Maintain OVERWEIGHT. Rubber glove stocks under our coverage have performed well following our upgrade eight months ago. Despite easing off from recent peaks, they remain strong outperformers YTD, led by SUCB (+18%), TOPGLV (+20%) KOSSAN (+13%) and HARTA (+6%). The stage is now set for a solid FY20 following three quarters of anemic quarterly earnings growth. Coming off this low base due to the lackluster demand of the past 12 months, forward earnings growth will amplify as re stocking activities ramp up on the current outbreak of the Wuhan virus which enforces higher hygiene standards. All in, we raised our valuations from +1.0SD to +1.5SD to better reflect rubber gloves players’ prospects in anticipation of restocking activities, resilient earnings and their constant evolution and progress to increase earnings. We have OUTPERFORM calls on HARTA (OP; TP: RM7.00; previously RM6.50); KOSSAN (OP; TP: RM5.90) SUPERMX (OP; TP: RM2.00; previously RM1.75) and TOPG (MP; TP:RM5.30; previously RM4.25). Our Top Pick in the sector is HARTA (OP; TP: RM7.00).

Upgrade our PER valuation to +1.5 SD above historical forward average. With the lackluster demand of the past 12 months behind us, we see re stocking activities ramp-up as the current outbreak of the Wuhan virus enforces higher hygiene standards. All in, we raised our valuations from +1.0SD to +1.5SD to better reflect rubber gloves players’ prospects in anticipation of restocking activities, resilient earnings and constant evolution and progress to increase earnings. Based on historical valuation at peak earnings, rubber glove stocks namely Kossan, Hartalega and Top Glove were trading at between +1.5SD to +2.0SD historical forward mean. We believe rubber glove stocks deserve further re-rating and should trade at their previous peak PER valuations given the following factors:- (i) re-stocking activities ramp-up as the current outbreak of the Wuhan virus enforces higher hygiene standards, (ii) uptick in ASPs as most players are running at high utilization rate of 80-90% since most players have cut back on production following concerns of oversupply in 2019, and (iii) margins expansion emanating from higher ASPs since players have scaled back and slowed down on expansion in 2019.

Potential higher ASPs in anticipation of a surge in demand and moderating supply growth in the past 12-months. Tell tale signs of demand outstripping supply could potentially lead to higher ASPs. Looking at the stable raw material price, ceteris paribus, hike in ASPs is expected to lead to margins expansion. We understand that some players have raised prices in anticipation of higher demand and we also noted the current high 90% utilisation rate for nitrile-centric players which is a stark contrast compared to the lacklustre demand in 2019.

Parallels with the SARS and H1N1 experience? During the SARS crisis, the infection was first detected in November 2002. Between then and February 2003, 5 people had died and over 300 were reported to have fallen ill of SARS in Guangdong province, China. During this period in 2003, Top Glove, Supermax and Kossan Rubber revenue and net profit grew between 15% and 25% while HARTA was only listed in 2008. Similarly, during the H1NI period, net profit grew 10%-20% for rubber gloves players under our coverage.

Stage set for a recovery in volume growth. More importantly, even before the Wuhan virus crisis set in, there were nascent signs of a solid uptick in demand for rubber gloves in coming quarters. 3QCY19 results season indicated a positive recovery in demand and hence volume growth from industry leaders - TOPG and HART. Both players recorded 6% and 14% sequential volume growth, respectively. From our ground checks, demand for nitrile gloves is picking up again with players’ new capacities swiftly taken up. We believe this uptick in demand is turning positive and should be reflected in players bottom-line in subsequent quarters.

Nitrile gloves' market share to gain further momentum with potential 30% growth. Based on our analysis, we expect nitrile gloves to continue growing and expropriating market share from latex gloves. The growth in nitrile segment is evident. For illustration purposes, going forward, assuming nitrile:latex breakdown of 80:20 (current is 67:37) and based on estimated global demand of 308b pieces in 2020 (forecast for 2019 is 300b pieces and assuming 8% growth rate in 2020), this implies nitrile growth rate of 30% or an additional 51b pieces from switching to nitrile gloves.

Our Top Pick in the sector is HARTALEGA. We like HARTA for: (i) its “highly automated production processes” model, which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins and reduction in costs, (ii) constantly evolving via innovative products development, and (iii) its nitrile gloves segment, which is booming. Our TP is RM7.10 based on 42x FY21 EPS (between +1.5SD to +2.0SD above 5-year historical forward mean).

Source: Kenanga Research - 7 Feb 2020