PP 7767/09/2010(025354)

13 August 2010

Malaysia Corporate Highlights

RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

Sector Upda te
13 August 2010
MARKET DATELINE

Rubber Glove Recom : Overweight

(Maintained)
Longer-Term Outlook Still Positive

Table 1: Rubber Glove Sector Valuations

EPS EPS growth P/NTA P/CF GDY
FYE Price FV (sen) (%) PER (x) (x) (x) (%) Rec
(RM/s) (RM/s) FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY10 FY10
Adventa^ Oct 2.80 4.16 27.4 37.8 24.4 38.1 10.2 7.4 2.0 7.1 4.3 OP
Kossan Dec 3.82 5.36 37.2 44.7 -0.8 20.3 10.3 8.5 2.6 8.3 1.4 OP
Top Glove Aug 6.16 6.90 40.9 46.0 +>100 12.4 15.1 13.4 3.8 12.1 3.7 MP
Hartalega^ Mar 7.75 9.29 71.5 83.6 21.0 16.9 10.8 9.3 3.8 10.0 3.1 OP
Sector Avg
^ FY10-11 valuations refer to those of FY11-FY12
♦ Recent events may dampen near-term sentiment for rubber glove
Chart 1: Relative
manufacturers. As highlighted earlier, we believe near-term sentiment Performance To FBM KLCI
for rubber glove manufacturers could be dampened by recent events such
Kossan
as: Adventa
o Orders slowing down. Seasonally, 2Q (Mar-Jun) tends to be a Top Glove

slower period in terms of orders. Coupled with latex prices hitting an

Hartalega
all-time high of RM7.78/kg in Apr ’10, orders slowed down even more
as customers became more conservative with respect to inventory FBM KLCI

levels during the quarter and in anticipation that latex prices would
eventually come down; and
o Time lag in passing on high latex cost and weakening US$.
Latex prices hit an all-time high in Apr ’10 of RM7.78/kg as a result of
a shortage in supply stemming from the El Nino effect. In addition, the
US$ has also weakened against the RM by 6.4% YTD. We believe the
Chart 2: Monthly Average
time lag in passing on the higher latex cost and weaker US$ could see Latex Price (Jul’09-Jul’10)
earnings for some of the glove manufacturers contract qoq.
♦ Latex price has since eased to around RM7.00/kg. Notwithstanding RM kg
8.00

the above, we believe the slowdown in customers’ orders for gloves is only
7.00

6.00

temporary. Given that latex prices have since eased to RM7.00/kg, 5.00

4.00

customers, we believe, are now more likely to stock-up and would increase 3.00

their stock holdings further when prices of gloves dip further.

2.00

1. 0 0

♦
-

Demand expected to stay strong. Longer term, we expect demand for

gloves to remain strong given that glove is the most basic and affordable
form of protection against viruses in the healthcare industry and coupled
with rising awareness in healthcare standards for the populated countries
(e.g. China and India), should help provide a boost to demand for medical
gloves.
♦ Risks. The risks include: 1) sharp surge in raw material (latex) and/or
energy (natural gas) prices, which may result in margin squeeze; 2) an
appreciating RM against the US$; and 3) execution risk from capacity
expansion.
♦ Forecasts. We are keeping our earnings forecasts for the glove
manufacturers unchanged.
♦ Investment case. We have retained our Overweight stance on the
sector as demand prospects for medical gloves remain favourable. We
maintain our Outperform call on Hartalega, Kossan and Adventa. We David Chong, CFA
(603) 9280 2179
reiterate our Market Perform call on Top Glove.
david.chong@rhb.com.my

Please read important disclosures at the end of this report.

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 13 August 2010

Sector Outlook

♦ Recent events may dampen near-term sentiment for rubber glove manufacturers. As highlighted
earlier, we believe near-term sentiment for rubber glove manufacturers could be dampened by recent events
such as:

o Orders slowing down. Seasonally, 2Q (Mar-Jun) tends to be a slower period in terms of orders. Coupled
with latex prices hitting an all-time high of RM7.78/kg in Apr ’10, orders slowed down even more as
customers became more conservative with respect to inventory levels during the quarter and in anticipation
that latex prices would eventually come down; and

o Time lag in passing on high latex cost and weakening US$. Latex prices hit an all-time high in Apr ’10
of RM7.78/kg as a result of a shortage in supply stemming from the El Nino effect. In addition, the US$ has
also weakened against the RM by 6.4% YTD. We believe the time lag in passing on the higher latex cost and
weaker US$ could see earnings for some of the glove manufacturers contract qoq.

♦ Latex price has since eased to around RM7.00/kg. Notwithstanding the above, we believe the slowdown in
customers’ orders for gloves is only temporary. Given that latex prices have since eased to RM7.00/kg,
customers, we believe, are now more likely to stock-up and would increase their stock holdings further when
prices of gloves dip further.

♦ Utilisation rates eased off as compared to last year but generally still high. Due to the surge in demand
during the H1N1 outbreak, most of the rubber glove manufacturers were running at full capacity last year.
However, utilisation rates currently have eased off slightly. This is largely due to the combination of additional
capacity that came in early this year and slower demand growth (e.g. Top Glove). However, manufacturers
such as Hartalega and Kossan continue to operate at high utilisation rates of between of 80-85% and 85-90%
respectively given that nitrile gloves make up a larger proportion of sales mix for both these companies (vs.
approximately 5-10% for Top Glove and Adventa). The respective management mentioned that demand for
nitrile gloves did not experience any slowdown given that the prices for nitrile gloves have remained steady and
in fact, there have been a switch in orders from latex gloves to nitrile gloves as latex gloves now are currently
priced higher than nitrile gloves. The same applies to Adventa (currently running at 85% utilisation rate), the
company also mentioned that its surgical gloves orders still remained strong with a current order backlog of
three months. As for Top Glove, the company is currently running at 75% utilisation rate. The company
believes that this is a comfortable level as it likes to keep some extra capacity to take advantage of any sudden
surge in demand moving forward.

♦ Demand expected to stay strong. Longer term, we expect demand for gloves to remain strong given that
glove is the most basic and affordable form of protection against viruses in the healthcare industry and coupled
with rising awareness in healthcare standards for the populated countries (e.g. China and India), should help
provide a boost to demand for medical gloves.

Risks

♦ Risks. The risks include: 1) sharp surge in raw material (latex) and/or energy (natural gas) prices, which may
result in margin squeeze; 2) an appreciating RM against the US$; and 3) execution risk from capacity
expansion.

Forecasts And Assumptions

♦ No change to our net profit forecasts. No change to our earnings forecasts for now.

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 13 August 2010

Valuations and Recommendation

♦ Top Glove – remains comfortable at 75% utilisation rate. Despite running at an average utilisation rate of
75%, management remains comfortable with its current utilisation rate and believes that the headwinds in the
glove industry right now are just short-term. It has been the company’s policy to operate at an utilisation rate of
75% in order to take advantage of any sudden surge in demand due to, for example, outbreaks in the future.
Capacity expansion plans are currently on track with the construction of F21 completed and expected to
commence commercial production this month (+1.5 bn pieces p.a.). Top Glove is also adding 16 new lines (+1.5
bn pieces p.a.) at its existing F7 factory in Thailand. All in, these will boost Top Glove’s annual production
capacity to 36.8bn by end-FY10, from 34.5 bn pieces currently. We maintain our fair value of RM6.90, which is
based on target PER of 15x (in line with our target market PER). We reiterate our Market Perform call on the
stock.

♦ Kossan – still an Outperform. Despite the slow down in orders for latex gloves, management believes that
demand for gloves would remain strong moving forward. Orders for nitrile gloves have been increasing, with the
product mix for nitrile gloves having increased to 40% (from 25% a year ago). The company mentioned that its
capacity expansion is still on track with the capacity expansion at its new factory in Jalan Meru ongoing. Upon
completion, this new factory will house a total of 32 double-former lines. This factory currently houses eight
double-former lines, which will start in Oct. Following that, another eight double-former lines will be installed
and will start commercial production by 4Q. The remaining 16 double-former lines will be broken down into two
phases, where the first phase will start commercial production by 2Q11 while the 2nd phase is expected to start
commercial production by 4Q11. All-in, Kossan’s annual production capacity would increase by 20.8% from 12
bn pieces currently to 14.5 bn pieces by end-2010 and further by 3.5% in 2011 to 15 bn pieces. Following the
cut to our target PER for Top Glove to 15x (from 17x) in our Healthcare Sector report (issued on 6 Aug), we are
lowering our target PER for Kossan to 12x from 13x previously. Our revised target PER for Kossan is at 20%
discount to our target PER for Top Glove, in-line with the historical discount that Kossan trades to Top Glove. As
such, our fair value has been lowered to RM5.36 (from RM5.81). Nevertheless, we continue to like Kossan for its
well-regarded management as well as for its prudent capacity expansion plans. We reiterate our Outperform
call on the stock.

♦ Hartalega – not affected by surged in latex prices. Hartalega is primarily focus on producing nitrile gloves
with 85% of its product mix predominantly in nitrile gloves. Hence, the group was not too affected by the surge
in latex prices. Nitrile price have been rather stable as compared to latex price recently and as a result, average
selling price of nitrile gloves have remained stable vs. the prices for latex gloves, which have risen over 10-15%
yoy. The company’s expansion plan for its fifth plant is well underway. By the end 2010, ten new high capacity
lines will be up and running. Following that, management intends to decommission ten of its old lines in Plant 1
(to be replaced with six high-capacity new lines). This would effectively raise Hartalega’s annual production
capacity further to 9.5bn pieces by end-FY12. Despite the cut in our target PER for Top Glove and Kossan, we
are maintaining our target PER for Hartalega at 13x. This is to reflect superior margins, e.g. EBIT margin of
approximately 31% in FY10 (vs. 15-18% for the other glove manufacturers i.e. Top Glove, Kossan, Supermax
and Latexx Partners), which allows Hartalega more leeway to absorb raw material price and forex fluctuations.
Our fair value of RM9.29 and Outperform call are maintained.

♦ Adventa – Outperform call is maintained. We like Adventa for its niche position as the largest surgical glove
producer in Malaysia. Its product mix for its gloves still remains 60%- surgical, 25%- dental and 15%
examination gloves. The management is looking to aggressively expand its surgical gloves production capacity
from 350m pairs currently to 450m pairs by end-2011. Management guided that the commercial production for
its new factory in Kluang, Johor started in June ’10, which would have contributed to Adventa’s 3Q10 earnings.
In-line with the cut in Top Glove’s target PER to 15x (from 17x), we have also lowered our target PER for
Adventa to 11x (from 13x). The cut in Adventa’s target market PER is also to reflect the lower market
capitalisation among the mid-tier glove manufacturers, i.e. Kossan (12x) and Hartalega (13x). Our fair value has
been lowered to RM4.16 (from RM4.92, which is based on target FY11 PER of 13x). Given the upside potential of
48.6% to our fair value, we maintain our Outperform call on the stock.

♦ Maintain Overweight on the sector. Except for Adventa, YTD, share prices of the glove manufacturers are
still up 12.5-57.1% compared to 8.1% for the FBM KLCI and 9.0% for the FBM 100. We continue to be positive
on the glove manufacturers as demand prospects for medical gloves remain favourable and hence, we maintain
our Overweight stance on the sector.

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 13 August 2010

Table 2. YTD performance for glove manufacturers agains FBM KLCI and FBM 100
FBM KLCI FBM 100 TOPG KRI HART ADV SUCB* LTX*
Returns (%) 8.1 9.0 25.4 42.4 26.3 (10.6) 57.1 12.5

Source: Bloomberg
*not rated

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The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or more
over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take on
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Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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