Wellcall a viable option to rubber gloves

KUALA LUMPUR: With volatile rubber prices and the weakening US dollar, many companies in the rubber sector have seen lower profits since the beginning of last year. However, Wellcall Holdings Bhd, the largest exporter of industrial rubber hoses in Malaysia, is one of the few that bucked the trend with its latest quarterly report.

Wellcall posted a 38.34% year-on-year rise in net profit to RM4.86 million for 3QFY11 ended June 30 from RM3.51 million a year ago. Revenue increased by a larger margin of 50.8% to RM38.11 million from RM25.27 million previously. Basic earnings per share (EPS) for the quarter was 3.68 sen compared with 2.66 sen a year ago.

“The better quarterly results were also due to the improved utilisation of our production lines and the gradual increase in the selling price of our products,” Alex Chew, executive director of Wellcall, told The Edge Financial Daily in an interview.

He added that the increase in raw material prices gave Wellcall room to raise selling prices.

“Wellcall actually favours the upward increase in raw material prices, but it has to be a gradual and not a drastic increase. As long as we have a reasonable leeway to communicate with our customers, we are able to pass down the cost,” Chew said.

Like other manufacturers, Wellcall has been facing rising raw material costs, in particular synthetic rubber and standard Malaysian rubber (SMR). The price of SMR 10 has been on the rise from around RM9.50 per kg in January 2010, peaking at RM16.70 per kg in February 2011. This month, it averaged around RM13.65 per kg.

The stronger ringgit is another headwind as 98% of Wellcall’s transactions are done in US dollars, but it also reduces the cost of imported synthetic rubber and chemicals, Chew said.
Chew: It has always been our strategy to focus on high-value products. We also provide a one-stop procurement for our customers to mix their products in one container.

To counter the effects of rising raw material costs and the strengthening ringgit, Chew said that apart from pricing up its products, Wellcall has improved efficiency by transforming its manufacturing process.

“Wellcall has been improving its efficiency in the manufacturing process by converting older manual machines to semi-automated ones. This exercise is an ongoing programme to cut labour costs,” he said, adding that in certain divisions, Wellcall has managed to reduce the workforce by up to 40%.

To buffer against volatitile raw material prices, Wellcall purchases its materials in bulk. Chew said Wellcall has in stock one month’s worth of natural rubber and two to three months of synthetic rubber.

Wellcall also has the flexibility to switch between natural and synthetic rubber, giving it room to minimise raw material costs, he said.

Wellcall’s products are sold to distributors and end customers in major application markets. These include the air and water hose, welding and gas, oil and fuel, automobile, ship building, and the food and beverage (F&B) markets.

Unlike rubber glove companies that cater for the mass market, Wellcall produces more for the niche markets, especially in the oil and gas (O&G) sector.

“Wellcall’s products are tailor-made and meant for the niche segment. So it is easier to pass cost increases to customers,” Chew said.

“One reason we are able to sustain a high margin is that not many are able to produce hoses for the O&G sector,” Chew said.

Wellcall has been focusing on high-value products in the F&B, O&G and mining sectors, riding on the commodity trend and increased mining activities in gold, iron and oil, he elaborated.

“It has always been our strategy to focus on high-value products. In addition, we provide a one-stop procurement for our customers to mix their products in one container,” he said.

Chew said the specialised high value products in these sectors also have higher profit margins, and Wellcall will continue to focus its research and development (R&D) in these sectors.

Wellcall also has the advantage of investing in new equipment cheaply, he said.

“We save up to about eight times in cost compared to our peers, as we have our own proprietary design and we fabricate our own mandrel production lines. Our return on equity is just two to three years,” he said.

The high cost of equipment in this industry also acts as a barrier to entry which means Wellcall has no significant competitors in Malaysia.

With its current production utilisation reaching 80%, Chew said Wellcall is looking for suitable land near its present location in Ipoh for expansion.

With a workforce of 400 on a 5ha factory plot, Chew said Wellcall’s operations are not labour intensive, but capital intensive.

Wellcall uses two methods to manufacture its hoses. The extrusion method is used to produce hoses with a diameter of less than 6cm. For hoses exceeding 6cm in diameter, the mandrel method is used. Wellcall currently has 22 extrusion lines and 32 mandrel lines.

The production lines have an output capacity of up to 30,000 tonnes of rubber hoses a year if run on three shifts a day, and up to 22,000 tonnes on two shifts.

With 90% of its revenue derived from foreign markets, Wellcall exports to more than 60 countries. For the nine months ended June 30, 23.4% of sales were from Asia, followed by the Middle East (19.9%), Europe (16.3%), USA/Canada (14.9%), Australia/New Zealand (9.6%), South America (12.3%) and Africa (3.6%). Malaysia only contributed 8.3% of sales.

Chew said Wellcall is expanding its customer base in places such as Africa, Russia and Latin America.

It is worth noting that Wellcall’s revenue of RM99.6 million for 9MFY11 has already equalised its FY10 annual revenue of RM96.6 million. It is 45.6% higher than revenue from the same period last year.

Operational profit from its export and local markets increased by 33.78% and 19.04% respectively, from the same period last year.

Net profit for the nine-month period, however, was marginally lower at RM10.78 million, or 8.17 sen per share, down 2.7% from RM11.08 million a year earlier.

What makes Wellcall stand out from the rubber gloves companies is its high dividend yields.

According to a CIMB Research report on Aug 16, Wellcall’s dividend yield for CY11 was 13.9%, whereas the highest among the rubber glove companies was 5.1% from Hartalega Bhd.

Wellcall has been debt free since its listing in 2006. As at end-June 2011, its balance sheet remained healthy with cash reserves of RM36.48 million.

Industrial hoses last from five weeks to eight months before they are replaced. Because of this, 85% to 90% of Wellcall’s sales come from the replacement market, said Chew.

Because of the continuous demand for hoses in new and old machinery, one could say Wellcall enjoys a “compounding” demand for its products in the future.

Chew mentioned that Wellcall does not hold stock of its products because production is based on a job order basis. This prevents overcapacity and price dumping.

He said the market for industrial hoses has a growth of 4% to 5% a year. The outlook for the rubber hose industry is still positive with original equipment manufacturers (OEM) continuing to outsource their requirements.

With the recent quarterly results, Chew hopes to regain shareholder confidence.

CIMB expects Wellcall to post a net profit of RM15.2 million for FY11 ending September, before rising to RM19.2 million in FY12, with EPS of 11.5 sen and 14.5 sen respectively. At last Friday’s closing price of RM1.17, the stock would be trading at just eight times FY12 EPS.

Over the past five years, Wellcall’s net profit rose from RM10.88 million in FY06 to a high of RM17.11 million in FY08, before declining to RM13.34 million in FY09 and then rising to RM14.62 million in FY10.

CIMB expects gross dividends of 15.2 sen for FY11 and 17.4 sen for FY12. This translates into dividend yields of 12.9% and 14.8% respectively.

Over the last year, Wellcall’s shares have traded between a high of RM1.33 and a low of RM1.04. Its net assets per share stood at 59 sen as at June 30. The company had a market capitalisation of RM154.86 million as at last Friday.

With rubber glove companies facing challenges such as intense competition and overcapacity, investors looking for exposure to the rubber sector would do well to to look at Wellcall, with high dividends to boot.