Rubber prices climbed to a record high on last week, putting more pressure on the margins of rubber glove manufacturers, which are already grappling with oversupply and normalising demand issues.
May 2011 delivery contract for the commodity traded on the Tokyo Commodity Exchange rose to RM15.48 per kg on last week. Tyre-grade SMR 20 rubber traded in Malaysia rose to RM14.81 per kg while the price of latex increased to RM9.79 per kg.
The year 2010 will be etched in rubber glove manufacturers’ corporate annals as a period of turbulence as they contended against macro headwinds which threatened the sector’s earnings and growth prospects. A weaker US dollar and costlier natural rubber, normalising demand for gloves after the end of the H1N1 influenza outbreak and overcapacity are some key issues the glove players are grappling with.
The general view is that these threats will translate into thinner profit margins for the glove producers. Normalising demand and excess production capacity suggest players will find it more difficult to pass down higher costs to buyers.
Will 2011 be any easier for local players? Unlikely, analysts and glove manufacturers said as the industry continues to grapple with the headwinds. The glove producers’ quarterly numbers have reflected the tougher operating environment.
Top Glove Corp Bhd, the world’s largest glove manufacturer, recently reported a 45% fall in net profit to RM36.1 million for the three months ended Nov 30, 2010, the first quarter of its 2011 fiscal year. The company noted that average latex prices rose by 57% from RM4.58 per kg in 1QFY10 to RM7.20 per kg in 1QFY11, while the US dollar weakened against the ringgit by 9.3% from RM3.43 in 1QFY10 to RM3.11 in 1QFY11.
Rubber prices are hitting record highs due to a scarcity of supply caused by the wintering season for rubber trees, as well as speculative buying and robust demand from automakers catering for the Chinese market. The spotlight inevitably falls more on the natural rubber or latex glove segment as rising natural rubber prices translate into higher priced gloves.
As such, it is anticipated that buyers would continue to switch to nitrile or synthetic rubber gloves, whose primary raw material is derived from crude oil.
MIDF Amanah Investment Bank Bhd analyst Belford Chang said higher latex prices and a weaker US dollar had eroded glove producers’ margins. Estimates by MIDF indicate that average earnings before interest and taxes (Ebit) margins in the sector could have peaked between the fourth quarter of 2009 and the first quarter of 2010.
“Cost-side factors primarily affect the sector’s earnings, rather than sales. In 2011, I believe the supply surplus will be more severe,” Chang wrote in an email reply.
Glove demand-supply dynamics, according to the analyst, could dictate profit margins even if latex prices retreated and the US dollar strengthened. This is because a higher supply environment means glove producers have less bargaining power to pass on higher raw material costs to buyers.
Chang also foresees that the cost per unit of output would increase due to lower capacity utilisation, taking into account the manufacturers’ larger production base. Malaysia accounts for around 60% of the world’s rubber glove market, making the country the biggest global producer.
Listed glove manufacturers in the country include Top Glove Corp Bhd, Supermax Corp Bhd, Kossan Rubber Industries Bhd, Hartalega Holdings Bhd, Latexx Partners Bhd and Adventa Bhd. Local players have aggressively expanded their global market share in the export-oriented sector where demand has traditionally proven to be firm despite a weaker economic landscape.
The resilience of the glove industry is due to the crucial fact that the product is deemed a basic necessity in the healthcare sector. The spread of several disease outbreaks in recent years, such as the H1N1 influenza, had also boosted demand for gloves.
According to industry players, global glove demand growth could touch 10% annually in the coming years, taking into account rising demand from major economies such as the US and China, apart from South American countries.
Another analyst, meanwhile, foresees nitrile glove manufacturers’ earnings improving in the current landscape of high natural rubber prices, as the pricing of all glove products should increase. But there could be more price competition in the nitrile glove segment as producers switch to synthetic rubber products to meet higher demand in the segment, the analyst said.
“We still prefer nitrile glove producers to latex glove manufacturers,” said the analyst who sees good prospects in Hartalega, Kossan, and Latexx Partners for their nitrile exposure.
Tan Sri Lim Wee-Chai, chairman of Top Glove told The Edge Financial Daily that 2011 could be “more challenging” for the industry compared to the previous year. Lim also foresees mergers and acquisitions as smaller players exit the tougher operating landscape. This, in turn, offers opportunities for larger players with financial muscle to acquire rivals.
“We expect the beginning of next year to be tough for the rubber glove industry but the situation (is expected) to improve gradually towards the end of the year,” said Lim, whose company has an annual capacity of 34 billion pieces of gloves.
Adventa managing director Low Chin Guan said that the changing industry environment had prompted the company to adapt to broader market price expectations, and rapidly-evolving medical technology.
The near future, according to Lim, could see a higher natural rubber prices, and change in hospital procurement requirements. “To adapt to the fast changing dynamics, the company has adapted similar modes of transactions to match,” said Lim, whose Kelantan-based company is a niche player in the surgical glove segment with a customer base in 120 countries.
Glove players raising prices
Malaysian Rubber Glove Manufacturers’ Association (Margma) president KM Lee had said in October 2010 that manufacturers may raise prices by about 10% to mitigate the effects of costlier raw materials, and a weakening US dollar.
About 80% of the increase, Lee said, could be absorbed by buyers while the remaining 20% would be mitigated via manufacturers’ cost efficiency initiatives. Latex makes up some 60% of glove producers’ manufacturing cost.
Worth noting is the fact that natural rubber demand is outstripping supply, helped by growing consumption of the commodity for tyre production in China and India’s fast growing automotive industries.
The pace of natural rubber production is also unlikely to keep pace with demand in anticipation of heavy rains in the major producing countries. Output is also being stifled by plantation owners’ reluctance to replace older trees with younger ones to capitalise on higher prices, hence, causing a fall in production yield.
The Association of Natural Rubber Producing Countries said production in Thailand, the world’s biggest rubber planter, may decline by 28% year-on-year in the final quarter of 2010 as the La Nina weather pattern causes unusually heavy rain in the southern provinces, which account for about 80% of Thailand’s rubber output.
Meanwhile, the ringgit has strengthened 8% year-to-date to 3.1365 versus the US dollar as at Dec 21. As about 90% of glove sales are transacted in the greenback, the strengthening ringgit means local players’ US dollar-denominated revenue will be less when converted back into the local currency.
Synthetic rubber’s supply and demand dynamics will also be closely watched. According to the Singapore-based International Rubber Study Group, the supply of synthetic rubber may be stifled in anticipation that oil companies may reduce the output of crude oil by-product butadiene, a major input for the production of synthetic rubber.
Valuation matters
In a note to clients, CIMB Investment Bank Bhd said the Malaysian glove manufacturing sector’s forward price-to-earnings multiple of less than 10 times is deemed undemanding. This is in anticipation of the industry’s earnings growth, and ability to pass on higher raw material costs to buyers.
According to CIMB, the sector’s earnings growth is well supported by long term structural trends like the modernisation of China and India’s healthcare sectors and a higher level of hygiene awareness in emerging nations.
Factors which could prompt a re-rating of the glove sector, according to the research house, include disease outbreaks which will spur demand for gloves, and a decline in natural rubber prices. JF Apex Securities analyst Ng Keat Yung said the glove players’ financial performance would hinge on their respective product mix and cost structures.
Although Top Glove’s latest numbers came in below analysts’ estimates, Ng said the results were not necessarily an indication of how other players would fare in the current environment.
“Glove players will have less bargaining power (to dictate prices) as there was no shortage of supply” said Ng, who has an underweight recommendation on Top Glove, and neutral calls for the other stocks in the sector.
MIDF’s Chang, who has a neutral call on the sector, has trading buy recommendations for Kossan and Hartalega. The research firm has a neutral recommendation for Top Glove.
Going forward, dynamics in the rubber glove sector will be closely watched given the challenging operating landscape. It will be interesting to see how the players execute their revenue growth and cost-management strategies as they contend with the external headwinds.
Also, a tougher operating environment will be a litmus test that separates resilient players from the less-competitive ones.
The subject of industry consolidation is also hard to ignore. With the current low cost of funds, larger companies may be encouraged to borrow and acquire their weaker rivals. In the process, they can improve efficiency through economies of scale and obtain better pricing power by reducing competition.
The key question now is, who are the potential takeover targets, and how will the landscape look a year from now?
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