Potential oversupply seen in rubber glove sector

The robust demand is attracting players to ramp up production


A Potential oversupply is looming in the rubber glove sector.

In an industry coverage note last week, Kenanga Investment Bank Bhd said anecdotal evidence suggests the share price rally of rubber glove makers was led largely by massive price-earnings (PE) ratio expansion as earnings growth has been pedestrian over the past eight quarters.

Its analysis suggests the strong surge in share prices of rubber glove stocks was mainly due to inflation in the PE multiple and not so much on earnings growth.

“Following a period of capacity consolidation starting back in mid-2016, which led to falling average selling prices (ASPs), nascent signs of glove makers ramping up capacities are emerging again,” the investment bank noted.

“The robust demand is attracting players to ramp up production. In anticipation of higher demand and a switch from vinyl gloves, players are raising capacities again.

“Our analysis suggests a potential oversupply is looming,” it added.

Kenanga said the previous two oversupply situations occured back in 2014 and 2016.

Checks with rubber glove players under its coverage revealed demand is mainly for nitrile and natural rubber, instead of vinyl.

Contrary to the market expectations of a massive industry switch from vinyl to rubber gloves, Top Glove Corp Bhd’s second quarter of 2018 (2Q18)/first half of 2018 (1H18) saw demand growth led largely by emerging markets (EMs) that are not predominant vinyl glove consumers.

Specifically, demand growth for natural rubber gloves stems from EMs, where healthcare awareness and hygiene standards are rising steadily, particularly Asia (excluding Japan) and Eastern Europe, which respectively saw a 60% and 40% boost in sales volume for 1H18 compared to 1H17, of which they were not vinyl glove-consuming nations.

Kenanga said another glove maker sees sustaining demand growth from the US and Europe, which are consumers of predominantly nitrile and natural rubber gloves consumers. As such, there might not be an aggressive switch from vinyl to rubber gloves.

Kenanga reiterates an ‘Underweight’ recommendation for the sector due to the rich PE valuations and flat sequential earnings growth.

It also has an ‘Underperform’ call on Hartalega Holdings Bhd, Top Glove and Supermax Holdings Bhd, while its top pick is Kossan Rubber Industries Bhd.

“We like Kossan for its strong high teens year-on-year earnings growth expected in subsequent quarters underpinned by new capacity expansion; it is moving from good to great due to transformation in the manufacturing processes via automation, hence potential margins expansion; and it is trading at an unwarranted 25% discount to peers and the valuation gap should narrow, considering the solid earnings growth ahead.

“Our target price of RM4.95 is based on 25.5 times financial year 2019 estimated earnings per share (+1.5 SD above five-year historical forward mean) due to Kossan’s strong high teens growth ahead,” Kenanga noted.