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CIMB: Rubber Gloves To Benefit From Oil Slump?
Aspire, Hot Picks | 11 February 2015
By: Lim Si Jie
Articles (169) Profile

In 2014, CIMB downgraded the Industrial Goods and Services (Rubber Gloves) sector from an Overweight to a Neutral from expectations of pricing pressures due to higher capacity.

Most players were rushing to build new capacity in order to obtain market share. Higher capacity in the sector would lead to higher competition, which would eventually lead to margin pressure. This could be made worse by the subsidy cuts by the government, which could further hurt the companies’ weakening margins.

The sector was heavily impacted by both “pricing pressure and higher operating costs as the government cut subsidies”. As a result, all rubber glove players (except Kossan) reported weaker earnings over the past three quarters.

Safe Haven In Volatile Market
As the demand for rubber glove products is pretty resilient, the rubber glove sector is the sector to look towards when the overall equity market is volatile, especially in 2015. Emerging diseases such as Ebola and the more severe flu season in the US could have a positive impact on share prices.

Sector Recommendation: Overweight
Moving forward, CIMB believes that 2015 will be a better year compared to 2014 and is thus raising its recommendation on the sector to OVERWEIGHT.

In FY15, companies are expected to return to earnings growth from earnings contractions in FY14, driven by capacity expansion. In view of the stronger-than-market earnings growth, stronger USD against the MYR, declining oil prices, and temporary removal of uncertainties over higher operating costs on potential subsidy cuts, share prices of glove companies will be well supported and have the potential to head higher.

Source: CIMB

Hartalega: HOLD To ADD
Hartalega reported year-on-year (yoy) earnings contraction and fell below consensus forecasts in the past three quarters. While Hartalega achieved higher sales volume yoy, the company was negatively affected by pricing pressures and higher operating costs which they found difficult to pass on to customers.

CIMB expects Hartalega to return to strong earnings growth in FY16, driven by its capacity expansion as they plan to build six manufacturing plants, which will increase its total capacity to 28.5bn p.a. in the upcoming five years.

Kossan: Sector Top Pick With Unchanged ADD Recommendation
CIMB raised Kossan’s target P/E to 18.9x CY16 and FY15-16 earnings forecasts by 3 percent. Kossan remains CIMB’s top pick within the sector. Kossan’s more balanced rubber glove product mix (55% in nitrile, 45% in natural rubber) means that it will be the least impacted by the inflow of new capacity.

In addition to a more balanced rubber glove product mix, Kossan also sells technical rubber products. The company also hasa good track record in producing nitrile gloves which are sold at reasonable prices.

Strong Earnings Growth Driver: Capacity Expansion, Spike in USD And Declining Raw Material Prices
Kossan is expected to deliver strong earnings growth in FY15, driven by capacity expansion. Upon the full commercial production from new plants, Kossan could see its annual capacity increase from the current 18 billion pieces to 22 billion pieces. From2015, Kossan aims to boost capacity by 5 billion – 6 billion pieces/annum. The company has secured a large order and is confident of filling up the extra capacity.

Source: CIMB

Besides capacity expansion, the strong earnings growth could also be fuelled by the sudden strong spike in the US dollar and declining crude oil prices. This helps to lower the raw material prices of rubber gloves.

Of all the rubber glove players, CIMB views Kossan to be the least impacted by stiffer competition given its nitrile delivery track record, more balanced product mix, quality products and reasonable pricing. It also has more diversified earnings. It is also important to note that Kossan has managed to outperform its peers in terms of earnings performance in the past four quarters.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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