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Not the time for bottom fishing

ASP downturn yet to find bottom; D/G to NEGATIVE

ASP is declining fast and could hit pre-Covid levels by mid-2022 i.e. another -42% from current level of about USD40/k pcs in Sep 21. With the stiff competition from China, we believe the Malaysian glove sector is experiencing a structural change and the oversupply situation could potentially extend longer than the typical downcycle of 6-9 months. A strong balance sheet is hence paramount to surviving the inevitable price war. We D/G the sector to NEGATIVE (from NEUTRAL). We are SELLers for Top Glove, Hartalega and Kossan.

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A few issues to contend with

ASP is falling faster than expected. Since May-June 21, industry players have been guiding for a weaker ASP outlook. ASP is expected to decline – 8% to -10% MoM (peak: USD130-140/k pcs in early 2021 vs. c. USD40/k pcs in Sep 21) and could return to pre-Covid levels of USD23-24/k pcs by mid-2022, representing a -42% decline from the current level. Rubbing salt into the wound are other issues such as lower utilization rates and additional operating costs on stricter SOPs as well as labour shortage. As
such, we expect weaker earnings performance in the coming quarters.

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China, a new force that can’t be ignored

The threat from China is real. Aggressive capacity expansion by the Chinese glove makers would likely lead to oversupply by 2023. Already, to seize the market share, the Chinese glove makers are selling their
gloves at more attractive pricing in Europe relative to their Malaysian counterparts. According to industry players, the Chinese glove makers are expected to contribute 23% of the world’s glove supply by 2022 (from 16% now) while Malaysia’s market share is expected to shrink to 60% in 2022, from 67%.

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D/G Hartalega and Kossan to SELL

We now value the glove players at -1SD of historical mean (-0.5SD before). This is to reflect increasing competition from China glove makers, which presents downside risks to ASPs. We downgrade Hartalega
and Kossan to SELLs (from HOLDs) after factoring in the change in valuation basis (for Kossan) and lower ASP assumptions (FY22: -45%; FY23: -21%) that have led to a -1% to -76%% downward revision to earnings. Positively though, the listed glove producers have strong balance sheets and low operating costs, and this will sustain them through this competitive phase.