Rubber Glove Higher demand offering greater opportunities

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1 Market Insight Friday, 26 January, 2018 YTD % Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Saffa Amanina Mohd Anwar saffa@bimbsec.com.my PP16795/03/2013(031743) Outlook 2018 Neutral Rubber Glove Higher demand offering greater opportunities Rubber gloves outlook remains positive on strong global demand from rising healthcare standard, supply curb in China, and increased usage of gloves from non-medical sector in developed countries. Global demand is expected to grow at a robust 8%-10% p.a. as the top 4 Malaysia gloves producers actively expand its capacity to meet the demand. Rubber glove producers face cost rising pressures with respect to energy, labour, and appreciating ringgit, but these are expected to be mitigated by their ability to pass through the cost to consumers. Maintain NEUTRAL stance on the sector with Top Glove (TP: RM10.40) remaining as our top pick. Top Glove is also among our top stock recommendation for the year. Paying for global dominance Overall, the glove sector recorded an impressive performance in The top 3 glove makers under our coverage has outperformed the KLCI in 2017, led by Hartalega (+122.4%), Top Glove (+47.4%) and Kossan (+25.9%). This is attributable to strong earnings performance led by capacity expansion and higher demand. Hartalega became the top performer in the glove sector, recording an earnings growth of +58% yoy for the first 9 months of FY18 due to strong nitrile glove sales and margin improvement from cost management efficiency and automation. At the other end, Supermax was a laggard (-5.2% YTD) as the company was slow off the starting block as compared to other companies in this sector. It was also hit by higher i) operating costs which we believe could be due to new overseas start up, ii) advertising and promotional cost in the contact lens division, and iii) lack of clear plan on capacity expansion. Chart 1: Share price performance vs KLCI (YTD) 140.0% 100.0% Hartalega, 122.4% 60.0% 20.0% -20.0% Top Glove, 47.7% Kossan, 25.9% KLCI, 7.2% Supermax, -5.2% Source: Bloomberg/ BIMB Securities Research On the whole, we expect earnings for the Glove sector under our coverage to be positive, growing at 23% in CY18. Companies under coverage are expected to expand through organic growth (Hartalega, Kossan, Top Glove), acquisition growth (Top Glove) and refurbishments of older production lines (Supermax). Demand for rubber gloves in our opinion will remain strong, growing at 19bn pcs (+8%) in This is due to i) greater healthcare and hygiene standard worldwide, ii) China s strict enforcement for environmental friendly glove factories have created a supply vacuum in the country, and iii) potential higher penetration and usage for gloves from current as well as untapped markets. The strong demand has created expansion opportunities for Malaysia s glove manufacturers where they are actively expanding their production capacities with the top 4 glove manufacturers (Hartalega, Kossan, Top Glove, Supermax) expected to increase c12% from its 2017 capacity. 1

2 Malaysia a leader in rubber glove production Rising world s healthcare standard Greater healthcare awareness worldwide has resulted in the relevant authorities and governments across the globe implementing higher standards and regulations for the healthcare industry. As a consequence, glove requirements in the industry have greatly increased in recent years. With the world population getting better educated and improving income levels from growing global economic prosperity, the world community is demanding better healthcare services. In developed countries for example, to meet the increasing demands and regulations, healthcare providers such as hospitals are offering healthcare packages that include quality medical gloves and specialty gloves. These developments bode well for the expansion of Malaysian gloves manufacturers. Malaysia is undisputed world s TOP rubber glove manufacturer Malaysia remain the world s largest producer and exporter of rubber gloves contributing 63% of the global supply followed by Thailand (21%), China (5%) and Indonesia (3%). The top 4 Malaysian s rubber glove makers, namely Top Glove, Hartalega, Kossan and Supermax controlled around 50% of global supply, providing them the upper hand when price adjustments for their products are necessary. Malaysia s dominance is difficult to replicate due to its strength in product differentiation where even its closest rival Thailand is unable to compete as it concentrates more on latex-based products. Other countries, would also be hard pressed to duplicate or challenge Malaysia s prominence on the world stage as the country has established itself as the world s major glove producer in terms of world-class quality and thus have significant influence on pricing and supply in the world market. Increasing demand for Nitrile gloves but latex still relevant Presently, Malaysia is the largest Nitrile glove producer in the world with medical gloves as the mainstay of Malaysia s glove producers. In 1H17, overall exports of Malaysia s rubber gloves grew by 11.6% yoy, driven by both growth of nitrile butadiene rubber gloves (+27.3%) and natural latex rubber gloves (+1.7%). The higher demand for nitrile gloves comes mainly from developed countries (US, UK and Western Europe) and were driven by i) US FDA ban on powder latex medical gloves, ii) hospitals switching to nitrile to decrease latex allergy caused by latex proteins and iii) nitrile gloves offering excellent resistance to punctures and tears. The popularity of nitrile gloves has led to major glove manufacturers switching their production preference to nitrile gloves. In this respect, Hartalega which is the largest nitrile glove producer with over 10 years of experience, have the advantage in product quality and market positioning. Currently, the company is at the end-stage of trial testing for the introduction of their specialty gloves i.e new non-leaching antimicrobial gloves that have the ability to overcome antibiotic-resistance bacteria. Chart 2: Share of USA import of nitrile gloves 80% 70% 60% 50% 40% 30% 20% 10% 0% 69% 71% 74% 17% 14% 13% 10% 10% 9% 3% 3% 3% Malaysia Thailand China Indonesia USA is the biggest market for rubber glove demand taking up 33% of global share. Mostly demand is for nitrile gloves. Malaysia grew market share due to its glove quality, competitive pricing and supply stability The biggest competitor for nitrile gloves still remains local producers. Source: Hartalega/ BIMB Securities Research 2

3 Chart 3: Malaysia natural rubber & nitrile export Percentage 70% 60% 50% 40% 30% 20% 10% 0% 51% 49% 58% 61% 57% 42% 43% 39% Nitrile Butadiene Rubber (NBR) Natural Rubber (NR) Source: Hartalega/ BIMB Securities Research Nevertheless, latex based rubber gloves are still in demand especially in emerging countries and some European countries due to its cheaper price and preference for latex eco-friendly characteristic respectively. With demand for latex based gloves still present, Malaysian companies are continuing to produce this type of products so as not to lose out in certain markets. Here, we believe Top Gloves product mix, where its latex based products are about even to its other products, have benefited on the advantage to capture a sizeable portion of the latex market. The chart below illustrates the product mix of the 3 largest Malaysian glove producers. Chart 4: Product mix Powdered free latex 20% Top Glove Surgical 2% TPE/CPE 5% Vinyl 8% Nitrile 37% Kossan Natural rubber 28% Hartalega Natural rubber 5% Powdered latex 28% Nitrile 72% Nitrile 95% Source: Company/ BIMB Securities Research Consolidation in the industry a strong possibility There are approximately less than 40 glove manufacturers in Malaysia compared to around 200 during the early 1990s. Understandably, due to technological advancements and business considerations, mergers and acquisitions (M&A) have taken place in the industry. As these remaining companies take stock of their strengths and weaknesses and how to compete profitably on a global scale, further M&As are a strong possibility and cannot be ruled out in the glove industry. The most recent development is the planned acquisition by Top Glove to acquire Aspion (surgical & medical gloves) for about RM1.3bn - RM1.4bn. 3

4 Demand and supply dynamics remain constructive Demand remains strong Demand for medical rubber gloves is largely inelastic and is primarily driven by the healthcare sector in the developed world. Over the past 5 years, global demand for rubber gloves has grown at a CAGR of 7.2% due to increasing worldwide demand especially from the US and European markets due to increase in healthcare regulations together with greater hygiene standards. Moving forward, according to the Malaysia Rubber Gloves Manufacturers Association (MAGMA) as well as industry participants, it is estimated that global demand for gloves will continue to increase by 8-10% p.a. over the next 4 years. We believe this demand would be supported by: Higher healthcare standards and gloves usage worldwide. Rising healthcare awareness have led to heightened healthcare regulations as well as reforms worldwide which provides the basis of support in rising global demand for rubber gloves. Greater requirements in the medical sector and the hygienic needs of a growing global ageing population also contributed to the higher demand. Additionally, rubber gloves consumption is supported by increasing usage in the non-medical sectors in developed countries such as handling of food, hazardous & dangerous materials and high precision instruments. China s environmental concerns curtailing vinyl gloves production. China s serious push for the use of more environmentally-friendly fuel sources (e.g. natural gas instead of coal) in line with the Paris Climate Agreement has impacted the production and caused shutdowns of vinyl glove factories. Given the lower supply of vinyl gloves for which China produces around 5% of total gloves production, the demand has shifted to nitrile and latex gloves which has benefited Malaysian glove manufacturers. Penetration into current and untapped markets. Currently, there is a disparity in global consumption of rubber gloves compared to the spread of world population (refer Table 1). In Asia, India and China, gloves consumption per capita is currently low at 6-11 pcs vs. global average of 27 pcs. This low market penetration and minimal usage of rubber gloves outside of the developed countries, coupled with increasing hygiene and health standard in emerging countries, suggests that there exists high growth potential from a demand perspective. As an illustration (based on our calculations), if the gloves usage in India and China meet just half of that used in the US, the demand for gloves in these 2 countries would increase c216bn pcs which is higher than the entire global demand of 210bn pcs in Table 1: Glove consumption vs population Developed Countries (USAS,EU29 & Japan) % of World Population % of Global Glove Consumption 18% 70% Others regions 82% 30% Remarks: Usage of gloves is dominated by developed countries which account for 70% of global glove consumption despite only 18% of the world s population. Other regions account for only 30% of glove consumption despite having 82% of the world s population. Source: Top Glove/ BIMB Securities Research Chart 5: % of Global glove consumption by region Source: Top Glove/ BIMB Securities Research 4

5 Chart 6: Global consumption per capita pcs China India Asia Japan EU USA Source: Top Glove/ BIMB Securities Research Chart 7: Global consumption of rubber gloves bil pcs Source: Hartalega/ BIMB Securities Research Increasing supply through expansion in production capacity Strong demand growth is providing opportunities for large manufacturers in Malaysia to expand. The top 4 players, Hartalega, Top Glove, Kossan and Supermax have already planned to expand capacity by building new plants & upgrading its machineries. The bulk of the new capacity coming on-stream is for nitrile gloves given the higher demand for this type of products. This development is expected to increase capacity by c12% in Table 2: Top 4 glover makers capacities expansion Company Current capacity (bn pcs) Capacity expansion 2018F (bn pcs) Hartalega Kossan Supermax Top Glove Total Source: Company/ BIMB Securities Research Oversupply risk in our opinion is low as we believe global demand remains on the uptrend with Malaysia accounting a majority stake for the world glove supply at c63%. This dominance provide Malaysian producers a certain degree of control over worldwide supply. Additionally, the major glove producers in Malaysia are currently in an oversold position with most of current capacity having been sold forward up to 3 months. Nevertheless, we believe these players have planned their expansion judiciously with incoming capacity being built in stages. 5

6 Companies are protected by cost pass-through Rise in glove operating costs Glove manufacturers can expect higher glove production cost in 2018 due to: Natural gas tariff hike. Net gas tariff have risen to RM /mmbtu (+22.9%). As gas costs currently makes up 12% of the glove maker s total costs, we estimate that the net cost increase is at around 2.8%. Higher labour costs. Rise in foreign worker levy, potential hike in the minimum wage and annual increment cost of wages are expected to push production costs. However, we believe the impact is minimal as labour costs constitute only 10%. Additionally, with glove makers investing in automation, this would be able to reduce the labour costs pressure as well as improve productivity. Chart 8: Costs breakdown Natural Rubber Gloves Nitrile Gloves Packaging 8% Fuel 12% Overhead & Others 12% Chemical 9% Labour 11% Natural rubbe latex 48% Packaging 6% Fuel 13% Overhead & Others 15% Chemical 9% Labour 10% Natural rubbe latex 47% Source: Top Glove/ BIMB Securities Research Soft latex and nitrile prices offset higher operating costs Last year saw latex price increased to its 5-year peak of RM8.18/kg (in Jan 2017) due to shortage of production, which was caused by seasonal wintering months (end-dec till May). However, latex prices had since tapered off to a low of RM4.60/kg as at 25 th Jan The average 1 year price was RM5.8/kg well below its peak for the year. Nonetheless, we expect latex price to rise slightly in the short term during the winter season of rubber trees but expect prices to ease after the seasonal period is over as we expect there will be ample supply in latex. According to the Association of Natural Rubber Producing Countries (ANPRC), supply will grow 4.8% and 5.5% in 2018 and 2019 respectively with demand expected to increase at an average annual growth rate of between % from 2018 to As for nitrile, butadiene prices also had tapered off from its peak of RM13.2/kg in Jan 2017 to a low of RM4.9/kg as at 25 th Jan 2018 or an average of RM6.3/kg for the year. Nitrile prices track closely that of latex prices for the past 3 years with an 87% correlation. The similarity in price trend is not surprising given that both are viewed as substitutes by global automotive sector, which consumes c70% of global rubber. Overall, we expect latex and nitrile prices to remain soft in 2018 with average forecast for latex and nitrile prices at RM5.50 and RM5.80 respectively. As raw material prices account for the largest chunk (48%) of total production costs, a stable price in 2018 would provide some relief for companies by offsetting the rising costs mentioned earlier. Chart 9: Price trend and correlation between latex and nitrile RM/kg Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Butadiene Latex Source: Bloomberg/ BIMB Securities Research 6

7 Impact from appreciating ringgit The Malaysian ringgit has appreciated about 13.7% to RM3.88 against the USD since its weakest level of RM4.49 in January Our house views that USD/MYR to trade at RM3.95 by end of 2018 (2017 averaging around RM4.20). We believe, the stronger ringgit is a near term negative to rubber glove players over the short-term period and as this is expected to have a slight negative impact on the companies bottom-line, given the natural hedge of about 50% stemming from imported costs (raw material and chemicals). In total, Malaysia and Thailand are producing about 84% of rubber gloves sold worldwide. Thailand being Malaysia s closest competitor is facing a similar problem as its currency is also rising against the USD over the same period. Therefore, we believe Malaysia still has an edge in bargaining power on product pricing. Our sensitivity analysis indicates that for every 1% change in ringgit against USD would impact our earnings estimates by 1.5-2%. Chart 10: MYR and THB against USD currency Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 USDMYR (LHS) USDTHB (RHS) Source: Bloomberg/ BIMB Securities Research Overall, we believe glove makers would still be able to manage the additional increase in costs through cost pass-through mechanism where they would likely adjust their ASPs higher to pass on the costs. Nonetheless, there is a time lag for the cost pass-through of about 2 months. Given the present robust demand and supply situation, we believe glove makers would have more bargaining power to raise their ASPs hence keeping their profit margin intact. Earnings Outlook is positive Moving forward, we anticipate the sector s earnings growth will continue to be capacity driven against the backdrop of healthy global glove demand of 8% to 10% p.a. We expect the sector s capacity (Top 4 gloves producer) to gradually increase by c12% in Ongoing investments in automation and latest technology as well as introduction of more value-added products (e.g. specialty gloves) should help drive the quality and marketability of Malaysian gloves to achieve greater penetration and market share in the global gloves market. Cost headwind on the other hand are expected to be mitigated by exiting cost pass-through mechanism that would provide protection for these companies. We also anticipate M&As taking place, with Top Glove stating its intention to acquire growth as part of its long-term strategy. Overall, we expect earnings for the glove companies under our coverage to grow at average 23% in CY18. Our average EBITDA margin expectation for the sector is c18.5%, with Hartalega s at the upper end at 25.9% and Supermax s being the lowest at 15.9%. 7

8 Valuation and recommendation We maintain our NEUTRAL stance on the sector, as we remain wary of near term negative impact on currency movement and we also believe the market has almost priced in the sector s strong fundamentals and prospect for The sector currently trades at 37x FY18 PER which is higher than the sector s all time high valuation recorded in December 2015 (averaging 30x). Despite, the elevated valuation, we remain positive on the sector s long term outlook as glove products provide an important contribution to the recession-proof healthcare industry and at the same time offers earnings enhancement driven by capacity expansion. Our top pick (BUY) is Top Glove with TP of RM We like the stock due to its strong fundamentals and earnings growth prospects from its organic and inorganic (acquisition) growth. The stock offers varied product mix which caters for demand from all global regions and markets. We are also in favor for its strong and experienced management team, as well as strategic capacity expansion plan to support robust global demand and avoid oversupply. We have Hold call for the other stocks under our coverage, i.e. Hartalega (TP: RM11.00), Kossan (TP: RM9.10) and Supermax (TP: RM2.18). Chart 11: Gloves sector PE Band Source: Bloomberg/ BIMB Securities Research Table 3: Peers Comparison price put 2 decimals. Price Market Cap Net profit (RMm) PER (x) FY18 Div Companies (RM) (RMm) FY17 FY18 FY19 FY17 FY18 FY19 Yield (%) FY18 ROE (%) Target Price (RM) Hartalega HOLD Top Glove BUY Kossan HOLD Supermax HOLD Rating Source: Company/ BIMB Securities Research 8

9 DEFINITION OF RATINGS BIMB Securities uses the following rating system: STOCK RECOMMENDATION BUY Total return (price appreciation plus dividend yield) is expected to exceed 10% in the next 12 months. TRADING BUY Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain. HOLD Share price may fall within the range of +/- 10% over the next 12 months TAKE PROFIT Target price has been attained. Fundamentals remain intact. Look to accumulate at lower levels. TRADING SELL Share price may fall by more than 15% in the next 3 months. SELL Share price may fall by more than 10% over the next 12 months. NOT RATED Stock is not within regular research coverage. SECTOR RECOMMENDATION OVERWEIGHT The Industry as defined by the analyst s coverage universe, is expected to outperform the relevant primary market index over the next 12 months NEUTRAL The Industry as defined by the analyst s coverage universe, is expected to perform in line with the relevant primary market index over the next 12 months UNDERWEIGHT The Industry as defined by the analyst s coverage universe, is expected to underperform the relevant primary market index over the next 12 months Applicability of ratings The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not carry investment ratings as we do not actively follow developments in these companies. Disclaimer The investments discussed or recommended in this report may not be suitable for all investors. This report has been prepared for information purposes only and is not an offer to sell or a solicitation to buy any securities. The directors and employees of BIMB Securities Sdn Bhd may from time to time have a position in or either the securities mentioned herein. Members of the BIMB Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein. The information herein was obtained or derived from sources that we believe are reliable, but while all reasonable care has been taken to ensure that stated facts are accurate and opinions fair and reasonable, we do not represent that it is accurate or complete and it should not be relied upon as such. No liability can be accepted for any loss that may arise from the use of this report. All opinions and estimates included in this report constitute our judgements as of this date and are subject to change without notice. BIMB Securities Sdn Bhd accepts no liability for any direct, indirect or consequential loss arising from use of this report. Published by BIMB SECURITIES SB ( X) A Participating Organisation of Bursa Malaysia Securities Berhad Level 32, Menara Multi Purpose, Capital Square, No. 8 Jalan Munshi Abdullah, Kuala Lumpur Tel: Fax: Azharuddin Nordin Head of Research 9