Gloves industry: Still attractive?

After Top Glove's expectedly good performance, I had wanted to update on position as to where some of these companies stand. As I have mentioned before, the gloves industry is one which we should look at if we are investing in Malaysian market, largely because we are doing so well in this area of business globally. Most of the companies are doing well, however as I have repeated before, the industry is definitely consolidating.

My rationale for its consolidation is due to as the industry matures, the number of players that are still around would definitely reduce. This is a typical consolidating, maturing profile of any industry be it in the B2C or B2B. Now, I have taken out 5 gloves companies from Bursa and did some comparisons. Companies that I have pulled out are the obvious - Top Glove, Hartalega, Supermax, Kossan and Latexx Partners.

Click on the picture to enlarge

I wanted to have a view on where these companies stand. 

These are the conclusions:

1. Among the 5, the one that definitely stand out is Hartalega - due mainly to its position in the nitrile gloves business which enjoy much higher margin. These margin is certainly reducing however due to more and more players starting to introduce and promote their lines of nitrile gloves.
2. The margin for the industry is thinning. Why is it so? - I feel that firstly between 2009 to 2010, the industry was enjoying a good run due to higher demand caused by some global epidemic as well as the growth in the healthcare demand due to awareness. As demand increases, the increase in supply will definitely follow later on. The current margin scenario of 10% - 12%, is probably a typical margin which we will see more over time.
3. Industry is still growing at 9% while the number of players are reducing - which is good for any of the larger players.



Chart on Net Margin of gloves companies

4. For the manufacturers, gloves is more or less a homogeneous product as long as the quality is up to mark. There is no 1 brand that is domineering the rest. Net margin is pretty much between 10% to 22%. This scenario will continue.
5. Top Glove continues to be the dominant player in terms of revenue. I have the tendency to think that part of Top Glove's strategy is to increase its market share in the industry and to do that, it has no qualms over reducing its margin to compete. It, in fact can and has the balance sheet strength to do that. Top Glove in fact is the prime mover into consolidating the industry. In "Three Kingdom's" term, Top Glove is the Cao Cao during the time when he was expanding his empire in Northern China. Look below, among the listed few, Top Glove's revenue is twice the size of the 2nd largest - Kossan.
6. As for Hartalega, it continues to build on its strength which is margin and nitrile gloves.

Revenue numbers in RM'000

With the above comparison, I still prefer the 2 companies i.e. Top Glove and Hartalega over the rest. The former due to its balance sheet strength and size while the latter is due to the higher profitability margin it is able to sustain compared to the rest. And of course, I still continue to like the industry due to the growth prospects and Malaysian companies dominance in the sector.

Net Profit chart (in RM'000)

Frankly, I would like to see EPF putting more money into this industry. Why is it not doing so?

Hartalega's 4th quarter 2012 results: Signs of things to come...

Hartalega registered a flat profit growth of RM64.5 million for the 4th quarter of FY2012 against RM66.3 million PAT in corresponding period. This is despite a 25% increase in its revenue.

Here are its comments:

The global demand for nitrile gloves continued to grow by 29% for the year 2011 due mainly to switching momentum from natural rubber gloves to nitrile gloves. This has spurred a significant increase in nitrile gloves production capacity by the industry which we are confident would be more than matched by resilient demand dynamics. Furthermore, we do not expect a price war from the second half of 2012, as claimed by certain quarters as global demand growth continues to outpace growth in industry capacity.
  
Comment: What they claimed of no price war (probably referring to claims from Supermax's CEO) is not quite true. If there is no price war, they could have passed the higher costs to its customers. Revenue registered increase of 25%, however profit remained flat. There may not be price war, but margin erosion is definitely faced by the industry.

On the contrary, we had to put some of our customers on allocation for their April 2012 purchase and beyond despite adding two new production lines in plant 5 to meet escalating demand. Based on our experiences, there are no expectations for a price war in the foreseeable future. Rather, the continued expansion in global demand for nitrile rubber gloves would be satisfied by industry capacity increase. This would only generate healthy competition among competitive rubber glove manufacturers.

Comment: Hartalega is leader in nitrile gloves, but as you can see most glove manufacturers are gearing up to produce more nitrile gloves from their new or existing plants. Capacity is definitely increasing, and it is difficult to estimate the increased capacity from the other players. As Hartalega is the largest and leader in nitrile gloves producing, customers shifting from them to other players will take time. I certainly expect the industry to consolidate after this with nitrile gloves making to be key focus to many of these players. Notice the comment from Hartalega is to alleviate shareholders fear of a price war.

We anticipate demand growth for nitrile gloves should be sustainable at 20% annually for the mid term. To meet the increasing export demands of nitrile gloves, our new plant, namely Plant 6, have begun construction in February 2012 with its first production line targeted to commence operations in August 2012. Plant 6 will commission 10 production lines in total and is expected to give at least a 30% boost to our production capacity which translates to a further 3.5 billion pieces per annum. The construction of the 10 production lines in Plant 6 is expected to be fully completed in June 2013.

Comment: If you read reports from the listed gloves manufacturer, all of them are talking of increasing capacities. This may definitely put pressure to price. While there may not be glut but all of the big players are definitely in the race towards larger capacity especially for nitrile gloves manufacturing. Over here, the one with healthiest balance sheet and strongest margin will prevail.

In view of current and anticipated bullish market conditions, we are making concerted efforts to put in place the foundation for long term sustainable growth. On this note, we have already strategized to beef up our human resource training facilities and manpower numbers. We view that the concerted long term planning and efforts should bear fruit due to productivity gains and benefits of economies of scale derived from building capacity and leveraging on in-house technological competence to countervail the potential margin compression arising from greater competition. Faced also with the systemic challenges of weak US Dollar and strong nitrile raw material pricing, we remained resilient and continued to grow our top line and bottom line.

Comment: Hartelega is definitely one of the bigger and better surviving player, but if you read their comment, I feel it is a little bit careless. It is common that in a competitive industry such as rubber gloves, players will move to areas that has large demand. With the demand for nitrile gloves expanding fast, it would be difficult to project the capacity expansion by all the players. These kind of competition is healthy and may allow another round of consolidation among the players. Small ones may not be able to survive or compete.

The Group has achieved the internal target growth for both sales revenue and net profit for the financial year ended 31 March 2012. The Board of Directors is optimistic that the Group will achieve continuous growth and securing better results for the next financial year.

Top Glove and Hartalega: Betting between latex vs nitrile gloves maker

As healthcare becomes more important and if you are an investor who is purely looking at the Malaysian market alone and not elsewhere, one industry which you will want to continue to monitor is the medical gloves industry. Why? Malaysia is the top producer of medical gloves globally and the quality of our gloves are competitive if not the best. Additionally, medical gloves is an industry which is growing much faster than the growth of any economies on average. As the industry matures, it is also much easier to identify the winners. The industry will consolidate and over time, there will definitely be lesser players as compared to during the growth stage.

For rubber gloves, one should concentrate on 2 companies - Top Glove and Hartalega. In fact, it used to be Top Glove only being the largest producer by quite a fair bit while the other players like Supermax, Kossan and Latexx Partners are smaller competitors. However, recently another player in fact became larger in the context of market capitalization and started to gain much followings - Hartalega.

Top Glove is the largest natural rubber gloves maker globally while Hartalega is the largest producer of nitrile gloves.

What are the major difference and significance between natural rubber gloves and nitrile gloves? (Obtained from wikipedia)

Medical gloves are disposable gloves used during medical examinations and procedures that help prevent contamination between caregivers and patients. Medical gloves are made of different polymers including latex, nitrile rubber, vinyl and neoprene; they come unpowdered, or powdered with cornstarch to lubricate the gloves, making them easier to put on the hands^. Cornstarch replaced tissue-irritating Lycopodium powder and talc, but since even cornstarch can impede healing if it gets into tissues (as during surgery), unpowdered gloves are being used more often during surgery and other sensitive procedures. Special manufacturing processes are used to compensate for the lack of powder.

Latex allergy
Due to the increasing rate of latex allergy among health professionals, and in the general population, gloves made of non-latex materials such as vinyl, nitrile rubber or neoprene have become widely used. Chemical processes may be employed to reduce the amount of antigenic protein in Hevea latex, resulting in alternative natural-rubber-based materials such Vytex Natural Rubber Latex. However, non-latex gloves have not yet replaced latex gloves in surgical procedures, as gloves made of alternative materials generally do not fully match the fine control or greater sensitivity to touch available with latex surgical gloves. (High-grade Isoprene gloves are the only exception to this rule, as they have the same chemical structure as natural latex rubber. However, fully artificial polyisoprene—rather than 'hypoallergenic' cleaned natural latex rubber  is also the most expensive natural latex substitute available. Other high-grade non-latex gloves, such as nitrile gloves, can cost over twice the price of their latex counterparts, a fact that has often prevented switching to these alternative materials in cost-sensitive environments, such as many hospitals.

Another thing is that due to the substantial rise of the natural latex prices, cost of producing nitrile gloves became lower than natural latex gloves - this significance happened since 2010. As a result of that, many players have started to partially switch from natural rubber to nitrile rubber - Top Glove included.

Will this switch cause Hartalega's margin to be affected? For sure but by how much, it is difficult to foresee. However, since Hartalega continues to lead in the R&D and also being the largest nitrile gloves maker, it is still continuing to enjoy the switch in demand to nitrile gloves from the medical fraternity. These however may not last long as the other players are surely chasing and allowing their production lines to be able to cater for nitrile gloves production especially the newer ones. How much will the effect is still unknown though. One thing for sure is that Hartalega is already in the lead while the other players (Top Glove inclusive) are doing the chasing.

One should look at the below comparison between Top Glove and Hartalega to understand the competitive side of the medical gloves business. As you can see, Top Glove's margin are much smaller despite its revenue being more than 2 times Hartalega. Balance Sheet - Both Top Glove and Hartalega are almost equally strong with minimal debt. Top Glove's capacity on the other hand is probably more than 2 times Hartalega.

Comparison between Top Glove and Hartalega

Over the period (of probably less than 20 years) where many of the gloves maker became very big and successful due to the increased global demand, we have witnessed Top Glove stands out to become the leader in terms of growth in production capacity, revenue and maybe even profit. Its balance sheet is also the healthiest. One should note that it is not as easy as we think to grow to a size as big as Top Glove (even for Hartalega and Supermax) as there must be ready market as well as operational ability to manage these expansion.

On the other hand, Hartalega due to its vision and focus in the nitrile gloves market has become the margin leader. They are enjoying the fruit of the better foresight now. Hence, who are we to bet on if we are asked to pick one only?

This is going to be a hard decision, as from the perspective of Top Glove, although they are moving into nitrile gloves producing, they are also definitely not letting go of latex gloves. Its move of buying land to produce rubber proves that. Hence, in this, we can see that Top Glove is betting that latex gloves will have its own consistent demand. They also feel that the price of rubber is overly speculated at this moment - hence over time, the price of producing latex gloves may still be cheaper than nitrile gloves. Note that Top Glove's rationale for moving upstream by owning its own rubber plantation is that it is the best long term hedge against fluctuations of the global raw latex price.

Hartalega, on the other hand is spending on efficiency and continuous R&D to produce better quality nitrile gloves.

We can know that most of the players do not know which of the type of gloves they will be concentrating on as Top Glove, Supermax, Kossan are now using production lines that are switchable. We configure that if they know, these players would not be relying on switchable lines.

Whatever the results, let's not take our eyes off the players and industry as its significance is going to be important, although I am a little bit bent towards Top Glove due to its capability to expand faster. I still think that due to the players inability to brand - size and efficiency matters more.

Serious Investing!