UOBKH sees further downside risks to Malaysian glove sector, maintains 'underweight'

UOB Kay Hian (UOBKH) is maintaining its "underweight" recommendation on Malaysia's glove sector, as it believes average selling prices (ASPs) are normalising, and deferred capacity and sub-optimal utilisation rates to be further downsides.

This comes after the sector's Q3 earnings came in below expectations, with its topline contracting 36.9 per cent quarter on quarter and ASPs falling 21 per cent.

Among the stocks under its coverage, Top Glove and Supermax fell below the research house's expectations, owing to the curtailed volume output during Malaysia's national lockdown.

Top Glove posted a 52.9 per cent year-on-year decline in net profit to RM607.9 million (S$197.4 million) for its third quarter, while Supermax saw a 19.1 per cent year-on-year fall in net profit to RM638.5 million in Q3.

In a report on Thursday (Nov 25), analyst Philip Wong noted that while ASPs are higher relative to pre-pandemic conditions, profitability per glove is approaching normality.

In the near term, he expects the industry's ASPs to hover around existing levels due to higher energy cost in China and expectations that distributors would replenish depleted inventories after holding out on purchases over the past months while waiting for ASPs to drop.

Beyond that, Wong expects ASPs to return to the pre-pandemic cost-plus basis model, which translates to ASPs of US$29.10 per 1,000 pieces in 2022 from US$65.40 per 1,000 pieces in 2021.

While the Malaysian Rubber Glove Manufacturers Association projects global demand for rubber gloves to grow 16.7 per cent and 15-20 per cent for 2021 and 2022 respectively, Wong notes that capacity growth currently appears to outstrip demand.

Therefore, given that there could possibly be over-capacity in the interim, any capacity expansion targets for the second half of FY2022 could be deferred, he said.

Not only that, utilisation rates could possibly undershoot pre-Covid levels of 80-85 per cent as well, he added.

Wong expects sector net profit to contract 67 per cent and 20 per cent year on year in 2022 and 2023 respectively.

"Our earnings projections already suggest 32 per cent downside to consensus' 2023 expectations. Should these pressure points be realised, there could be further downside to both our and consensus' projections," he said.

And given the significant downside, sentiment may continue to deteriorate, he added.

Wong does not expect investor interest to be piqued until a bottom is found.

"Given the uncertainty and unfavourable reward-to-risk payoff, we suggest investors minimise their exposure to the sector," he said.