Since the recent outbreak of the new coronavirus in Wuhan, share prices for the glove makers under our coverage universe have surged as the market anticipates stronger gloves demand. The number of confirmed cases and fatalities continue to climb in the absence of a vaccine that can effectively treat the coronavirus and we believe that history might repeat itself, where the valuations for the glove players will continue to expand and trade up to +2.0 SD of their respective historical 5-year mean, similar to the H1N1 outbreak in April 2009. On a side note, MARGMA also revealed that the Malaysian glove manufacturers have received urgent shipment request from China and as a result, we lift our earnings forecast for the glove players under our coverage for FY20-FY21F by 3-5% to account for the expected extra orders. We upgrade our rating on the rubber glove sector from Neutral to Overweight on a tactical basis, as we believe valuations will continue to expand as the absence of vaccine might lead to the coronavirus being spread across more countries.
Outbreak of coronavirus. The new coronavirus outbreak, 2019-nCoV, that began December 2019 in Wuhan, China has thus far infected more than 4500 individuals, death toll soaring to 106, while infections have been confirmed in more than 10 countries. According to World Health Organization (WHO), the new strain belongs to the same family of virus that includes the common cold and viruses such as SARS and MERS. Experts also believe that the deadly virus will last for another 6 months and infect tens of thousands of people, at the very least.
Unexpected increase in glove demand. Following the coronavirus outbreak in China, MARGMA revealed that the glove players have recently received urgent demand requests from China. Utilization rates for glove counters under our coverage are currently running at c. 88% and we believe that there is room for the glove makers to ramp up further to c. 95%, to meet the urgent shipment requests from China. We view that Top Glove is likely to be the largest beneficiary from this unexpected demand surge, as it has the strongest capacity growth (+16.8% YoY), while Hartalega and Kossan’s capacity will grow by 9% YoY and 10% YoY respectively in CY20. We are of view that the sudden spike in demand might drive glove ASP higher, hence resulting in slight margin expansion.
Possible further valuation expansion. Historically during other epidemic outbreaks, the glove counters have experienced valuation expansion, trading up to +2.0 SD of their respective 5-year historical mean due to market sentiment, coupled with an increase in gloves demand. The trend can be observed during the large outbreak of H1N1 (see Figure 4 & 5), from April 2009 to August 2010, where the valuations for both Top Glove and Kossan peaked at +2.0 SD during the tail end of the outbreak. However, the trend was less apparent during the SARS outbreak (see Figure 2 & 3), from November 2002 to August 2003, as the glove manufacturers had much lesser following back then. Not to mention that Kossan was also rather illiquid at that point in time, hence the valuation did not expand significantly, like during the H1N1 outbreak. With the recent coronavirus outbreak, we are of view that history might repeat itself and the glove players might trade up to its respective +2.0 SD like the prior H1N1 outbreak. While we note that a team of Hong Kong researchers have reportedly developed the vaccine to treat the coronavirus, it is also noteworthy that the pre-clinical and clinical studies are likely to take more than a year before it will be fit to use on humans. Therefore, we reckon it will not be so soon that the coronavirus outbreak can be conclusively addressed.
Upgrade to Overweight. We are upgrading our rating on the rubber gloves sector from Neutral to Overweight on a tactical basis, amid the outbreak of this deadly virus as we expect glove players’ valuations to expand as a result. We raise our PE valuation for Top Glove, Hartalega and Kossan to 43x, 48x and 29x (all valued at +2.0 SD of its respective historical 5-year mean, with the exception of Top Glove, at slightly below +2.0 SD as we ) respectively. We also raise our earnings forecast for glove makers under our coverage universe in FY20-FY21F by 3-5% to account for the possible extra orders from China that, in our view, will materialize. We also see slight margin expansion resulting from better bargaining power in the hands of the glove manufacturers.
Source: PublicInvest Research - 29 Jan 2020
https://klse.i3investor.com/blogs/PublicInvest/2020-01-29-story-h1482962148-Rubber_Gloves_Lifted_by_the_Epidemic_Outbreak.jsp
