We upgrade the sector from UNDERWEIGHT to OVERWEIGHT following recent retracement in share prices, coupled with improvement in fundamentals, and tariffs on China glovemakers that ratcheted up last week with brought-forward timeline. Indications are pointing towards a strong demand recovery moving into 2HCY24 and CY25 that will exceed the level we had previously assumed, underpinned by inventory rebuilding from distributors and faster-than-expected industry consolidation. We expect glove stock prices to re-rate in anticipation of near-term earnings upsurge. Moreover, tell-tale signs of predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competition) have diminished as Chinese players’ utilization hit>90%. We upgrade HARTA (OP↑; TP: RM3.20↑), KOSSAN (OP↑; TP: RM2.60), which have more sizeable US sales exposures. This is followed by Market Perform in both TOPGLOV (MP↑; TP: RM0.97↑) and SUPERMX (MP↔; TP: RM0.83↔).

With market expectations of losses and falling ASPs increasingly being priced in, we see value emerging being derived on a medium-term horizon. Specifically, the recent retracement in the sector share prices (between 22% and 37% from YTD peak for stocks we cover) coupled with improvement in fundamentals have prompted us to upgrade the sector from UNDERWEIGHT to OVERWEIGHT. Amplifying the optimism are: (i) Indications are pointing towards a strong demand recovery moving into 2HCY24 and CY25 that will be stronger than what we had previously assumed, underpinned by inventory rebuilding from distributors and faster-than-expected industry consolidation,( ii) tell-tale signs of predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competitors) have diminished as Chinese players’ utilization hit >90%, and (iii) US imposition of tariff ratchets up to 50% and 100% in CY25 and CY26, respectively (revised up as announced on 13 Sept) making Malaysian glove makers the prime beneficiary. We expect glove stock prices to re-rate in anticipation of near-term earnings upsurge which clearly is a positive for the sector.

Nascent signs pointing towards a stronger-than-expected demand recovery. Indications are pointing to a strong demand recovery moving into 4QCY24 and CY25 that will exceed our previous assumptions, underpinned by inventory rebuilding from distributors. Specifically, there has been uptick in orders over the past two quarters. The rise in demand comes as the inventories of major distributors across all regions have returned to normal levels.

Faster-than-expected industry consolidation. Oversupply is less acute than we had previously forecast, in turn potentially achieving equilibrium faster than expected, by 2026. The oversupply situation will gradually improve following signs of players culling production capacity via decommissioning of selective plants and exit of new entrants. From our recent channel checks, we believe the market is witnessing a faster-than-expected industry transitioning into a rationalisation and consolidation phase from massive industry over-capacity. Indications are pointing towards a faster-than-expected improvement in supply-demand equilibrium as players take the opportunity to shut down older plants or productions lines that are no longer efficient and speed up the industry consolidation. We understand that global supply is currently standing at 500b-530b pieces compared to our earlier forecast of 600b pieces.

US revised up tariffs further, with a brought-forward timeline, making Malaysian glove makers prime beneficiary. The United States Trade Representative (USTR) has just unveiled tariff increases on Chinese imports which includes a higher tariff of 50% (instead of the previously announced in May CY24 imposition of 25% effective CY26) and 100% on China’s rubber medical and surgical gloves’ exports into the US beginning CY25 and CY26, respectively. Historically, the US accounts for 30%-50% of sales volume to HARTA, KOSSAN, TOPGLOV and SUPERMAX. For illustration purposes, a 50% tariff hike is expected to raise Chinese glove producers’ ASP to USD25-USD26/1,000 pieces (we assume base case ASP at USD19/1,000 pieces). This compares to Malaysian players’ ASPs currently at USD16-21/1,000 pieces and we expect Malaysian glove makers to benefit from the US import tariff hike from 7.5% to 50% on Chinese glove imports in CY25.

Upgrade our FY25F net profit and introduce FY26F. HARTA: We raise our FY25F and FY26F net profit by 4%/25% to RM163m/RM194m as we raise our volume sales by 3%/15%. KOSSAN: We raise our FY24F and FY25F net profit by 3% and 8% to RM122m and RM135m, respectively, and introduce FY26F net profit of RM151m. TOPGLOV: We raise our FY25F net profit by >100% from low base to RM108m and introduce FY26F net profit RM139m. Our FY25F ASPs per 1,000 pieces are at USD20 to USD21, which hasn’t reflected the full potential of the above tariffs. Ceteris paribus, every USD1 difference affects CNP by a range of 1.2% and 1.6% for FY25F.

Upgrade Target Prices, HARTA and KOSSAN to from UNDERPERFORM to OUTPERFROM. Due to the improved outlook, we are now attaching a P/BV valuation of between 1.7x – 2.3x which is at a discount to sector’s recovery cycle of between 1.8x to 2.5x i.e. the levels seen emerging from an oversupply downturn in 2008, and a discount we believe is valid due to the emergence of Chinese glove makers. Our previous valuation was 0.5x-1.7x which was at 30%-70% discount previously attached to the sector’s average of 1.7x charted during previous downturn in 2008. Our ratings are as follows (pls see Table in page 7): HART (OP↑; TP: RM3.20↑), KOSSAN (OP↑; TP: RM2.60↑), TOPGLOV (MP↑; TP: RM0.97↑), and SUPERMX (MP ↔; TP: RM0.83 ↔).

Nascent signs pointing towards a stronger-than-expected demand recovery. Specifically, there has been uptick in orders over the past two quarters (pls see charts below). Case in point - HARTA expects to hit sales volume of 2.2b pieces/month in 2HFY25. Already, HARTA has seen 1QFY25 orders hitting close to 2b pieces per month compared to 1.5b1.8b pieces per month in 4QFY24 and 3QFY23. TOPGLOV is optimistic that the strong growth momentum will sustain, as customers continue replenishing their depleting glove stockpiles. The group continues to see MoM uptrend in sales volume in June 2024 and expect customers’ replenishment activity to pick up in subsequent quarters, underpinned by inventory rebuilding from distributors, indicating early signs of potential recovery in demand. It has seen sales order rising 25%-30% MoM. Tell-tale signs of predatory pricing by certain overseas players (i.e. selling below cost over an extended period of time to eliminate competitors) have diminished. Specifically, glove players under our coverage have seen their ASPs rising over the past two quarters, potentially implying demand is on the path to a recovery boosted by order replenishment.

Our channel checks revealed that sales orders is expected to continue to sustain moving into 2HCY24 which has seen glove makers under our coverage registering solid QoQ growth in 1QCY24 and 2CYQ24. We understand that most customers have reinitiated their restocking activities given that earlier excess inventories have been largely drawn down. Based on our forecasts, we estimate utilisation rate of glove makers under our coverage to recover from a low of 30% to 60-70% moving into 2H 2024 and CY2025.

Source: Kenanga Research - 18 Sept 2024