Rubber Glove - Headwinds ahead

We maintain a Neutral rating on the rubber glove sector. In the nutshell, we believe the latex prices should continue to trend down throughout 2013. However, the price may be supported during the winter period (between Feb and May) for rubber trees. While we believe the declining trend  in raw material prices could improve glove makers’ margins, this benefit will eventually be passed down to purchasers via lower average selling prices (ASPs). Coupled with the strengthening trend in Ringgit vs. USD and other headwinds such as higher natural gas prices and the minimum wage policy, which will be effective from Jan 1, 2013, we are generally NEUTRAL on the sector. Our only OUTPERFORM call is on Kossan Rubber Industries (“KOSSAN, TP: RM3.64) due to its undemanding valuations and its more diversified product mix, which makes its earnings less sensitive to raw material price movements. 

Strengthening Ringgit negative for glove makers. Since sales are USD denominated, theoretically, an appreciating ringgit against the dollar will lead to less receipt in revenue for glove makers. The ringgit is currently hovering between RM3.00 and RM3.08/USD. Ceteris paribus, a 1% RM appreciation against USD will lead to a 2%-3% drop in the net profit. Nonetheless, we understand the glove makers are able to renegotiate with the purchase and pass-down the cost.

Potential upward movement in latex price going into the winter months.  Latex prices have been trading at a stable rate of between RM5.50/kg and RM5.90/kg over the last 2-3 months, which augers well for rubber glove players. However, in anticipation of a lower latex production entering into the winter period (between Feb and May), the latex price is expected to move upwards. This could potentially lead to a lower-than-expected sales volume of natural latex rubber gloves. 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. 

Headwinds emanating from high energy and labour costs going forward. Looking ahead, we believe rubber glove players may face higher production costs ahead from higher energy prices as well as the recently announced minimum wage policy. Effective Jun 2011, the government has raised the gas price by 7% to RM16.07 per mmbtu from RM15 per mmbtu. There will be a subsequent 8%-19% price increase every 6 months until 2015. However, the dateline for the last review in December 2011 has passed but no price increase has been implemented since then. Recall that in 2011, the electricity tariff rate was raised by 8%-10%. The hike in the energy prices was expected as it was in line with the Government’s subsidy reduction rationalisation programme. Meanwhile, the minimum wage policy is expected to hit Top Glove, Kossan Rubber and Hartalega’s CY13 bottom lines by 7-15% assuming a "no-cost -pass-through" scenario and before restructuring the revised new wage scheme to incorporate some fixed allowances into the calculation of the minimum wage. That said, given that manufacturers who are affected have a 6-month grace period from the gazette date, we believe that rubber glove payers can still gradually pass down the cost. For now, we are keeping our earnings forecast unchanged. 

Demand for gloves still intact, moving towards nitrile gloves.  We believe that the average 8%-10% demand p.a. for rubber gloves over the next few years is still intact. On the overall, the demand is expected to continue to be led by natural rubber (NR) gloves but synthetic rubber (SR) gloves have consistently been taking up the former’s market share. Over the last two years, Malaysia’s exports of NR and ST rubber glove have deteriorated. According to the Malaysian Rubber Export Promotion Council (MREPC), in 2011, Malaysia’s total export of gloves was 35.6b pairs, 4.5% lower YoY. However, in terms of sales value, the exports rose 9.8% YoY to RM9.4b largely due to higher ASPs. While latex-based gloves or NR is still dominant (as a percentage to the overall exports of rubber gloves) in Malaysia, the trend is moving towards SR. This is evident from the NR:SR sales volume percentage ratio of 69:31 in 2010 to 58:42 in 2011. The quantity of NR gloves exported in 2011 fell 20% YoY to 20.5b pairs due to the high cost of input raw materials. Meanwhile, exports of SR gloves increased 29% in 2011 to 14.8b pairs of gloves. As at 9M2012, the NR:SR sales volume ratio was at 55:45. Both the NR and SR sales volume rose 7.0% and 20.0% respectively as at 9M2012. Amplifying the demand growth for nitrile gloves are its superior quality and lightness (vs. natural rubber gloves) as well as the fact that volatile latex prices have narrowed the ASP gap between latex and nitrile-based gloves, making the  latter cheaper during a rising latex price environment.   

Source: Kenanga