Rubber gloves — rubbing it in

Rubber gloves sector
Downgrade to underweight (from Overweight): We are making a tactical downgrade to “underweight” because two key near-term negative news stories are  expected to depress share price performance: (i) Aggressive expansion plans, notably in the nitrile segment, could lead to average selling price (ASP) weakness; and (ii) Supernormal margins and profit enjoyed in the Brazilian market in the past will normalise as more players enter the market. Despite recent sharp share price declines (-16% to 29% from the peak in July), we see no reason to aggressively buy glovemakers on a six-month basis.

We are seeing an overcapacity emerging in the nitrile gloves market, with 9.4 billion new capacity earmarked for nitrile production coming onstream in 2010. This is 18% year-on-year (y-o-y) higher than the industry’s overall new capacity in 2009 (eight billion gloves). In our view, some players could delay their expansion plans because of this, but we are seeing a short-term price undercutting trend emerging from several manufacturers who have recently commissioned their lines to fill up new capacity.

A potential price war could be brewing in the nitrile glove segment. YTY Industry Sdn Bhd, in our opinion, is the most aggressive in its expansion plans, growing capacity by 63% y-o-y to 5.2 billion pieces now. We gather that YTY is pricing its ASP competitively to fill up capacity from new customers. We foresee other competitors, notably Hartalega (largest nitrile producer in the world) countering this by putting further pressure on ASP. Hartalega has the margin advantage over its peers in any prolonged price war. Its Ebit margin of 31% is higher than YTY and Kossan (+10 to 16 percentage points).

Latex glove competition is heating up in Brazil with at least seven OEM manufacturers now qualified to sell their product (predominantly latex gloves) in Brazil  (against two in early 2009), players like Top Glove (among the early movers there with super-normal margins in 2009) will be affected most as it derives 13% of its sales from Brazil with a 50% share of the market. We expect Top Glove’s margins to contracting by one percentage point y-o-y in FY2011/12.

We expect our gloves universe three-year aggregated core net profit CAGR to taper down to 14% now from 17% previously. We downgrade Top Glove from a “buy” to a “sell” with a revised target price (TP) of RM5.40 (-17%) largely on normalising demand outlook and weaker near-term earnings and margins ahead. Hartalega and Kossan are now “holds” (“buy” previously) with TPs of RM5.40 (-11%) and RM3.60 (29%) respectively, largely on an impending price war and overcapacity concerns in the nitrile market. — Maybank IB Bhd Research, Sept 15


This article appeared in The Edge Financial Daily, September 17, 2010.