Monday, 4 March 2013

Rubber Glove - 4QCY12 Results Round-Up – Neutral

The just concluded 4QCY12 results season was within our expectations, with four of the stocks under our coverage coming in generally within ours and the consensus expectations. Sales volume largely grew QoQ across all the companies, led by Kossan Rubber Industries. We believe that the latex prices should continue to trend down throughout 2013, although the winter months (between Feb and May) could support prices in the short term. While we believe the declining trend in the raw material prices could improve the glove makers’ margins, this benefit will eventually be passed down to purchasers via lower average selling prices (ASPs). The stable volume growth and the mildly positive weakening trend of the Ringgit vs. USD are expected to be negated by the minimum wage policy and over the longer term, higher natural gas prices. We are maintaining our NEUTRAL rating on the sector. Our only OUTPERFORM call is on Kossan Rubber Industries (“KOSSAN, TP: RM3.64).

4Q12 results were largely within expectations. All four rubber glove stocks that we cover reported results that came in within ours and the market expectations in the justconcluded results reporting season. Sales volume largely grew QoQ across all the companies led by Kossan (+17% QoQ; 40% YoY), Supermax (+13% QoQ; 10% YoY), Hartalega (+7% QoQ; +29% YoY) and Top Glove (+6% QoQ; +23% YoY) due to capacity expansions as well as higher demands fueled by the lower ASPs due to the easing input of raw material prices. The average bulk latex prices declined by 5% QoQ (from an average of RM6.20/kg in 3Q2012 to RM5.88/kg in 4Q2012) while nitrile prices fell by 9.3% QoQ. YTD 2012, the average input latex and nitrile prices declined by 20%.

Potential margin squeezed in 1QCY13? Due to the implementation of the minimum wage policy starting 1 Jan 2013 and the low latex production in 1QCY13, rubber glove players could face a margin compression in 1QFY13. Latex prices have been trading at a stable rate of between RM5.50/kg and RM6.00/kg over the last 6-9 months, which augur well for rubber glove players. However, in anticipation of a lower latex production between Feb and May, the latex price is expected to move upwards. Moreover, the lag effect in passing on the higher cost to customers via higher ASPs could crimp the margins of rubber glove players in the short term. Meanwhile, in a bid to mitigate the effects of the minimum wage policy, most rubber glove players have adjusted upwards their ASPs by 2-4%. In addition, most of the players have invested in the automation and computerisation of their manufacturing processes and have gradually reduced their reliance on manual workers to minimise the adverse effect of the minimum wage policy. Some of the automations put in place include the: (i) automated mechanical stripping system (removing gloves off hand moulds) and (iii) glove puller and stacker system. The benefits from automation will take some time to mitigate the effects of the minimum wage policy. Similarly, the increase in ASPs may not be enough to counter the average increase of between 30% and 50% in wages.

Foreign workers to pay levy instead of employers with immediate effect. Recall that the Cabinet has decided on 30 Jan 2013 that foreign workers should pay the levy instead of employers. The decision is to be enforced with immediate effect on new foreign workers and those who wish to renew their work pass, employment pass or temporary work visit pass. The levy imposed on foreign workers in the rubber glove industry is expected to be RM1,250/month. This cost savings to employers, however, is of little cushion to the additional 30-50% increase in wages that they have to absorb from the implementation of the minimum wage policy above. Based on our back-of-the-envelope calculation, assuming a no cost passthrough scenario, and taking into account of: 1) the minimum wage policy; and 2) cost savings on foreign workers levy, the overall impact is expected to hit Top Glove, Kossan Rubber, Hartalega and Supermax’s bottom lines by between 7% and 10%. Note that labour accounts for 9.0% of the overall production cost.

Weakening of Ringgit vs. US dollar is positive to rubber glove players. Generally, a weakening Ringgit is positive for glove makers. Since sales are USD denominated, theoretically, a depreciating ringgit against the dollar will lead to higher revenue for glove makers. The ringgit is currently hovering between RM3.08 and RM3.11/USD. Ceteris paribus, a 1% depreciation of RM against USD will lead to an average 1%-2% increase in the net profit of rubber glove players.

Source: Kenanga

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