan Adventa Top Glove 14.0 MSCI Malaysia PE (CY10E) Source: IBES and Citi Investment Research and Analysis estimates 3

4 Figure 4. Top Glove: 12-Month Forward Rolling P/E Figure 5. Top Glove: 12-Month Forward Rolling P/B x x x x x x 7.0 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 12m-Fwd Rolling P/E Mean +1SD -1SD 1.0 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 12m-Fwd Rolling P/B Mean +1SD -1SD Source: IBES and Citi Investment Research and Analysis Figure 6. Supermax: 12-Month Forward Rolling P/E Source: IBES and Citi Investment Research and Analysis Figure 7. Supermax: 12-Month Forward Rolling P/B x x x Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 12m-Fwd Rolling P/E Mean +1SD -1SD x x x Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 12m-Fwd Rolling P/B Mean +1SD -1SD Source: IBES and Citi Investment Research and Analysis Figure 8. Kossan: 12-Month Forward Rolling P/E Source: IBES and Citi Investment Research and Analysis Figure 9. Kossan: 12-Month Forward Rolling P/B x x x x x x Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 12m-Fwd Rolling P/E Mean +1SD -1SD Nov-09 Feb-10 May-10 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 12m-Fwd Rolling P/B Mean +1SD -1SD Nov-09 Feb-10 May-10 Source: IBES and Citi Investment Research and Analysis Source: IBES and Citi Investment Research and Analysis 4

5 Figure 10. Malaysia Glove Manufacturers Earnings Forecasts and Key Assumptions Top Glove Supermax Kossan Sector (3 Gloves Manufacturers) (RMm) CY09A CY10E CY11E CY09A CY10E CY11E CY09A CY10E CY11E CY09A CY10E CY11E Revenue 1, , , , , , , , , ,878.0 Revenue growth (%) (1.0) (6.1) EBITDA EBITDA growth (%) EBITDA margin (%) Adjusted PBT Adjusted PBT growth (%) Adjusted PBT margin (%) Adjusted Net Profit Adjusted Net Profit Growth (%) Adjusted Net Profit margin (%) FD EPS (sen) FD EPS Growth (%) DPS (sen) Dividend Yield (%) Production Capacity Number of lines Installed capacity (bil/yr) Volume sales (bil/yr) Source: Company reports and Citi Investment Research and Analysis estimates 5

6 Investment Summary Top picks Kossan and Supermax; Hold Top Glove Kossan and Supermax offer more compelling valuation We initiate coverage of Malaysia s three largest glove manufacturers, with Buy/Low Risk ratings for Kossan Rubber Industries and Supermax. Industry leader Top Glove is rated Hold/Low Risk. Top Glove is currently trading at 15.4x P/E CY10E, while Supermax and Kossan are valued at P/Es of 11.7x and 10.4x respectively. These multiples compare favorably against a market valuation of 15.4x CY10E earnings, particularly when earnings are still expected to improve after the exceptional 65% yoy surge in net profits in Pegging FY11E EPS of these three stocks at 1SD above their historical mean P/Es, our 12-month price targets of RM4.95 (target P/E: 10.5x) for Kossan and RM7.40 (target P/E: 12x) for Supermax suggest ETR of 26.5% and 22% respectively. Top Glove s ETR is a lower 13.5% based on a target price of RM7.25 (target P/E: 16x). Quant analysis: Top Glove - Glamour Glove stocks set to re-rate in 3Q10 Top Glove lies in the Glamour quadrant of our Value-Momentum map with strong momentum but relatively weak value scores. The stock has moved from the Attractive quadrant to the Glamour quadrant in the past 3 months indicating strong momentum with weakening valuation scores. Compared to its peers in the healthcare sector, Top Glove fares worse on the valuation metric but better on the momentum metric. Similarly, compared to its peers in its home market of Malaysia, Top Glove fares worse on the valuation metric but better on the momentum metric. We believe our preferred glove stocks would get another up-cycle from 3Q10 driven by: [1] Easing of latex prices on a seasonal rise in rubber production in Aug-Sep; [2] Release of robust 2Q10 results in the Aug reporting season that point to still above-trend margins (although off the peak in 4Q09); and [3] Healthy sales growth. These catalysts, in our view, would once again bring to the fore the sector s investment merits. Malaysian glove manufacturers offer investors: [1] Abovemarket earnings growth at what we think are undemanding valuations. Current CY10E P/Es of 11-12x (Kossan and Supermax) and aggregate earnings growth of 30% are attractive compared to MSCI Malaysia P/E of 15.4x and EPS growth of 23%; [2] Sustainable long-term growth with global consumption of gloves projected to increase by 8-10% pa; [3] Healthy balance sheets with net gearing of less than 60%; and [4] Exposure to an industry that Malaysia has market dominance (65% share of the world s latex gloves market) and pricing power. Demand has normalized, but sky is still blue for some Glove companies enjoyed a very strong up-cycle in share prices over the past 18 months, particularly in 2Q09 and 4Q09-1Q10. Their strong outperformance relative to the KLCI was driven by the upswing in quarterly earnings in 2009 as the industry ramped up production to meet the A(H1N1) pandemic led demand. Then, favorable demand conditions overshadowed the uptrend in latex prices and the appreciation of the ringgit. 6

7 Figure 11. Relative Share Performance, Dec 2008 to Present 1, Top Glove Supermax Kossan KLCI Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Source: Bloomberg and Citi Investment Research and Analysis Figure 12. Malaysia Glove Manufacturers Performance in Recent Quarters (1Q09 to 2Q10) Price %QoQ Qtr Top Glove Supermax Kossan KLCI Top Glove Supermax Kossan KLCI CY1Q % 10.0% 2.9% -0.5% CY2Q , % 88.6% 29.2% 23.2% CY3Q , % 51.2% 16.4% 11.8% CY4Q , % 88.0% 25.4% 5.9% CY1Q , % 43.6% 47.3% 3.8% CY2Q , % 7.7% -5.0% -0.5% Source: Company Reports and Citi Investment Research and Analysis Today, demand growth has normalized as the A(H1N1) virus has been brought under control but latex prices have remained stubbornly high while the ringgit s strength has been held up by increases in Malaysia s policy rate. Our channel checks revealed that there are early signs of excess supply in the commodity powdered glove segment. This could lead to some downward pressure on prices should smaller producers, hurt by the contraction in orders, start to cut prices. Reflecting the moderation in demand, Top Glove guided that net profit growth for financial year ending August 2011 would decelerate to 10-15% (FY10E: +49% yoy). But Supermax and Kossan remain upbeat about their prospects and indicated that earnings growth of circa 20% is achievable for 2011E. Against such a backdrop, we would advocate a preference for niche players as they would likely be impacted less by overcapacity and price wars. Supermax can rely on its higher mix of powder-free and nitrile gloves (55% of production) and niche in the dental segment; Kossan specializes in the manufacture of medical grade gloves. Top Glove, given the sheer size of its production capacity, competes in the commodity powdered glove segment (57% of production) and would be impacted by any intensification in competition. Nevertheless, Top Glove s lean and efficient operations as well as strong balance sheet would enable the group to withstand any price war better than its competitors, in our view. 7

8 Headwinds would not cloud earnings outlook How does our forecasts and ratings compare with consensus? The industry is facing four key challenges that investors are concerned about: [1] Overcapacity; [2] Record-high latex prices; [3] RM appreciation; and [4] Cuts in gas subsidies. These headwinds are not new and past experience supports our view that glove producers can and will adjust selling prices to protect profitability. Malaysian glove manufacturers pricing power is underpinned by its global leadership and market dominance. Our FY10E-11E earnings projections for Supermax and Kossan are in line with consensus estimates but we are 5% below the Street s forecast for Top Glove. Our slightly more downbeat projection for Top Glove underscores our belief that its earnings growth would decelerate at a sharper rate than the other two companies given its bigger exposure to the more crowded powdered glove segment. We expect aggregate net profit of the three companies to rise 31% to RM564m in CY10E and improve a further 15% to RM647m in CY11E. We are consensus Buyers of Supermax and Kossan but have a non-consensus Hold rating on Top Glove. Risks to our investment view Main risks to our investment view include: Stronger-than-expected capacity expansion by glove manufacturers resulting in severe over-supply; Surge in demand for latex from other industries leading to shortage of raw material supplies to the glove industry; and Sharp volatility in latex prices and US dollar as this would hamper glove producers ability to accurately adjust selling prices and raw-material purchases. 8

9 Affordable Recession-Proof Product Necessity for medical practitioners, increased use elsewhere Rubber examination gloves are a necessity as barrier protection for the healthcare industry. The use of examination gloves surged in the early 1990s driven by increased public awareness of HIV and the risks healthcare professionals faced. The importance of barrier protection was further reinforced by global epidemics such as SARS, bird flu, A(H1N1) over the past few years. Soon after the HIV outbreak, many other professionals like dentists, rescue workers, and police officers began wearing examination gloves. The increasing use of disposable rubber gloves for non-medical applications, led by the US, underpinned the healthy 8-10% pa growth in global consumption of rubber examination gloves over the past decade, regardless of the economic cycles. In 2009, global consumption of rubber gloves increased by an estimated 18% to bn pieces due to the outbreak of the A(H1N1) pandemic in April Malaysian glove companies benefited from the surge in demand and posted record earnings. The industry was one of few that was unscathed by the global economic recession. Steady 8-10% pa consumption growth over long term Notwithstanding a consumption CAGR of 11% between 2001 and 2009, glove manufacturers in Malaysia are optimistic global demand for examination gloves would continue to rise at a sustained 8-10% pa over the next few years. Industry dynamics that would support growth include: Increasing healthcare and hygiene awareness, particularly in developing countries; Stringent health regulations in western countries i.e. the US, Europe and Latin America, that are barriers to entry for lower quality gloves; Increasing occurrence of global pandemic and health threats such as SARS, bird flu, A(H1N1), Anthrax; and Growing use of rubber gloves for non-medical purposes in developed countries - especially in laboratories, cleanrooms, food industry, postal services, home care and other industries. 9

10 Figure 13. Estimated Global Consumption of Gloves Bil pcs % A(H1N1) SARS Bird flu E 2011E Est. Global Consumption % YoY Source: Companies, Citi Investment Research and Analysis Developing nations offer vast potential One of the key factors underpinning Malaysian glove manufacturers optimism of the industry s prospects is the vast potential for growth in use of examination gloves in developing nations such as Brazil, Russia, India and China (BRIC). Currently, the US and Europe are the biggest consumers of examination gloves, accounting for 60-80% of sales of Malaysia s top three glove producers (Figures 13-16). But rising healthcare and hygiene standards in BRIC countries are expected to fuel demand for examination gloves. Figure 14. Sales by Geographical Mix Top Glove, May 2010 Figure 15. Sales by Geographical Mix Supermax, March 2010 Asia 9% Middle East 5% Rest of world 3% North America 28% Europe 26% Asia 6% Middle East 6% North America 42% Europe 34% Latin America 21% Latin America 20% Source: Company and Citi Investment Research and Analysis Source: Company and Citi Investment Research and Analysis 10

11 Figure 16. Sales by Geographical Mix Kossan, March 2010 Figure 17. Sales by Geographical Mix Top 3 Glove Producers As % of Sales Revenue Europe 30% Asia 2% Rest of world 8% North America 50% Top Glove Supermax Kossan North America Latin America Europe Asia Middle East Rest of world Latin America 10% Source: Company and Citi Investment Research and Analysis Source: Company and Citi Investment Research and Analysis While we do not expect healthcare spending in BRIC countries to reach levels seen in the US and Europe, the wide disparity is a good indication of the growth potential offered by developing nations. According to the World Health Organization s World Health Statistics 2010, global healthcare expenditure was 9.7% of GDP in 2007 compared with 9.2% in The US had the highest healthcare bill at 15.7% of GDP (2000: 13.4%), while Brazil spent 8.4%, Russia 5.4%, China 4.3% and India 4.1%. Figure 18. Healthcare Expenditure of Selected Countries As % of GDP Healthcare Exp Per capita (US$) Population (mil) CAGR % 2008 US ,703 7, France ,256 4, Switzerland ,529 6, Germany ,372 4, Canada ,082 4, Portugal , Denmark ,478 5, Australia ,728 3, Netherlands ,916 4, Italy ,541 3, Spain ,036 2, Brazil UK ,769 3, Japan ,827 2,751 (0.4) Russia Malaysia China , India , Global Source: WHO World Health Statistics 2010, World Bank, Citi Investment Research and Analysis 11

12 Figure 19. Healthcare Expenditure as % of GDP % of GDP US France Switzerland Germany Canada Portugal Denmark Australia Netherlands Italy Spain Brazil UK Japan Russia Malaysia China India Source: WHO World Health Statistics 2010, Citi Investment Research and Analysis Among the new markets, glove manufacturers are particularly excited about China. Supermax projects China s consumption of rubber examination gloves to grow by 11-12% pa driven by the Chinese government s healthcare reform plan, the country s strong economic growth and large population of 1.32bn. In January 2009, the government announced an Rmb850bn or US$124.3bn 3- year plan to build clinics in each of the country s 700,000 villages and raise hygiene standards. According to the Malaysian Rubber Export Promotion Council (MREPC), China s medical industry uses mainly vinyl gloves (69.8% of total) instead of latex gloves (29.8%). We believe this could be attributed to the cheaper cost of vinyl gloves as well as less stringent standards set by the country s health authorities. But as income levels rise and hygiene standards improve with economic growth, we expect a shift towards latex gloves, which are a safer barrier protection. China s consumption of examination gloves grew by m pieces pa in Assuming new demand of 650m pieces and a higher mix of 33% for latex gloves, consumption of latex gloves would reach 3.43bn pieces or an increase of 520m pieces. 12

13 Figure 20. China Consumption of Medical Gloves, Figure 21. China Consumption of Medical Gloves by Type, (bil pcs) (%) Latex 29.8% Nitrile 0.4% Vinyl 69.8% Vinyl Latex YoY % Source: MREPC and Citi Investment Research and Analysis Source: MREPC and Citi Investment Research and Analysis Overhauling US healthcare In March 2010, the US government passed a sweeping healthcare legislation that rewrote the rules governing medical industries. The two bills, which will cost US$940bn over 10 years, will ensure that 32m uninsured Americans (or 10.3% of US population of 309.7m) will get medical coverage. The new healthcare bill will ensure coverage for 95% of Americans. While the new healthcare bill is not expected to result in a sudden surge in orders for examination gloves, the progressive extension of medical coverage to the 32m uninsured American citizens would sustain demand growth coming from the US over the longer term. No perfect substitute Latex gloves under threat? Examination gloves are available in latex (powered and powder-free), nitrile and vinyl. In recent years, there has been a push for latex-free examination gloves in the US due to latex proteins allergy and in January 2008 The John Hopkins Hospitals became the first major medical institution to ban the use of latex gloves and almost all medical latex products. It was reported that 6% of general US population have latex allergy and 17% of healthcare workers are reported to be affected. Kimberly-Clark was one of the first examination glove manufacturers to catch on to this trend when it decided in 2006 to exit the production of latex exam gloves to focus on its synthetic examination glove business. Kimberly-Clark s exit was partly due to a decision to outsource the production of latex gloves to contract manufacturers (OEM) and not worry about rising cost of raw materials and need to invest in R&D to improve on quality. Domestically, Latexx Partners had in May 2010 entered into a strategic tie-up with Budev B.V. to apply and commercialize Budev s patented technology (MPXX) to reduce the major allergens that cause protein allergy in latex gloves. Latex gloves, still the preferred type Notwithstanding the growing use of nitrile gloves, latex examination gloves still account for at least 80% of examination gloves used globally each year. Although Malaysian manufacturers have been increasing production of nitrile gloves, latex gloves will continue to account for the bulk of their production. This is largely because latex gloves are more economical (15-30% cheaper) than nitrile gloves and they offer better barrier protection than the cheaper 13

14 vinyl gloves. Although examination gloves are low-priced medical consumables, the volume of usage is high and developing countries are likely to prefer the cheaper but effective latex examination gloves. The majority of medical practitioners, particularly surgeons, are said to prefer latex gloves as these provide high strength and elasticity, comfort, fit and feel. Figure 22. Top Glove Sales by Glove Type Figure 23. Supermax Sales by Glove Type Vinyl 6% Nitrile 7% Surgical 4% Others 2% Latex powdered 57% Nitrile 20% Surgical 3% Latex powdered 42% Latex powder-free 24% Latex powder-free 35% Source: Company, Citi Investment Research and Analysis Figure 24. Kossan Sales by Glove Type Source: Company, Citi Investment Research and Analysis Figure 25. Sales by Glove Type As % of Sales Revenue Top Glove Supermax Kossan Nitrile 40% Latex powdered 20% Latex powder-free 40% Latex powdered Latex powder-free Nitrile Vinyl Surgical Others Source: Company, Citi Investment Research and Analysis Source: Companies, Citi Investment Research and Analysis Besides John Hopkins Hospitals, no other hospital group in the US has switched to a latex-free environment. We gather that the lobbying for such a change has died down and most Malaysian glove manufacturers do not foresee the US medical industry making a complete switch to synthetic gloves in the near future. In any case, Malaysian glove manufacturers do have the capability to produce nitrile gloves and their production lines are designed with the flexibility to switch between latex and nitrile gloves. Furthermore, latex glove is a green product made from sustainable resources compared with synthetic gloves which are non-biodegradable. 14

15 What makes Malaysia the global leader A quality manufacturer, recognized by MNCs Malaysia meets an estimated 65% of global demand for latex gloves Malaysia is the world s leading rubber glove manufacturer, supplying an estimated 65% of global demand for latex gloves. As a testament of the country s industry leadership and production quality, the major players are contract manufacturers (OEM) for multi-national companies (MNCs) such as Ansell Healthcare, Kimberly-Clark Safeskin, Mediflex, Microflex, Cardinal Health and Medline Industries. To qualify as a supplier to these MNCs, glove producers have to pass plant audits conducted by its clients and have the required certifications from health authorities in the US, Canada, Europe, Latin America and UK. More than 90% of examination gloves exported from Malaysia are OEM sales with the balance 10% under own brand names (OBM). Among Malaysia s top three producers, Top Glove and Kossan operate on an OEM model with 80-90% of production supplied to MNCs. Supermax has a different business strategy with OBM sales accounting for a bigger 65% of sales and OEM sales for 35%. Supermax has carved a niche in the supply of rubber gloves to the dental industry under its own brands. Today, it is the second biggest supplier of gloves to the US dental industry with a market share of 8.6%. Supermax expanded its market share from a mere 2.5% in 2005 while leader Microflex saw its market share eroded from 15.5% to 9.9% over the same period. Able to produce comprehensive range of glove products Malaysian glove manufacturers are able to produce a wide range of latex, nitrile and vinyl glove products that cater to the different needs and requirements of users in various industries. For instance, Top Glove offers a comprehensive range with 13 key products. Having a good portfolio of products is vital as MNC customers will find it convenient to purchase their supplies from a just few key suppliers. 15

16 Figure 26. Malaysia Glove Manufacturers Key Products Produced Glove Types Latex examination gloves Powdered and Powder-free Nitrile examination gloves Vinyl examination gloves Medical gloves - available in latex, nitrile and vinyl for both powdered and powder-free gloves Surgical gloves powdered and powder-free Disposable gloves Cleanroom gloves - available in latex and nitrile Household gloves General purpose gloves Description & Functional Benefits Made from natural rubber latex. Offers best barrier protection in areas of potential risk associated with blood-borne pathogens and other substances or biohazards. The physical properties of the material provide excellent flexibility and uncompromised protection with high degree of sensitivity. It provides excellent comfort and feel. Latex outperforms other glove materials in terms of elasticity and tensile strength. Latex examination gloves are generally affordable and economical. Made from synthetic rubber which is non-latex and protein free, hence suitable for users who are sensitive to natural rubber proteins. Soft formulation or low modulus nitrile gloves provides excellent feel, fit, comfort and flexibility to users and reduces hand fatigue. It has good resistance to oil, grease and wide range of toxic chemicals and solvents. Nitrile gloves possess high abrasion and puncture resistance properties. Its elasticity is good but less superior as compared to natural rubber. It is generally more costly than natural rubber gloves. Made from Poly Vinyl Chloride (PVC). It is ideal for users who are sensitive to natural rubber latex protein allergy. Vinyl gloves have good resistance to oil, ozone, grease, acid and bases. Vinyl provides a relaxed and comfortable fit that feels like a second body skin. Soft vinyl formulation offers greater comfort, fit and better flexibility. It has anti-static properties suitable for cleanroom and critical environment applications. Vinyl gloves are generally very affordable and economical. The highest quality of Medical-Grade Exam Gloves is to act as a reliable, protective barrier which prevents the transmission of organisms and blood-borne pathogens to its users. Exam gloves are not necessary in sterile form, it can be in non-sterile to protect your hands from exposure. It is widely used in hospitals (outside operating theatre) and other industrial and home applications. Made from high quality natural latex. Sterile surgical gloves are at the top of the range of quality protective gloves and are typically used by surgeons and operating room staffs. Disposable Gloves are generally used in the following applications: Food handling, salons/spas, electronic assemblies, laboratorial work, packing process, automotive, janitorial, general pharmaceutical and home use/diy. These gloves are not suitable for medical use, especially to prevent transmission of organisms, blood-borne pathogens and protection against various chemicals. Cleanroom gloves are used in facilities where air supply, distribution and filtration, apparel worn, equipment used and operation procedures are regulated to control airborne particle concentrations to meet specific cleanliness levels are defined by federal Standard 209 or ISO The air in this controlled room is thousand of times cleaner or particle free than in a typical hospital operating room. These facilities are used in semiconductor industry which fabricates microchips, wafers and hard disk drives. Made from latex. Household gloves are used for industrial, domestic cleaning, food processing and handling purposes. It provides excellent abrasion, cut and tear resistance with excellent grip and dexterity. It also protects against alkalis but not against petroleum and other oil based solvents. General Purpose Gloves are used for everyday application from household repairs to automobile light parts assemblies. It is also economical for many light task applications such as food service, automotive, gardening, cleaning, hair drying, painting, janitorial, and refinishing. Polyethylene gloves (PE gloves) Source: Top Glove, Citi Investment Research and Analysis Disposable polyethylene or PE gloves are made with materials approved by USDA, provide protection from organic vapors, dusts and mists thus making them a smart choice for any food service application. All of the gloves are powder free. Advantages: Access to latex supplies, support industries Proximity to latex supplies Latex examination gloves are made from natural rubber latex, which typically accounts for 50-57% of glove manufacturers production cost. As latex comes in liquid form, being near its source of supplies is an advantage as this would reduce transportation and storage costs. Malaysia is the world s third largest producer of rubber latex, after Thailand and Indonesia. Besides buying from local suppliers, glove manufacturers also source from Thailand and Vietnam. Malaysian glove companies do not purchase raw materials from Indonesia due to higher transport costs as well as different quality of latex produced, which is more yellow and require additional processing to reduce the color. 16

17 Good supporting industry Malaysia still the preferred location Given the long history of this industry, glove manufacturers in Malaysia are supported by engineering companies with good technical know-how and experience. This is vital for design of new plants, manufacture and assembly of new production lines, and quick response time for repairs and maintenance work. A well designed production line will generate higher output and lower wastage. Even glove manufacturers in Thailand and Indonesia order their production lines from these Malaysian engineering companies. As operations of Malaysian glove producers expanded over the years, many have conducted feasibility studies on the possible set-up of plants in Thailand and Indonesia given the availability of raw materials and cheaper labor cost. But only Top Glove and APL Industries (delisted and wound up) have ventured abroad with mixed results. For Thailand, ideally plants would be located in southern Thailand where there are rubber plantations but constant political unrest in that area has made that country a less suitable manufacturing base compared with Malaysia. Over in Indonesia, besides the issue of latex rubber being less suitable for glove production, manufacturers there have to contend with energy brown outs. The resulting wastage would be costly. Leads in R&D to improve quality, increase efficiency A key barrier to entry into the glove manufacturing industry is good technical know-how: Constant R&D to develop new and higher value-added products e.g. lower protein content in latex gloves, Kossan s chemical-free nitrile gloves, Supermax s patented honey-combed gloves for the dental industry; Technical know-how to improve efficiency via [1] upgrading of production processes to increase output and reduce wastage; [2] design of flexible production lines that are capable of producing latex and nitrile gloves with minimum downtime required for switch over; [3] production lines with double formers to reduce use of land area; [4] auto stripping system. All these R&D efforts have helped Malaysian glove manufacturers produce new and improved products to meet new healthcare standards required by developed countries as well as stay ahead of the competition. Four Key Concerns 1. Industry overcapacity Glove manufacturers held back on expansion plans in 2008 till mid-2009 after the industry encountered several headwinds in Challenges that hit the industry were [1] higher energy bills as natural gas price was raised by 78% and electricity tariff was increased by 26%; [2] latex price surged to a high of RM7.20/kg; [3] chemical prices were up 30-40%; and [4] the ringgit appreciated 3.2% to RM3.33:US$1.00. The A(H1N1)-induced surge in demand in 2009 has prompted almost every glove producer to roll out expansion plans. The top three manufacturers are expected to boost production capacities by an aggregate 5.8bn pieces in 2010E and 15.4bn pieces in 2011E. This compared with the mere 1.5bn pieces that they added in 2009 and the annual global consumption growth of 10-11bn pieces. 17

18 Figure 27. Production Capacity of Top Three Manufacturers Period (Million pieces) Top Glove Corp 7,200 8,928 15,000 22,000 28,200 30,000 31,500 33,000 41,250 Supermax Corp 3,108 5,398 7,128 8,632 10,420 14,500 14,500 17,600 21,700 Kossan Rubber Ind 1,730 3,000 3,900 5,500 7,900 9,300 9,300 10,500 13,600 Total - Top 3 12,038 17,326 26,028 36,132 46,520 53,800 55,300 61,100 76,550 Increase 2,870 5,288 8,702 10,104 10,388 7,280 1,500 5,800 15,450 Est. Global Consumption 80,000 90, , , , , , , ,000 Increase 10,000 10,000 10,000 12,000 11,000 12,000 5,000 11,000 11,000 Source: Companies and Citi Investment Research and Analysis We believe that the risk of a massive overcapacity hitting the industry is low. We take comfort in the fact that producers will fine-tune their expansion plans based on demand conditions, as they did in late-2008 and For instance, Top Glove, which has the most aggressive expansion plan amongst the three, guided that it would defer the rollout of new production lines should its overall capacity utilization rate fall below 70% (currently 75%, down from a high of 90% in 2009). Furthermore, smaller players that do not have the production scale, efficiency and balance sheet strength to withstand any downward pressure on pricing would exit the industry. This ongoing consolidation within the industry, which has reduced the number of players from 200 in 1990 to 65 in 2000 and 45 in 2009, would restore equilibrium within the industry. 2. Record-high latex prices Natural rubber latex makes up 50-57% of glove manufacturers production cost. Hence, with latex prices on an uninterrupted 12-month uptrend from an average of RM4.09/kg in 2Q09 to a high of RM7.23/kg in 2Q10, there are concerns demand would be crimped and margin squeezed. Figure 28. Latex Price, Dec 2007 to Present 8 RM/kg Q08 RM5.89 2Q08 RM6.28 3Q08 RM6.44 4Q08 RM4.14 1Q09 RM4.10 2Q09 RM4.09 3Q09 RM4.42 4Q09 RM5.29 1Q10 RM6.98 2Q10 RM Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Source: Malaysia Rubber Board, Citi Investment Research and Analysis 18

19 Gloves a necessity for barrier protection Producers have pricing power, win-win pricing arrangement with customers However, the record-high latex prices have not led to any decline in consumption as exam gloves given its importance as a necessary protection barrier. The importance of protection far outweighs the potential cost savings from reduced usage or any switch from latex gloves to the cheaper vinyl gloves. Instead, buyers have changed their purchasing patterns in recent times. Rather than placing orders days ahead of the delivery date, the lead time has been reduced to 40 days. This happens because buyers expect latex prices to ease from current record high levels and do not want to lock in orders at high prices. Similarly, Malaysian glove manufacturers have also been careful to only quote selling prices a month prior to physical delivery. Selling prices are set based on the previous month s average latex price. Generally, Malaysian glove manufacturers aim to maintain profit per unit rather than margins. This is achieved by raising selling prices to pass through cost increases (raw materials, packaging, fuel) and US dollar fluctuations and lowering prices when there are favorable cost savings. Hence, in times of rising latex prices where selling prices are increased just sufficiently to cover the higher production cost, margins would be compressed but profits earned on each unit of glove sold remain largely intact. Conversely, the average selling price (ASP) would retreat when latex prices ease. Such an arrangement keeps both buyers and producers happy and works for a long-term business relationship. Figure 29. Latex Price vs. Average Selling Prices 8 RM/Kg US$/ Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Latex LP (Food) LP (Med) LPF (Med) Source: Supermax, Malaysia Rubber Board, Citi Investment Research and Analysis Other factors that would help protect profitability include: [1] having high quality MNC clients as these tend to be more focused on product quality and are less price sensitive; [2] a wide customer base of accounts with no one customer accounting for more than 5% of sales means glove producers protect themselves from being held ransom by any one customer. Admittedly, ability to fully pass on cost increases is also dependent on the demand situation. When demand is strong, glove manufacturers can pass on 100% of the cost increase without any resistance from customers. Otherwise, they pass on approximately 80% of cost increases with the balance compensated by improving efficiency and cost containment efforts. 19

20 Since 2005, there have been several up-cycles in latex prices but these have not resulted in any discernible negative impact on glove companies earnings. We do not expect the situation to be any different with the current high latex price. Figure 30. Top 3 Glove Producers Quarterly PBT vs Latex Price Figure 31. Top Glove Quarterly PBT vs Latex Price RM/Kg RM mil Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 PBT - Top 3 RM/kg RM/Kg Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Top Glove RM/kg RM mil Source: Citi Investment Research and Analysis Figure 32. Supermax Quarterly PBT vs Latex Price Source: Company, Malaysian Rubber Board, Citi Investment Research and Analysis Figure 33. Kossan Quarterly PBT vs Latex Price RM/kg RM mil RM/Kg RM mil Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Supermax RM/kg KRI RM/kg Source: Citi Investment Research and Analysis Source: Citi Investment Research and Analysis The rise in latex prices over the past few years is not due to supply shortage but due mainly to speculative activities driven by high crude oil prices. From data compiled by the International Rubber Study Group (IRSG), there has been a good equilibrium between demand and supply of natural rubber latex for the past five years. 20

21 Figure 34. World Rubber Production and Consumption Production ('000 tonnes) Consumption ('000 tonnes) Natural Synthetic Total Natural Synthetic Total ,634 9,880 16,514 6,570 9,870 16, ,577 10,390 16,967 6,650 10,280 16, ,762 10,870 17,632 7,340 10,830 18, ,332 10,483 17,815 7,333 10,253 17, ,326 10,877 18,203 7,556 10,874 18, ,020 11,379 19,399 7,939 11,386 19, ,746 11,999 20,745 8,718 11,878 20, ,904 12,136 21,040 9,200 11,936 21, ,791 12,690 22,481 9,714 12,691 22, ,801 13,430 23,231 10,224 13,308 23, ,031 12,784 22,815 10,154 12,619 22, ,602 12,168 21,770 9,547 11,878 21,425 Source: IRSG, Citi Investment Research and Analysis Figure 35. Latex Price vs Production of Natural Rubber 8 RM/kg ('000 tonnes) Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Production Latex Price Source: Malaysia Rubber Board, Citi Investment Research and Analysis 3. Strengthening ringgit Examination gloves are exported and sold in US dollars. The ringgit s 6.5% appreciation against the greenback since early 2010 has led to concerns that Malaysian glove manufacturers would be earning less. However, the impact is not as severe as feared. Malaysian glove manufacturers purchase approximately 70% of their latex requirements from domestic producers, while the balance 30% comes mainly from Thailand. Latex bought from local producers is paid in ringgit while those imported from Thailand is denominated in US dollars. Coupled with US dollar purchases of chemicals and other raw materials, Malaysian glove producers enjoy a natural hedge of approximately 70%. 21

22 Glove manufacturers manage the strengthening ringgit as it would the rising cost of raw materials. Selling prices quoted to customers takes into account not just fluctuations in raw material prices but also movements in the local currency. This has not eroded the competitiveness of Malaysian glove companies as other major rubber glove producing countries (Thailand and Indonesia) have also seen a strengthening of their local currencies. Figure 36. USD vs. Ringgit Figure 37. USD vs. Thai Baht Dec-07 USD:RM Feb average : 3.33; +3.2% YoY 2009 average : 3.52; -5.4% YoY Jan-Jul 2010: +6.5% YTD Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun Dec-07 USD:THB Feb average : 33.3; +3.6% YoY 2009 average : 34.3; -2.9% YoY Jan-Jul 2010: +3.3% YTD Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Source: Bloomberg, Citi Investment Research and Analysis Figure 38. USD vs. Indonesian Rupiah Source: Bloomberg, Citi Investment Research and Analysis USD:IDR average : 9,678; -5.6% YoY 2009 average : 10,399; -6.9% YoY Jan-Jul 2010: +3.7% YTD 6000 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Source: Bloomberg, Citi Investment Research and Analysis Like rising latex prices, the ringgit s appreciation against the US dollar has not hurt earnings of glove manufacturers. Although the local currency strengthened throughout end-2005 to March 2008, aggregate profits of the three top glove producers remained on a steady increase. 22

23 Figure 39. Top 3 Glove Producers Quarterly Profits vs. Ringgit Movement RM mil US:RM Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun PBT - Top 3 US:RM Source: Companies, Bloomberg, Citi Investment Research and Analysis Incidentally, the periods of ringgit strengthening coincided with sharp upswing in latex prices. But as illustrated earlier, this has not negatively impacted earnings of glove manufacturers. We believe Malaysia s leadership and market dominance would allow for continued adjustments in selling prices to offset changes in raw material price as well as currency fluctuations. That said, extreme volatilities on these two fronts would result in imperfect pricing and this would hurt glove producers bottom line. Figure 40. Latex Price vs. Ringgit Movement 8 RM/kg US:RM Latex: RM RM3.24:US$ Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun RM/kg US:RM Source: Malaysia Rubber Board, Bloomberg, Citi Investment Research and Analysis 23

24 4. Removal of gas subsidies Glove manufacturers in Malaysia enjoy subsidized natural gas supplies. The industry is paying RM15/mmBtu, a sharp discount to market price of RM30/mmbtu. The government lowered natural gas prices to RM15/mmBtu in March 2009 from RM24.54/mmBtu (raised by 91% in June 2008). As part of its plans to reduce the country s Budget deficit from 7% of GDP in 2009 to 5.3% in 2010E and 2.8% in 2015E, the government has made known intentions to reduce its annual subsidies of RM73bn. To achieve this, the government said it would review energy prices every six months with the plan to moving to a market price regime within five years. The gradual removal of gas subsidies, we believe, would not adversely impact glove manufacturers. Fuel cost accounts for only 10% of overall production costs and not all of this is for natural gas. Over the last couple of years, glove producers have been increasing the use of biomass as a source of energy. This was partly spurred by the non-availability of gas supplies for new plants. Figure 41. Production Cost Top Glove Figure 42. Production Cost Supermax Packaging 6% Overhead & others 9% Packaging 8% Overhead & others 7% Labour 9% Labour 9% Chemical 8% Latex 59% Chemical 9% Latex 57% Fuel 9% Fuel 10% Source: Company, Citi Investment Research and Analysis Figure 43. Production Cost Kossan Source: Company, Citi Investment Research and Analysis Figure 44. Production Cost Top 3 Glove Producers Packaging 9% Labour 9% Chemical 9% Overhead & others 8% Latex 56% As % of Production Cost Top Glove Supermax Kossan Latex Fuel Chemical Labor Packaging Overhead & others Fuel 9% Source: Company, Citi Investment Research and Analysis Source: Company, Citi Investment Research and Analysis 24

25 Production scale to weather volatility in latex prices, ringgit Volatility in raw-material price and the ringgit has made it difficult for smaller manufacturers to survive in the glove manufacturing industry. According to the Malaysian Rubber Glove Manufacturers Association (MARGMA), Malaysia s rubber glove industry has evolved from a highly fragmented industry with 200 players having 23% global market share in 1990 to a much reduced 45 players but with an enlarged 65% of world s market in Smaller producers are less able to withstand price wars during times of excess capacity or fluctuations in selling prices during times of volatile latex prices or ringgit movement. Figure 45. Malaysia s Rubber Glove Industry Consolidation & Global Market Share Number of Malaysian Glove Manufacturers Global Market Share 23% 45% 62% Source: MARGMA, Citi Investment Research and Analysis Wide customer base limits risk of pricing pressure Malaysian glove manufacturers are not beholden to any one particular customer. Each of the top three producers boast long customer lists of accounts with no one buyer accounting for more than 5% of sales revenue. This limits glove companies risk of being held ransom by customers demanding for lower prices. For instance, Supermax had recently dropped Cardinal Healthcare as a customer when the latter attempted to squeeze the glove maker for lower prices. Differentiated strategies Top Glove: Volume producer eyeing developing markets Top Glove, by virtue of its large production capacity of 33bn pieces or approximately 23% of global consumption, prefers a strategy of catering to demand for powdered gloves. Notwithstanding growing preference for powderfree and nitrile gloves in rich developed countries, powdered gloves still make up an estimated 40-50% of examination gloves used. Management takes the view that as its bigger competitors change their production mix to a higher level 25

26 of powder-free and nitrile gloves, the commodity powdered gloves market would have reduced competition. Furthermore, new emerging markets such as Brazil, China and India, which offer stronger growth than developed markets like the US, Canada and Europe, are buyers of the cheaper powdered latex gloves. By focusing on the largest market segment, Top Glove adopted a strategy of aggressive capacity expansion of 30-35% pa to gain market and drive earnings growth. Although management continues to plan for two to three new factories a year, its actual rollout of new capacity takes into consideration the global demand outlook. It would defer expansion plans should utilization rate fall below 70%. Risks of targeting emerging markets include buying that tends to be kept to spot buying and is more volatile as it tracks movements in latex prices. Supermax: OBM for additional income, earnings stability When Supermax set up its distribution centers in 2001, many expressed skepticism over Supermax s business strategy to manufacture latex gloves under its own brand name (OBM). Skeptics argued that examination glove is a commodity and branding is of little importance. Also, being an OBM could result in a loss of OEM contracts as customers may feel threatened by the competition. Management proved its skeptics wrong. Today, Supermax s OBM gloves have made good inroads into the dental and scientific laboratory markets in the US and Brazil. OBM sales account for 65% of total revenue. This decision to move downstream has provided Supermax with an additional income stream from distribution activities via joint ventures with local partners in export markets. There would also be brand loyalty and reduced risk of revenue loss on expiration or termination of OEM contracts. Kossan: Medical segment for better margins, earnings stability Kossan s strategy is to carve a niche in the supply of medical grade examination gloves. This means a production mix that is skewed towards powder-free and nitrile gloves and customers in developed countries. More than 80% of Kossan s production is sold to developed nations such as the US, Canada, Europe, Japan, Germany, Scandinavian countries and Australia. A key benefit of having medical practitioners as its main customer group, is more stable demand as this group of customers is more concerned about having quality protection and is less sensitive to price changes. Another plus is the better margins that medical grade gloves can command. Due to the more stringent quality standards required for medical grade gloves, manufacturers are able to command better selling prices. Competition in this segment is also less intense as not all glove players can produce medical grade gloves. 26

27 Company Focus Top Glove (TPGC.KL) Sticking with Volume Strategy to Capture Emerging Markets Initiation of coverage Hold/Low Risk 2L Price (27 Jul 10) RM6.54 Target price RM7.25 Expected share price return 10.9% Expected dividend yield 2.6% Expected total return 13.5% Market Cap RM4,125M US$1,290M Price Performance (RIC: TPGC.KL, BB: TOPG MK) Initiate at Hold, target RM7.25 We rate Top Glove as Hold/Low Risk (2L). Our RM7.25 target price values the stock at 16x FY11E EPS, or 1SD above its historical P/E of 13.5x. While we believe the stock to continue to command premium valuations given its larger earnings base and excellent track record, we expect the premium gap to narrow as earnings growth momentum moderates and growing market share becomes increasingly challenging. Earnings growth to moderate We forecast net profit to rise 11% in FY11E after strong 54% growth in FY09 and a projected +49% for FY10E. We see Top Glove s earnings growth decelerating in FY11-12E given the normalization of global demand and its much enlarged base. Management guided that a margin of 17.6% seen in 3Q FY10 (-3.9ppt) is more realistic. Demand has normalized, margins to contract With the spread of the A(H1N1) virus brought under control by end-09, global demand for examination gloves normalized. We expect volume growth to revert to 8-10% in FY11E from +20% in FY10E. EBITDA margin has fallen to 17.6% in 3Q FY10 (2Q FY10: 21.5%) on lower capacity utilization and the 95% surge in latex prices to a high of RM7.56/kg in Apr 10 from RM3.87 in Jun 09. Staying focused on powdered gloves Top Glove s strategy is to focus on production of powdered latex gloves to tap enormous growth opportunities in emerging markets such as Brazil, China and India. Due to their lower percapita income, these countries tend to buy mainly powdered latex gloves. Plans 23% capacity expansion in FY11E Although the current utilization rate is circa 75%, management plans to invest RM80m in three new factories in FY11E. Unless there s another global health pandemic, we believe the 23% (7.5bn pieces) boost in annual capacity to 40.3bn would see utilization rate fall. But we take comfort in management s guidance that plans would be deferred should utilization dip below 70%. Mixed results from expansion strategy Vinyl glove operations in China have been loss-making over the last two years due to high crude oil prices and low selling prices. Management remains optimistic its China business can improve in a year. Top Glove also plans to venture into brownfield planting of rubber trees with an initial budgeted investment of RM200m. Statistical Abstract Year to Net Profit Diluted EPS EPS growth P/E P/B ROE Yield 31 Aug (RMM) (RM) (%) (x) (x) (%) (%) 2008A A E E E Source: Powered by datacentral 27

28 For further data queries on Citi's full coverage universe please contact CIRA Data Services Asia Pacific at or Fiscal year end 31-Aug E 2011E 2012E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data (RM) EPS adjusted EPS reported BVPS DPS Profit & Loss (RMM) Net sales 1,378 1,529 2,032 2,227 2,410 Operating expenses -1,237-1,300-1,701-1,860-2,008 EBIT Net interest expense Non-operating/exceptionals Pre-tax profit Tax Extraord./Min.Int./Pref.div Reported net income Adjusted earnings Adjusted EBITDA Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow (RMM) Operating cash flow Depreciation/amortization Net working capital Investing cash flow Capital expenditure Acquisitions/disposals Financing cash flow Borrowings Dividends paid Change in cash Balance Sheet (RMM) Total assets 1,110 1,132 1,402 1,656 1,896 Cash & cash equivalent Accounts receivable Net fixed assets Total liabilities Accounts payable Total Debt Shareholders' funds ,019 1,196 1,377 Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital

29 Paul Chanin Data as of: 16-Jul-10 Radar Screen Quadrant Definitions Quants View Glamour Top Glove currently lies in the Glamour quadrant of our Value-Momentum map with strong momentum but relatively weak value scores. The stock has moved from the Attractive quadrant to the Glamour quadrant in the past 3 months indicating strong momentum with weakening valuation scores. Compared to its peers in the Health Care sector, Top Glove fares worse on the valuation metric but better on the momentum metric. Similarly, compared to its peers in its home market of Malaysia, Top Glove fares worse on the valuation metric but better on the momentum metric. From a macro perspective, Top Glove has a low Beta to the region, so can be expected to hold it's own given a decline in the regional market. Glamor Poor relative value but superior relative momentum Unattractive Poor relative value and poor relative momentum Attractive Superior relative value and superior relative momentum Contrarian Superior relative value but poor relative momentum Figure 46. Radar Quadrant Chart History Apr Jul Jan- 31-Jul- 30-Oct Health Care Malaysia Figure 47. Radar Valuation Momentum Ranks Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Comp Momentum Comp Value Source: CIRA Source: CIRA Figure 48. Radar Model Inputs IBES EPS (Actual and Estimates) FY(-2) 0.18 Implied Trend Growth (%) FY(-1) 0.19 Trailing PE (x) FY Implied Cost of Debt (%) 5.93 FY Standardised MCap (0.16) FY Note: Standardised MCap calculated as a Z score (mkt cap - mean)/std dev capped at 3 Source: Citi Investment Research and Analysis, Worldscope, I/B/E/S Figure 49. Stock Performance Sensitivity to Key Macro Factors Region 0.43 Commodity ex Oil 0.18 Local Market 0.64 Rising Oil Prices 0.01 Sector 0.02 Rising Asian IR's 0.03 Growth Outperforms Value 0.19 Rising EM Yields (0.02) Small Caps Outperform Large Caps 0.69 Weaker US$ (vs Asia) 0.04 Widening US Credit Spreads (0.17) Weaker (vs US$) 0.30 Source: Citi Investment Research and Analysis 29

30 Top Glove Company description Top Glove is the world s largest rubber glove manufacturer. It produces a comprehensive range of 13 glove products from natural and synthetic rubber. Top Glove has 20 manufacturing facilities spread over Malaysia (14 glove factories), Thailand (2 glove factories, 2 latex concentrate plants) and China (2 vinyl glove factories). As at June 2010, the group had 371 production lines with annual capacity of 33bn pieces of gloves. Its latex concentrate plants supply 60-70% of Top Glove s requirement. Investment strategy We rate Top Glove as Hold/Low Risk (2L). The company is well managed, in our view, has an excellent earnings track record and a strong balance sheet. However, we believe slowing earnings growth momentum, a 3-year CAGR of 22% for FY10E-12E vs. 36% for FY01-09, and an above-trend valuation vs. its historical mean of 13.5x P/E would weigh on the stock. Its peers are trading on less demanding P/Es of 11-12x, while the market is being valued at 15.4x. Valuation Our 12-month target price for Top Glove is RM7.25, derived from 16x FY11E EPS. Our target P/E is pegged 1SD above the stock s historical multiple of 13.5x since 2004 because margins have improved and are showing signs of further improvement. We believe Top Glove would continue to trade at a premium valuation given its status as the global leader and its much larger operations and earnings base. Risks We rate Top Glove Low Risk using our quantitative risk-rating system that tracks 260-day historical share price volatility. Key risks that could cause the stock to trade above our target price include: [1] Outbreak of a global health pandemic; [2] A sharp and rapid decline in latex prices, which would result in margin expansion in the immediate term; and [3] Better-than-expected penetration into developing markets, which would boost annual sales. Downside risks that could prevent the stock from reaching our target price include: [1] A sharper-than-expected slowdown in demand for powdered gloves; [2] Aggressive price wars for powdered gloves; and [3] Expensive acquisition of rubber plantation land. 30

31 Company Focus Supermax (SUPM.KL) OBM Route for Additional Income Stream, Earnings Stability Initiation of coverage Initiate at Buy, target RM7.40 We rate Supermax Buy/Low Risk with a target price of RM7.40, implying a potential return of 22.5%. We value the stock at 12x FY11E EPS, 1SD above its historical P/E of 8.4x. Expect another strong year in FY10E Supermax looks set to follow up FY09 s 98% surge in core earnings with strong 42% growth to RM180m in FY10E and +15% to RM207m in FY11E. This would come from capacity expansion and growth in its distribution business. Buy/Low Risk 1L Price (27 Jul 10) RM6.17 Target price RM7.40 Expected share price return 19.9% Expected dividend yield 2.6% Expected total return 22.5% Market Cap RM2,094M US$655M Price Performance (RIC: SUPM.KL, BB: SUCB MK) Resumes capacity expansion after 2 years hiatus Having halted expansion plans in to deal with issues from acquisitions of Seal Polymer and APLI, Supermax will add 3.1bn pieces (+21%) in FY10E and another 4.1bn (+23%) in FY11E, lifting total annual capacity to 17.6bn and 21.7bn pieces for the two years. New capacity would be absorbed by still strong orders, 8.1bn pieces up to Mar 10 46% of 2009 s 17.5bn pieces. Addition of new lines and refurbishment of several old lines would also boost efficiency. Expanding distribution network To develop its OBM business, Supermax has had to move downstream to set up distribution centers via joint ventures with local partners in targeted export markets. This has turned out to be a profitable venture with additional income from distribution activities accounting for 44% of FY09 pretax profits. To further build its OBM business, Supermax recently added Germany to its distribution network and is working to include China to the list. Past experience has shown that having a distribution centre in new markets gives Supermax a first-mover advantage and would enhance growth of its OBM business. Financials strengthened There was a marked improvement in FY09 financials after management bit the bullet and wrote off its investment in APLI. Net gearing was cut to 31% (FY08: 90%), the receivables cycle shortened to 2.1 months (from average of 4) while the inventory cycle fell below 2 months. We believe the improvements are sustainable. Glove City, a 10-year project Work on Phase 1 commenced in Mar 10 and the 32-line plant (4.1bn pieces p.a.) is targeted for commissioning in 1H11. This project, which covers 33 acres in Bukit Kapar, Klang, will double capacity to 30bn pieces per annum. Statistical Abstract Year to Net Profit Diluted EPS EPS growth P/E P/B ROE Yield 31 Dec (RMM) (RM) (%) (x) (x) (%) (%) 2008A A E E E Source: Powered by datacentral 31

32 For further data queries on Citi's full coverage universe please contact CIRA Data Services Asia Pacific at or Fiscal year end 31-Dec E 2011E 2012E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data (RM) EPS adjusted EPS reported BVPS DPS Profit & Loss (RMM) Net sales ,023 1,313 1,451 Operating expenses ,101-1,199 EBIT Net interest expense Non-operating/exceptionals Pre-tax profit Tax Extraord./Min.Int./Pref.div Reported net income Adjusted earnings Adjusted EBITDA Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow (RMM) Operating cash flow Depreciation/amortization Net working capital Investing cash flow Capital expenditure Acquisitions/disposals Financing cash flow Borrowings Dividends paid Change in cash Balance Sheet (RMM) Total assets ,036 1,211 1,376 Cash & cash equivalent Accounts receivable Net fixed assets Total liabilities Accounts payable Total Debt Shareholders' funds Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital

33 Supermax Company description Supermax is Malaysia s second largest examination glove manufacturer. It produces natural rubber and nitrile gloves at its nine manufacturing facilities in Malaysia. As at June 2010, the group had 153 production lines with annual capacity of 17.6bn pieces of gloves. Besides producing for OEM customers, Supermax is the largest OBM producer in Malaysia. It has distribution centers in the US, Brazil, Belgium, Australia and Canada. Investment strategy We rate Supermax shares Buy/Low Risk (1L). We are positive on Malaysia s gloves industry: [1] Malaysia has global leadership, helped by competitive advantages such as availability of latex supply, better logistics and technical know-how; [2] Demand is not only recession-proof but is also projected to grow at a sustainable 8-10% pa over the next 5-8 years; and [3] Industry players have pricing power. Supermax is expanding capacity by 21% in FY10E and 23% in FY11E to cater to demand growth and expansion of its distribution network into Germany and new emerging markets. This would help its earnings grow at a compounded 23% pa in FY10-12, based on our estimates. Valuation Our target price for Supermax is RM7.40, derived from 12x FY11E EPS. Our target P/E is pegged 1SD above the stock s historical mean of 8.4x P/E since 2004 because margins have improved and are showing signs of further improvement. Our target multiple is at a discount to the current valuation of 15.4x for the Malaysian market and at a 25% discount to Top Glove s target multiple of 16x. The discount to Top Glove s valuation is warranted, in our view, given Supermax s smaller earnings base. Risks Our quantitative risk-rating system which tracks 260-day historical share price volatility, rates Supermax shares as Medium Risk. However, we believe Supermax deserves Low Risk as the surge in its share price over the past year was largely due to fundamental improvements in its balance sheet, which contributed in part to the sharp earnings surge in FY09. Key risks that could cause the stock to trade below our target price include: [1] Sharp volatility in latex prices and the US dollar would hamper Supermax s ability to accurately adjust selling prices and raw-material purchases; [2] Larger-than-expected capacity expansion by industry players, resulting in overcapacity; and [3] Unexpected loss of OBM customers. 33

34 Company Focus Kossan Rubber Industries (KRIB.KL) Niche in Medical Segment for Better Margin, Earnings Stability Initiation of coverage Buy/Low Risk 1L Price (27 Jul 10) RM4.00 Target price RM4.95 Expected share price return 23.8% Expected dividend yield 2.8% Expected total return 26.5% Market Cap RM1,279M US$400M Price Performance (RIC: KRIB.KL, BB: KRI MK) Initiate at Buy, target RM4.95 We rate Kossan Buy/Low Risk (1L) with a target price of RM4.95, implying a potential return of 26.5%. We peg the stock at 10.5x FY10E P/E, 0.5SD above its historical mean of 9.2x. A leader in medical-grade gloves Kossan is the global leader in the production of powder-free medical examination gloves. About 80% of annual capacity of 12bn pieces is supplied to hospitals in North America and Europe. Kossan focuses on the medical segment as medical practitioners emphasize quality and are less price sensitive. Competition is also less intense as there are fewer producers that can meet the quality standards. Beneficiary of shift to nitrile gloves The 62% surge in latex prices since Mar 09 has narrowed the premium paid for nitrile gloves to 15% from over 30%. In developed countries where there is already growing preference for protein-free exam gloves, the narrower price differential is encouraging more medical practitioners to opt for nitrile gloves. Kossan benefits from this shift given its edge in production of nitrile gloves and MNC customer base. Less vulnerable to challenges faced by powdered glove segment With its niche in the nitrile segment, Kossan does not have to worry about potential overcapacity in the powdered glove segment. It is also less affected by high latex prices while more stable crude-oil prices have been an added plus. Cautious approach in capacity expansion Kossan s capacity expansion is driven by customer demand. This keeps its utilization at circa 90%, among the highest in industry. Kossan plans to raise capacity by 54%, or 6.5bn pieces, in four phases from 3Q10 to The RM200m project is geared toward production of powder-free latex and nitrile gloves. Production of nitrile gloves is expected to rise to 6.3bn pieces in FY11E (FY09: 3.0bn). Balance sheet healthy Net gearing is projected to improve to 25% in FY11 from 47% in FY09 as strong earnings would help fund capacity expansion. 3-year earnings CAGR of 19% Core net profit is forecast to improve 11% to RM123m in FY10E and a stronger 23% to RM151m in FY11E on volume growth of 13% and 29.5% for the two years, offsetting the expected compression in margins with normalization of demand. Statistical Abstract Year to Net Profit Diluted EPS EPS growth P/E P/B ROE Yield 31 Dec (RMM) (RM) (%) (x) (x) (%) (%) 2008A A E E E Source: Powered by datacentral 34

35 For further data queries on Citi's full coverage universe please contact CIRA Data Services Asia Pacific at or Fiscal year end 31-Dec E 2011E 2012E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data (RM) EPS adjusted EPS reported BVPS DPS Profit & Loss (RMM) Net sales ,062 1,277 1,545 Operating expenses ,068-1,293 EBIT Net interest expense Non-operating/exceptionals Pre-tax profit Tax Extraord./Min.Int./Pref.div Reported net income Adjusted earnings Adjusted EBITDA Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow (RMM) Operating cash flow Depreciation/amortization Net working capital Investing cash flow Capital expenditure Acquisitions/disposals Financing cash flow Borrowings Dividends paid Change in cash Balance Sheet (RMM) Total assets ,032 Cash & cash equivalent Accounts receivable Net fixed assets Total liabilities Accounts payable Total Debt Shareholders' funds Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital