Rubber product (glove) sector
Maintain overweight: We are maintaining our “overweight” call on the rubber glove sector, as we believe that the recent set of results demonstrates the companies are not at significant risk of lower margins due to rising production costs. We are also less concerned about any potential overcapacity issues, as our recent channel checks suggest that the order lead times have normalised to around 45 days. Kossan Rubber Industries Bhd and Supermax Corp Bhd remain as our top picks for the sector.

 
Although sector earnings for the first quarter of 2019 (1Q19) contracted by 4.3% year-on-year (y-o-y), we believe the results were still broadly in line with both our and consensus estimates, delivering around 22% of our respective forecasts. The decline in profit was mainly due to the weak results of Hartalega Holdings Bhd, where profits declined by 22% y-o-y, as its margins were negatively impacted by the volatility of the ringgit. However, despite facing a similar operating environment, Kossan was able to deliver a profit growth of 32% y-o-y during the quarter.

Share prices for the sector had corrected by 20% in early 2019, as there were concerns that manufacturers’ margins could contract due to the strengthening of the ringgit and rising production costs. However, we believe that concerns about overcapacity should ease, as our recent channel checks suggest that the order lead times have normalised to around 45 days from the 30 days earlier this year. We have, however, revised lower our capacity growth forecast for 2019 to 13% from 10%, as some manufacturers have partially delayed their targeted expansion plans for the year.

We believe that the recent weakening of ringgit to US dollar from 4.06 to 4.19 in the past two months will have a positive impact on rubber manufacturers’ margins due to the lagging effect of their pricing. Based on our estimates, for every 1% change in the ringgit to US dollar, the impact to the bottom line is around 0.3% to 0.5%. Apart from the favourable currency movement, raw material prices are also on a downward trend. Nitrile prices have continued to trend lower to US$1,050 per tonne from US$1,145 per tonne since the beginning of the year.

Although we have an “overweight” call on the sector, we still prefer Kossan and Supermax for their undemanding valuations and higher-than-industry growth rates, and have “buy” calls on those stocks. We have a “sell” call on Hartalega due to its rich valuation, and its growth rate is also expected to slow. — AffinHwang Capital, June 12