Feature Glove makers to compete for international demand

by **Cals** Thu 27 Jun 2013, 16:11

Business & Markets 2013

Written by Elaine Boey

Thursday, 27 June 2013 14:46

KUALA LUMPUR: In 2012, Malaysia exported about 100 billion pieces of rubber gloves, approximately 63% of the world’s supply, to more than 180 countries.

There are glove makers in other countries such as Thailand and Indonesia but locally listed Hartalega Holdings and Top Glove Corp are the global market leaders for nitrile and latex gloves respectively.

The bulk of the demand comes from hospitals, hence the healthcare industry is an important one for glove makers. This burgeoning industry is expected to hit US$3 trillion by 2015 on the back of growing health awareness, increased spending on healthcare in emerging markets and the occurrence of new infectious diseases.

Analysts tracking the glove sector are looking at a decent annual growth rate of 10% for natural rubber gloves. Nitrile gloves, which does away with the risk of latex sensitivity, is fast gaining popularity. Global demand for these gloves is estimated to increase by 20% a year.

Resilient growing demand bodes well for the four listed glove makers in Malaysia — Hartalega, Top Glove, Kossan Rubber Industries and Supermax Corp. Instead of trying to cannibalise market share from each other, they are focused on competing for new customers around the world.

The share prices for all four companies have been trending up, underpinned by higher sales volume in the first quarter of this year. During the period, Kossan’s sales volume increased 23% year-on-year, Top Glove’s was up 20%, Hartalega’s 16.9% and Supermax’s 8.1%.

All four glove makers are ramping up supply and have announced CONSTRUCTION [] of new plants. They are also looking at producing a “balanced product mix” to capitalise on the growing preference for technical nitrile gloves and the steady consumption of natural rubber gloves.

The concern is that more gloves being produced may lead to a glut and trigger a price war. In early June, Supermax founder and CEO Stanley Thai spoke about intensifying competition that might drive down the price of nitrile gloves by 9% to 11% possible in the second half of this year.

But growing demand may be able to avert a glut. The current global nitrile gloves consumption of 60 billion pieces a year is expected to increase by 12 billion pieces (20%) per annum. Nitrile gloves produced by the four companies this year and next is not expected to surpass this demand.

A price war, if it occurs, will take place in the longer term but since these glove makers have production lines that can be halted, they can adjust their production output to avoid oversupplying the market, observes an analyst. In any case, the four companies are exploring different ways of reducing cost should profit margins start to compress in the future.

Bright outlook for all

All glove makers emjoy resilient and growing demand for their products. The risks that they face are also the same: a weaker greenback against the ringgit will impact profits since exported gloves are priced in US dollars, rising latex and crude oil (nitrile butadiene rubber is a by-product) will eat into margins until this higher cost is passed down to consumers.

Glove makers are well covered by research houses and analysts who follow this sector see unique advantages for each glove maker. Each glove maker has had at least one “buy” recommendation from a research house after the announcement of their first-quarter financial results this year.

While Hartalega and Top Glove are the market leaders and command a premium for their shares, Supermax and Kossan are trading at lower valuations. This means investors have to pick a glove maker based on their personal preferences.

“They can look at how the company operates and its ability to generate cost efficiencies (cost savings). Do they like the management team? And is the company is in a position to benefit from future trends in glove consumption?” says an analyst with local research house, which has a “buy” call for Hartalega and Top Glove. He has yet to start coverage on the other two glove makers.

The most notable trend in the healthcare industry is a growing preference for nitrile gloves. Latex gloves or natural rubber gloves make up the largest percentage of Malaysia’s total rubber gloves exports but synthetic rubber or nitrile gloves are quickly moving into its market share (see box). According to a report by Kenanga Research, the sales volume ratio of natural rubber gloves to synthetic rubber gloves moved from 58:42 in 2011 to 54:46 in 2012.

Hartalega is currently the world’s largest nitrile glove producer. It makes about 9.9 billion nitrile gloves a year, which is 90% of its total production output. With a 33% operating profit margin, the highest in the industry, the company is known as the most efficient and profitable glove producer in the country.

According to reports, average line speed at the company’s new Factory No 6 has reached 45,000 pieces an hour, the fastest in the industry. Moving forward, it plans to maintain its top position by continuing to automate processes in its factories.

HWANGDBS Vickers Research has issued a “buy” recommendation: “Our RM6.60 target price is pegged to 18 times CY14 earnings per share (fully diluted), which is similar to Top Glove’s. Hartalega is currently trading above historical mean and supported by consistent earnings. It has the highest margin (30% vs 12% in the industry) and highest return on equity (31% vs 17%) in the sector.”

Nonetheless, foreign investors looking for exposure to this sector tend to prefer Top Glove over Hartalega since the latter suffers from a low free float. Top Glove is the world’s largest natural rubber glove producer.

Top Glove’s factories are labour intensive and implementation of the minimum wage policy at the start of this year was initially a concern. But the company managed to improve operating efficiency by automating some of its processes. “This should cushion the impact of an expected 30% wage increase. Management is still guiding for profit growth of 10% to 15% per annum. We are projecting a more conservative 10% increase,” says a research note from TA Securities dated March 15.

Last year, the company announced a 15-year plan that entails aggressively ramping up production and venturing into rubber PLANTATION []s. Its plan is to increase capacity to 120 billion gloves a year to maintain its position as market leader. Top Glove also has a unique strategy of diversifying into plantations, a move that not all analysts initially agreed with. But more of them are now of the opinion that consistent raw material will reduce volatility and minimise supply disruptions for the company in the long run.

Top Glove has already acquired a 95% stake in PT Agro Pratama Sejahtera in Indonesia and will commence its first planting cycle in the middle of this year. More mergers and acquisitions are expected in the near future.

Supermax, the country’s third-largest glove maker, has also been aggressively automating its manufacturing processes, specifically its stacking and packing functions, which are more labour intensive. Its CEO cum group MD, Thai is a supporter of Pakatan Rakyat and joined their 13th general election campaign trail earlier this year. On April 18, Supermax announced that the Employees Provident Fund had ceased to be a substantial shareholder. Thai’s political affiliation is not seen as a concern as most of Supermax’s gloves are exported overseas.

“1Q2013 revenue rose by a whopping 29% year-on-year due in part to the low base of the previous year but also a result of higher output from new capacity and refurbished lines. Natural rubber and nitrile costs have been stable and have not escalated like in previous periods, meaning Supermax has been able to pass on costs more effectively,” says a May 31 CIMB Research report entitled “Making a comeback”.

“Consequently, EBITDA [earnings before interest, taxes, depreciation and amortisation] recovered and surged by 49.5% year-on-year due to operating leverage. Likewise, margins rose by 2.5% year-on-year.” The research house has a “buy” (outperform) on this stock and a target price of RM2.37.

Kossan topped its peers in terms of sales volume in the first quarter of the year with an increase of 23%. The company surprised analysts with an improving profit margin for this period when it implemented the minimum wage policy.

Hartalega’s earnings were also resilient but Top Glove and Supermax’s profit margins were more adversely affected. This year, Kossan plans to improve its share’s liquidity with bonus issues and/or free warrants for shareholders. It is also looking at setting up factories in Indonesia with a local partner. The company is targeting an annual output of 15 billion gloves and is looking at capacity of another 1.5 billion to 2 billion gloves this year.

CIMB Equities Research has an “outperform” recommendation on Kossan and is keeping its target price of RM4.81 unchanged based on a price-to-earnings ratio of 9.9 times or a 30% discount to Top Glove’s two-year average of 14.15 times.

This article was first published in Personal Money magazine July 2013 .