The anticipated normalisation of earnings for the rubber products sector has begun as the supernormal earnings are in their final legs, says RHB Group Research analysts.
In a Sept 28 note, analyst Sean Chew maintains “neutral” on the rubber products sector, with a “neutral” recommendation on six out of the eight regional stocks covered as the expectation of average selling price (ASP) moderation has been largely priced in.
The selling prices of rubber gloves have fallen from the highs, with current ASPs of nitrile and latex gloves ranging between US$40 to US$45 and US$30 to US$35 respectively per 1,000 pieces.
Due to this, RHB is trimming its normalised price assumption per 1,000 pieces to US$27 for nitrile and US$21 for latex. This is based on the expectations that prices will revert back to the cost-plus basis, says Chew.
“Glove capacity expansion plans are dependent on supply and demand dynamics, which in turn determine selling prices. Listed glove manufacturers under our coverage are expected to expand their production capacity to 319 billion pieces per annum by 2023.
“Given the quicker-than-expected price erosion, we believe glove makers may decide to scale back on their expansion plans to prevent the risk of oversupply and suboptimal utilisation rates,” says Chew.
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However, if non-Malaysian manufacturers proceed with their aggressive expansion, the Malaysian manufacturers would suffer in market share loss. This may result in the latter reacting by continuing their expansion and possibly under-pricing their products, says Chew.
“Additionally, manufacturers are likely to prioritise clearing their high-cost inventory when ASPs trend south, with prices overshooting downwards before settling at a higher equilibrium. As such, prices could fall below our expectations and pose a margin compression risk to our forecast,” he adds.
RHB believes that a steeper price war resulting in prices falling to cost-efficient levels could prompt a further sector de-rating.
By collating publicly announced expansion plans by various manufacturers and conducting a supply and demand analysis, RHB found that an oversupply scenario is unlikely to happen for the next two years. The dynamics, however, may be close to parity in 2023.
Given the sharp moderation in share prices recently, RHB believes the aforementioned factors have largely been accounted for, with domestic institutions heavily reducing their exposure for the past few months.
“That being said, we have yet to see value or catalysts to rerate the sector and the balance of risks still remain tilted towards the downside,” says Chew.
In the Malaysia space, RHB favours Top Glove, given its entrenched market leadership. Additionally, Top Glove’s exposure to latex gloves (49% of FY21 sales volume) points to lesser price competition versus its pure-nitrile peers.
In the Singapore space, the firm likes Riverstone, as the downtrend in healthcare glove ASP will partly be cushioned by its higher-margin cleanroom segment which continues to enjoy demand arising from the growing tech manufacturing and pharmaceutical sectors.
RHB maintains Riverstone at “neutral” with a new target price of 95 cents, representing a 4% upside. The firm’s analyst cut its FY22F to FY23F earnings by 71% and 55% after revising its ASP assumptions.
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The firm also incorporated a 2% environmental, social and governance (ESG) discount to its target price, as RHB’s proprietary methodology found that Riverstone’s ESG is below the country mean.
RHB also remains “neutral” for UG Healthcare, with a lower discounted cash-flow-derived target price of 37 cents. After revising its ASP assumptions, the RHB analyst slashed its FY22F to FY23F earnings by 27% and 18%. The firm ascribed a 6% ESG discount to the target price as UG Healthcare’s ESG stands below the country mean.
As at 2.45pm, shares in Riverstone are trading 0.552% lower at 90 cents. Meanwhile, shares in UG Healthcare are trading at 2.89% higher at 35.5 cents.