Malaysia Gloves Sector OVERWEIGHT (Unchanged)
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January 14, 2015 Malaysia Gloves Sector OVERWEIGHT (Unchanged) Analyst Pent up growth ahead Lee Yen Ling . Industry will see increasing competition ahead due to the (603) 2297 8691 Malaysia incoming capacities. [email protected] | . However, mitigating factors are the high USD/MYR and low rubber prices. Maintain Overweight. We have BUYs on Hartalega (unchanged TP MYR8.50), Kossan (raised TP to MYR5.90) and Riverstone (unchanged TP SGD1.20). RESEARCH What’s New, What’s Our View The nitrile-skewed glove stocks outperformed the KLCI by 20% in 2014 due to their superior earnings growth prospects and the stronger USD/MYR towards the end of 2014. SECTOR Looking into 2015, we see several positive external factors for the sector. Glove makers are net beneficiaries of the strong USD, as almost all of their sales receipts are USD-denominated while approximately 50% of their production cost is in USD. Additionally, given that the fall in NBR price has substantially lagged the decline in latex and butadiene prices, we see more downside to the price of NBR in 2015. The price of latex may also stay benign in view of weak global demand. Eventually, the USD gains and cost savings from low rubber prices will likely be passed through in this increasingly competitive environment, but with a time lag. The industry’s capacity expansion will be aggressive in 2015 with planned new capacity growth of 17% for Malaysia’s Top 4 producers. We believe the new capacity could be absorbed by new demand on an expected global glove demand growth of 7% and higher outsourcing orders from the MNCs which are shutting down plants in Thailand and Malaysia. Among the stocks under our coverage, we expect Hartalega to report the highest 2-year EPS CAGR (2014-16) of 21%, followed by Riverstone (18%), Kossan (15%) and Top Glove (5%), driven by their respective expansion plans. Our top pick is Hartalega (unchanged TP MYR8.50, 21x 2016 PER), the market leader in nitrile glove segment. We also have BUY calls on Kossan (TP raised to MYR5.90 (from MYR5.00) as we roll forward our 19x PER to 2016) and Riverstone (unchanged TP SGD1.20, 15x 2015 PER). Stock Mkt cap Rating Price TP Upside P/E (x) P/B (x) Dividend yld (%) What’s Our View Click here to enter text. (USD'm) (LC) (LC) (%) 15E 16E 15E 16E 15E 16E Hartalega 1,555.0 Buy 7.00 8.50 21 24.4 18.6 4.4 3.5 1.7 2.2 Kossan Rubber 878.4 Buy 4.90 5.90 20 17.6 15.8 3.4 3.0 2.0 2.2 Top Glove 798.7 Hold 4.59 4.60 0 14.7 14.1 1.9 1.8 3.4 3.5 Riverstone Holdings 283.6 Buy 1.02 1.21 18 13.0 11.3 2.5 2.2 3.5 4.0 SEE PAGE 8 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS PP16832/01/2013 (031128) Malaysia Gloves Sector 2014: An unexciting year Earnings growth of local glove makers was mild in 9M14 due to capacity constraints and margin squeeze from mild nitrile ASP competition. Glove makers spent the past year building new plants (i.e. Hartalega and Kossan) and improving plant automation (for future savings on worker costs). For 9M14, Malaysia’s glove exports rose slightly by 3% YoY, led by exports of latex gloves (+6% YoY) while exports of nitrile glove was flattish. This is in stark contrast to nitrile glove exports over the past three years, when nitrile glove exports enjoyed robust growth of 20-35% and were the key driver of Malaysia’s exports. We believe that nitrile glove exports have flattened out due to the capacity constraint of local glove makers (i.e. Hartalega and Kossan). Additionally, Supermax also encountered a fire mishap at its plant in Malacca, which caused some production loss. Nevertheless, taking cue from the world’s largest glove importer – the US, we believe that supply from other countries has not increased significantly and Malaysia has largely retained its global market share of sub-60%. This would suggest that global market dynamics are very much dictated by Malaysia where its economies of scale, efficiencies and product quality limit the level of competition from the other countries. Malaysia: Export of rubber gloves (pcs) '000 pcs Glove export quantity: 9M14 (YoY) 80,000 Total: +3% Latex: +6% 70,000 Nitrile: 0% 60,000 50,000 40,000 30,000 20,000 10,000 0 9M10 9M11 9M12 9M13 9M14 Nitrile gloves Latex gloves Total gloves Source: MREPC, Maybank KE US: Top 4 rubber glove suppliers (by country) b pcs p.a. 30.0 25.0 Market shares in US 20.0 2012 2013 2014 15.0 Malay sia 55% 57% 56% 10.0 Thailand 29% 28% 27% China 9% 9% 11% 5.0 Indonesia 6% 6% 6% 0.0 Malaysia Thailand China Indonesia 2012 2013 2014 Source: GTA, Maybank KE January 14, 2015 2 Malaysia Gloves Sector 2015: Pent-up growth ahead Large capacity expansion this year For stocks under our coverage, Hartalega and Kossan will have the strongest earnings growth ahead, underpinned by their aggressive expansion strategy. In terms of the timing of new capacity in 2015, Top Glove will see moderate increment in January (+5% to 45b pcs p.a.), followed by massive capacity from Kossan by Feb (+29% to 22b pcs p.a.) and Hartalega by Dec (+57% to 22b pcs p.a.). Additionally, Riverstone will also add 1b pcs capacity in 3Q15 (+23% to 5.2b pcs), a mild increment to the industry but this is significant relative to its own size. As for Supermax, its plant expansion has been delayed since 2012 for various reasons and it remains to be seen if it will be completed in 2015. In total, capacity from the Top 4 + Riverstone is expected to expand by a sizeable 17% or +19b pcs p.a. by end-2015. We believe the new capacity could be taken up by: (i) global new demand of 11b pcs p.a. on expected growth rate of 7% (from 8-10% in the past due to higher base); and (ii) higher outsourcing opportunities from the two MNCs which are shutting down their plants in Thailand and Malaysia – outsourcing orders could amount to 5b pcs p.a.. Malaysia’s key producers: Aggressive expansion in 2015 (+19b pcs or +17% YoY) Source: Companies, Maybank KE Global glove demand: Expect new demand of 11b pcs in 2015 (+7% YoY) Source: Companies, MREPC, Maybank KE January 14, 2015 3 Malaysia Gloves Sector Price competition partly offset by stronger USD With sizeable capacity coming onstream, we believe ASP competition will intensify in 2015; glove makers will be in a rush to fill their capacities, competing for the same orders/clients. They will therefore have to defend their margins with higher production efficiencies (improving output/hour). However, we note that the stronger USD/MYR and benign rubber prices could cushion the margin squeeze from competition. Glove makers are net beneficiaries of the strengthening USD as almost all their sales receipts are USD-denominated while approximately 50% of their production costs are USD-denominated. Although we expect the revenue gains to eventually be passed on, glove makers could enjoy a time-lag of 1-2 months. USD/MYR spot rate: 4Q14 (+5% QoQ), Jan 15 (+9% YoY) Source: Bloomberg Price of NBR could continue to trend down The recent floods in the southern and northern parts of Peninsular Malaysia had limited impact on rubber prices and we think that rubber prices could stay benign in 2015 given waning car sales in China. Additionally, there could be more downside to the price of NBR (Jan 2015: -8% YoY) as the fall in NBR price in 2014 was substantially less than the fall in butadiene (-49% YoY; feedstock of NBR) and latex prices (-16% YoY). A weaker NBR price will benefit primarily Hartalega and Riverstone (90% of gloves use nitrile as input) as well as Kossan (60% of gloves use nitrile as input). Assuming all else constant, every 10% fall in NBR price will lift Hartalega, Riverstone and Kossan’s bottomline by 4%/4%/3% respectively. Price trends of rubber inputs latex, NBR and butadiene Source: Companies, Bloomberg, Maybank KE January 14, 2015 4 Malaysia Gloves Sector Valuations and recommendations Riverstone outperformed the sector in 2014 with a share price appreciation of 39% due to its double-digit earnings growth (9M14 net profit: +16% YoY) and undemanding valuations; its forward PER has re-rated from 12x to 15x presently. Towards the end of 2014, Kossan and Hartalega outperformed the KLCI on the rising USD/MYR and the commencement of their new production lines. Share price performance in 2014: Riverstone, Kossan and Hartalega outperformed KLCI 160 140 Riverstone effethjhjhjhjhhjhjhjhjhjh 120 Kossan 100 Hartalega KLCI e 80 Top Glove hj 60 Supermax outperformers 40 Jul-14 Jul-14 Apr-14 Oct-14 Jan-14 Jun-14 Mar-14 Mar-14 Feb-14 Dec-13 Nov-14 Dec-14 Dec-14 Aug-14 Sep-14 Sep-14 May-14 May-14 Source: MREPC, Maybank KE Looking forward into 2015, we expect earnings growth to be volume driven and believe the gloves sector (especially Hartalega, Kossan and Riverstone) will outperform the KLCI. We project a 2-year EPS CAGR (CY14-16) of 21%, 18%, 15% and 5% respectively for Hartalega, Riverstone, Kossan and Top Glove. Our earnings projections have also imputed for supply-led ASP pressure (FY15-16: 4-5% lower YoY). Prospective net profit projections MYR m CY15 CY16 350 319 300 Net profit: YoY growth 264 CY15 CY16 250 Hartalega 21% 21% 196 203 198 200 178 Top Glov e 6% 3% 152 150 136 Kossan 19% 11% 89 Supermax * 19% 12% 100 77 Riv erstone 19% 16% 50 0 Hartalega Top Glove Kossan Supermax* Riverstone *Forecasts for Supermax is obtained from consensus Source: Bloomberg, Maybank KE January 14, 2015 5 Malaysia Gloves Sector We made no changes to our calls and earnings forecasts.