Rubber glove sector sees potential downside risk from China's environmental policy

KUALA LUMPUR: Share prices in the rubber gloves sector have corrected by 11.5% year to date despite being one of the best performing sectors in Malaysia for 2018. 

Affing Hwang Capital research maintained its overweight call on the sector although it noted potential downside risk depending on the outcome of China's environmental policy.

Its top picks are Kossan (buy, TP: RM5.15) and Supermax (buy, TP: RM2.30) as it believes their valuations will close in to that of Top Glove (hold, TP: RM6) and Hartagela (hold, TP: RM6.30).

In a research note, Affin Hwang said the vinyl glove shortage has eased as the Chinese government has set a longer grace period to convert their coal-based burners to more environmentally friendly gas-based burners.

"Nevertheless, as we still believe that the China government is still keen on improving the country’s air quality, the conversion will resume, in or view.

"We still expect prices for vinyl gloves to rise, expediting the switch from vinyl gloves to latex/nitrile gloves," it said.

The research house noted that if trade tensions escalate, resuting in a 25% tariff imposed on all items imported from China, Malaysian maufacturers could potentially benefit. 

"China’s medical glove export market share to US is around 30%, and 70% of those gloves are vinyl based. US is the world largest medical glove consumer, consuming 30-35% of global production," said Affin Hwang.

Manufacturers will be able to pass on rising production costs to customers within a reasonable period. 

Affin Hwang said it is not too concerned over the ringgit strengthening against the US dollar as it has assumed an exchange rate of RM3.9/USD by end 2019.

"However, the spike in volatility of the RM recently might put pressure on margins, as manufacturers might not able to revise their pricing significantly in over a short period of time. Nevertheless, we believe the problem is short-term in nature."

Malaysian manufacturers are expected to raise their capacity by 14-18% in 2019, which may outpace demand growth of 8-10%. 

Affin Hwang believes this will not create an overcapacity issue as older production lines will be phased out to cater for speciality gloves while manufacturers will have a new avenue for growth in the non-medical sector.