Maintain neutral: Two (Top Glove Corp Bhd and Karex Bhd) out of four companies under our coverage were in line.
Hartalega Holdings Bhd’s and Kossan Rubber Industries Bhd’s third quarter of financial year 2016 (3QFY16) and 4QFY15 results were below expectations mainly due to one-off foreign exchange-related adjustments.
Upcoming quarterly results of the sector are expected to remain flat quarter-on-quarter (q-o-q) as stronger volume would be offset by the strengthening ringgit as well as a mild increase in costs.
The biannual adjustment in the natural gas price, higher electricity and a minimum wage hike (RM1,000 for Peninsular Malaysia, and RM920 for Sabah and Sarawak effective July 2016) are likely to put pressure on the margin.
The impact of the higher levy on foreign workers (RM1,850 from RM1,250) is minimal at about 1% of earnings.
Despite a recent spike in natural rubber and nitrile latex prices, we still expect raw material prices to be capped with downside bias due to a supply glut and slower growth in China’s auto industry.
We note that the strong US dollar catalyst has diminished as the ringgit is poised to maintain its strength given its resilient economic fundamentals. We already trimmed our ringgit assumption to RM3.80/US dollar in our FY16 to FY17 forecasts (versus RM4/US dollar previously).
Low raw mat prices, a still strong US dollar, the beneficiary of the Trans-Pacific Partnership agreement and resilient global demand will continue to contribute favourably to the sector (both glove and condom). However, it will be neutralised by rising energy and labour costs.
The industry practice of passing on cost savings may also transpire during the year.
We like Top Glove (“buy”; target price: RM6.46) as: i) it has been the sector’s leader in terms of market share, revenue and earnings; ii) its resilient capacity expansion ahead; iii) cost reduction via product line automation and SAP SE’s enterprise resource planning system; and iv) its price-earnings ratio valuation has lagged its peers and it is trading at an average 41.9% discount to Kossan and Hartalega. — Hong Leong Investment Bank Research, March 30
