UOB Kay Hian is reiterating its “overweight” stance on the glove sector as the demand for the personal protective gear remains high.
“Industry outlook has improved further, with higher Average Selling Price (ASP) revisions and spot sales mix,” explains analyst Philip Wong in a July 27 note. Already, the Big 3, Malaysia-based Top Glove, Kossan and Hartalega have revised their ASP guidance upwards for the months of August and September.
Top Glove in particular, has raised its spot sales mix to 20-30%, from 10-15% previously. By contrast, the industry spot sales ASPs remain unchanged at 2-3x contract ASPs, observes Wong.
“With the higher revisions and spot sales mix, we expect 2020 industry blended ASP to increase by 69% year-on-year (vs 23% previously),” he adds.
“Order visibility as reflected by delivery lead time is further extended to 540 days (from 300 days in June). Contracted capacity for 2H21 is almost secured. This suggests new orders being placed may only be received in 2022”.
Collectively, the big 3 have surged to gain 510% year-to-date already, but Wong believes there is further upside to the counters. Factoring in the recent ASP guidance, higher spot sales mix and accelerated capacity addition, he expects peak earnings to grow by 850% compared to 2019.
At this level, Wong says earnings are 80% above consensus estimates, “leaving ample positive surprises for the few quarters ahead”. With the normalized valuations based on 2022 suggesting support to existing valuations, he believes the “reward-to-risk trade-off still appears attractive at this juncture”.
Looking forward, Wong observes glove demand to feel tremors from the development of a vaccine for Covid-19. Currently, four vaccines are in the third phase of development, with another 13 more in the pipeline.
Of these three vaccines have commenced phase 3 in May and July and are slated to reach a conclusion sometime in 4Q20 between October and December. Based on historical data, vaccine approvals for phase 3 candidates have had a 65.9% success rate.
As for the 17 candidates in phases 2 and 3 of development, Wong says they “are well poised to deliver a few alternative vaccines” given the high success rate of Phase III vaccines for infectious diseases.
He adds that the and U.S. Food and Drug Administration’s (FDA) requirement of only a minimum of 50% efficacy could further accelerate the candidates’ success.
The impact of this is “unlikely to dent immediate glove demand,” Wong points out.
This is as the scaling of global manufacturing capabilities of a vaccine to achieve herd immunity is achieved in approximately 12-18 months. Additionally, disrupted supply chains could see global distribution networks as a bottleneck.
Even so, Wong cautions that the vaccine discovery is “likely to spark profit taking”. “The sheer gains by the glove sector and retail exuberance are likely to spark profit taking or kneejerk selling on the glove sector. Upon such an occurrence, we ascribe investors to consider buying into weakness with our normalised target prices in mind,” he mulls.
Of the three counters, Top Glove is his top pick.
The counter came under the limelight earlier this month when its headquarters in Meru, Klang was raided by Malaysia’s Human Resources Ministry, following allegations of a breach in movement control order rules and housing of foreign staff in cramped quarters.
The authorities have since cleared the company of imposing forced labour.
See: Malaysian Human Resources Ministry clears Top Glove of forced labour allegations
That has no dampened Wong's liking for the counter. “We like it for its increasing allocation to spot sales mix coupled with above-industry expansion growth,” he elaborates.
He is maintaining his “buy” call on the counter at a revised target price of RM36.90 ($11.97, on Bursa). This is up RM15.00 from his previous RM21.90 call and is based on earnings adjustment of 16.0x 2021F PE.
“We believe valuations should be at a discount to its historical PE mean as: a) it is being pegged to windfall peak earnings, b) its upside to earnings are being increasingly factored in, and c) the risk-to-reward at this juncture is increasingly pronounced given the surge in its share price,” observes Wong.
As at 12.15pm, shares of Top Glove were down a cent or 0.116% to $8.64 on the Singapore Exchange.
