Rubber Gloves Manufacturing - G-love is in the air

2009 is a year of strong recovery for Malaysian glove makers, which dominate approximately 65% of the global natural rubber glove supply and about 50% of global nitrile glove supply, led by easing raw material costs and extra demand following the outbreak of the H1N1 virus. However, the sector could be heading into a slower growth phase beyond 2009, hampered by measured capacity expansion and slight margin cost pressure – weaker export receipts and higher commodity price when the US dollar weakens. Nevertheless, there are still good trading opportunities and valuations of some undervalued producers like Kossan Rubber are bound to stretch considerably.

Slower growth era after 2009. Glove manufacturers are expected to record impressive 17-24% earnings growth in 2009 on favourable exchange rates, as well as respite from 2008’s steep rise in raw material prices. However, revenue growth from 2010 onwards would trend towards the global demand growth of 8-10% as other macro trends (outsourcing and industry consolidation) have moderated. Industry earnings growth should ease from high teens previously to low to mid-teens post-2009.

More stable margins as industry capacity growth slows. Margins are expected to remain relatively stable as most manufacturers are strategising on measured capacity growth through 2010-11. We expect industry utilisation rates to rise marginally, providing sufficient pricing power for producers to pass on higher costs. We also expect raw material prices to rise in 2010 by 40% from their current levels, reflecting price levels similar to 2007-08, where crude oil prices were sustained at US$80/bbl.

Industry trends and beneficiaries. We expect the following segments to feature above-trend growth – synthetic gloves such as nitrile gloves, medical gloves, emerging markets (expected to grow at 15% annually). Users for natural latex gloves will shift to nitrile gloves eventually when prices of the latter become more affordable (currently, the price difference is about 30%). Among the producers which we monitor - Top Glove, Kossan and Hartalega - we expect Kossan to register better incremental margins from the shift to nitrile gloves. Kossan and Hartalega are the larger beneficiaries should the H1N1 pandemic continue to gain traction, given their larger exposure to the medical segment (see overleaf).

Companies which we cover in the sector are Top Glove Corporation (TOPG MK/HOLD/Fair: RM6.70, based on mid-2011 12x PE) and Kossan Rubber Industries (KRI MK/BUY/Target: RM4.24, based on mid-2011 8x PE). Top Glove is fairly priced given its current valuation premium (4.69x PE), which factors in better trading liquidity and market leadership, has already surpassed its average historical PE premium to peers of 4.60x. We like Kossan, which is a sector laggard and provides the cheapest exposure (mid-2011 PE of 6.8x) of a considerable size to the glove manufacturing sector.