• Downgrade to SELL from Buy, new MYR0.86 TP from MYR2.05, 14% downside. While most of the negative news has been priced in, we believe the risks for Kossan Rubber remain tilted towards the downside, as the rubber glove industry is currently operating at sub-optimal levels. This also comes on top of a further round of share price corrections stemming from Top Glove’s (TOPG MK, SELL, TP: MYR0.49) potential exclusion from the KLCI followed by passive fund rebalancing post index re-constitution. This report marks the transfer of coverage on the stock to Oong Chun Sung.

• ASP back to pre-pandemic levels. As per our channel checks, local glovemakers should not engage in a price war with their China counterparts, even though the latter is selling gloves at c.USD19 per 1,000 pieces (local ASP: USD24 per 1,000 pieces as of August, marking a difference of 21%). Note that gloves from China are still subjected to a 7.5% import tariff from the US – but this is expected to expire in end-November. There could be a potential downside risk of ASP erosion, if the United States Trade Representative abolishes the tariff on Chinese glove imports.

• Demand unlikely to pick up yet. The inventory levels of some prominent glove distributors were still high as of June (higher than pre-pandemic levels by c.30-50%) despite seeing some signs of depletion recently. We think that the glove distributors’ inventory drawdown may take at least a year before easing to pre-pandemic levels – in view of the normalised demand and the lofty inventory levels of the glove distributors (inventory on hand could still last for another six months). As such, we expect global demand growth to remain sluggish, at 4% and 6% for 2023 and 2024.

• Supply. Industry supply remains elevated – at 429bn pieces by end-2022F, with the Malaysian top four producers accounting for 47% of global market share according to effective production capacity (or 201.7bn pieces). This also includes our assumption of a delay in capacity commissioning towards 2H23, given the current low industry utilisation rate of 50-60%. Encouragingly, the top four players’ inventories had depleted by 9% (on average) in the recent Jun/Aug 2022 quarter. However, the percentage of finished goods vs total inventories remains elevated, as per data from the companies’ annual reports.

• Earnings revision and valuation. We slash FY22-23F revenue by 29% and 24%, and corresponding net profit by 49% each year – after decreasing assumptions on the utilisation rate and capacity expansion, while lifting our raw material cost estimates. Our DCF-derived TP of MYR0.86 has also incorporated a 0% ESG premium/discount to our intrinsic value.

• Key upside risks are: An increase in glove ASPs, faster-than-expected capacity expansion, higher-than-expected utilisation rates, and cheaper- than-estimated raw material prices.

Source: RHB Research - 28 Sep 2022