Maintain neutral: After a spectacular year in 2015, the outlook of the rubber products sector is expected to remain favourable. Catalysts of strong US dollar and subdued latex prices will continue to underpin the sector’s robust earnings throughout most of 2016.
Capacity expansion is set to outpace steady demand growth. Global demand for rubber products is expected to grow steadily at a compound annual growth rate of 8% to 9%. However, there could be erosion of pricing command towards the second half of 2016, given the possibility of oversupply of rubber products due to higher installed capacity.
We expect natural rubber and nitrile latex prices to remain subdued due to a supply glut, slower growth in China’s auto industry and butadiene prices, but production costs to increase. The biannual adjustments in natural gas price and lower electricity rebate will give rise to higher production costs in 2016. In addition, the hike in minimum wage (RM1,000 for Peninsular Malaysia and RM920 for Sabah and Sarawak effective January 2016) will also eat into its profitability this year. In this regard, most expansion blueprint is focusing on automation to reduce headcounts. All in all, “neutral” call is maintained. Low raw material prices, the strong US dollar, benefits of the Trans-Pacific Partnership agreement and the resilient global demand will continue to contribute favourably to the rubber products industry (both glove and condom). However, it will be neutralised by rising fuel costs and wages. For the glove industry, erosion of pricing command is likely, given the oversupply of gloves. Last but not least, the industry practice of passing on cost savings may also transpire during the year.
Among the players in the rubber glove sector, we like Top Glove Corp Bhd (Valuation: 1.10, Fundamental: 2.70) (Buy, target price [TP]: RM16.25) as it has been the sector’s leader in terms of market share, revenue, and earnings; its fast capacity expansion; cost reduction via product line automation and SAP enterprise resource planning system; and its price-earnings ratio (PER) valuation has lagged its peers and it is trading at an average 28% discount to Kossan Rubber Industries Bhd (Valuation: 1.10, Fundamental: 2.10) and Hartalega Holdings Bhd (Valuation: 0.50, Fundamental: 2.30).
Catalysts could include a surge in demand in the event of a disease outbreak; more stringent requirements and increased spending in the healthcare sector; appreciation of the US dollar against the ringgit and lower rubber prices to boost profitability. Risks include mismatch between demand and supply in rubber glove; potential increase in natural and/or synthetic latex prices; depreciation of the US dollar against the ringgit. Positives include softening of natural and/or synthetic latex prices and continuous improvement in cost efficiency.
Meanwhile, the negative would be the weakening of the US dollar against the ringgit. We maintain “neutral” on the sector with the following ratings: Hartalega (Hold, TP: RM6.47, 28.5 times calendar year 2017 [CY17] earnings per share , EPS pegged to one standard deviation [SD] above five-year historical average PER); Kossan (Hold, TP: RM7.81, 16.6 times CY17 EPS pegged to one SD above five-year historical average PER); Top Glove (Buy, TP: RM16.25, 20.6 times CY17 EPS pegged to one SD below five-year historical average PER); and Karex Bhd (Valuation: 1.10, Fundamental: 2.55) (Hold, TP: RM4.52, 26.9 times CY17 EPS pegged to one SD above five-year historical average PER). — Hong Leong Investment Bank Research, Jan 13
