Challenging the Gloves valuation - Top Glove as example

This article is going to be hugely unpopular. But let me put it, I am a supporter of Malaysian gloves business, you can do a search on my write-ups. The recent events on increasing valuation for gloves not just by retail investors but analysts' recommendations really surprised me. Let me take the largest of the gloves maker - Top Glove which is the largest maker by far. I have no doubt that the demand-supply had gone out of whack. However, how is it that the valuation can be this high.

Two analysts put it at around RM20, another put it at RM23. Today, Top Glove's price is around RM15.60. That translates to RM52.6 billion, RM60.5 billion and RM41 billion valuation respectively. Numbers are just numbers. I am taking those numbers and try to present where it is based on that valuation and what are the risks by picking those prices, especially at RM23 and RM20.

Below are the most aggressive numbers based on a RM23 valuation. The analyst presented the numbers for the subsequent 3 years between 2020 to 2023 and went silent on numbers further down the road. It is obvious the next 2 years will be period where numbers are going to be very high - I do not dispute. I am thinking even at 2022/23 (PAT RM836.6 million), if the profits is going to double the numbers for the normal period of 2019/20 - that is a stretch.

However, let us just say I am going to be hugely bullish i.e. after the period 2022/23, it will still grow at 10% per year for the next 6 years. Based on the above situation, I have put up 3 situations i.e. at what average PE would the company be given their price of RM23, RM20 and RM15.60. The average PEs for 10 years would be very high indeed - 64x (at RM23), 55.5x (RM20) and 43.3x (RM15.60)

To go for a more humble situation, I would not challenge the numbers for the next 3 years but let us put the 2023/24 PAT at a more realistic number. Post 2023, the PAT will drop by 20% - even then its number would be 84% higher from its normal year i.e. 2019/20. Subsequently, the profit numbers would grow 5%. That translates to 80.51x PE for price of RM23, 70x PE (RM20) and even a very high 54.61x PE for its current price of RM15.60.

Even, at a price of RM10 (which is not something we can expect given it is now RM15.60, the average PE would have been 35x, given the scenario above. See below's table. That is still high.

Now, let's look at the economics of rubber gloves.

Remember, rubber gloves while at today's situation it is difficult to create enough supply to meet demand, however are we saying that the demand-supply will still be abnormal after COVID-19. In fact, with the creation of extra capacity at large quantities, it is possible that there could be oversupply situation by then i.e. 3 years after this pandemic started in Jan 20.

Rubber gloves business is not a monopolistic business, although there are situations where certain companies such as Top Glove, Kossan and Hartalega are the larger of the manufacturers. Are we saying that with COVID-19 assuming to be still around after this 2 years, there will not be ramp up of supplies by these guys who would act as check and balance of each other in terms of competition? What about the other players?

How long does it take to create new factories and new lines? More than a year?

I cannot see the economics of it as this business is not in a situation where barriers of entry is very high. No player has huge advantage over the other except for some extra efficiencies and economies of scale. Given the huge margins today, many new companies will not even bother with scale. There could even be new entrants - have any of the analysts thought of this given it is so lucrative?

There are just too much unknowns and many of these are not put into considerations. For many businesses, by putting a overly high price, they run into risks of being shun when situation becomes normal. Typically for this business, it is about long term relationships. I understand that some of them had created a new idea by putting a percentage of their supplies on the spot market (meaning let it be done through bids). However, business like this is not done in such manner. It is not our typical commodities.

Top Glove: Where it did not tell the truth...

Top Glove is a company which has done very well over the last decade or more. It has done well for itself, shareholders and the management. The CEO has done well too hence it has grown into the largest rubber glove company in the world. There are not much it needs to prove but to be more honest and be transparent for its shareholders.

I wrote an article last year. Actually the gist of that article was on Top Glove.

The most part of it reads as below:
It is easy to think that all companies that sells overseas (exports) their goods or services will do well in 2016. Nobody if I were to ask 12 months ago would think that our Ringgit would have dropped to 4.30 against USD. Nobody would expect the unusual exposure of the supposedly wrongdoings of our government would happen in 2015 - true or not many still think that it is true.

Same things may happen again for 2016 - I don't know. If one is to look at now, companies that mainly depend on local input cost and sells overseas would be an easy pick. They are of course all the companies such as the rubber gloves - Top Glove, Hartalega, Supermax, Kossan - or companies like Wellcall, Chin Well or the furniture companies like Latitude, Homeritz - or those in the electronics exports - Inari, Vitrox or even the new kid on the block, Aemulus etc.

Would they continue to perform. All these companies have already done well and their shares have reflected that - some have increased many folds. Of course, the companies claimed that they are better in costs control, manage the companies better (Hey, nobody would say that they are not good) but in actual fact it is the Ringgit vs Dollar - STUPID! It is the low oil price and price collapse in almost all other commodities - copper, gold, palm oil, iron ore, cotton. That's the story of 2015.

Now, if oil can drop to USD36 from USD100 a year ago, can it go back to USD60 in a year? What if Ringgit improves to 3.70 or 3.80 - let's not be too optimistic that it would go back to the level we see 18 months ago i.e. 3.3. What would happen to all those super performing companies in 2015? Would they look like an Average Joe again? Let's not forget their extra margins for 2015 was the currencies. Nothing else!

Hence a company that usually makes profits of RM100 million back in 2013, 2014 - for 2015 alone they could make RM300 - RM400 million. An example, an exporter that typically makes 10% net margin, just because Ringgit dropped 30% in one financial year suddenly stands to make that extra 30% margin without being extra smart. Hence, if the revenue is RM1 billion and typically the company would make RM100 million profit, they stand the chance to make RM400 million just for 2015 (see the change). There's no strategy involved. That's luck and they were at the right place at the right time. (Nothing wrong with that, but we think that they suddenly will continue to make the same)

But all of a sudden we think these companies are superstars. They are not. They are good but not extraordinary. One if looked further will know that the owners are not stupid and they have been selling. They know that this unusual situation does not come all the time and will not last. But we are that stupid to chase for them to sell.

Why did I highlighted that. Well, as below is the press release after Top Glove achieved its best ever quarter in 1Q2016 (ending October 2015) i.e. last year.

If you read the last sentence, "While we have benefited from the USD, our performance is not reliant on tailwinds, the effects of which are only temporal," Tan Sri... clarified.

What has it achieved in the same comparative quarter for this year? As below for same quarter in comparison, its Net Profit dropped from RM129 million to RM73.6 million. So what happened to the statement "not reliant on tailwinds."

I am not here to attack but when a company wants to provide "releases", guidance, projections etc. they have to be HONEST. Again, Top Glove has done well enough to not having the need to do this. You know, in some markets, the management can be sued by shareholders.

This is its share price after the record profit quarter last year.

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?

Rubber gloves companies buying land: Just when you thought Top Glove is wrong

Some people were questioning the rationale for a rubber gloves company such as Top Glove into moving upstream - i.e. buying land for cultivation of rubber trees for the gloves. Kossan is now doing the same - and getting some flaks from CIMB.

I would presume because of the volatility of commodity prices, it is very difficult to predict what can happen in the future. What CIMB Research is saying is that these rubber gloves companies can hedge their future positions. Perhaps, we can learn from Airasia few years ago when they hedged their positions in fuel futures and the company had to write off hundreds of millions in derivatives losses. In hedging, it can go either way, as we do not know where prices of commodities are heading.

I am just wondering, wouldn't buying land and cultivating rubber trees itself is a form of hedging? - for the very long term in fact. (Perhaps, better than paying banks for hedging fees) I am suspecting that the reason why these companies are into cultivating their own rubber trees could be due to supplies as well besides the high volatility in prices. We sitting here sometimes may not know the difficulties or challenges companies get in terms of supplies. Remember, gloves is not the largest consumer of rubber. Perhaps tire is. Hence, these guys can't act like Nestle or Starbucks in capitalizing on their scale into cornering coffee supplies.

Let me give another example. When the Kuok group was owning a large chunk of sugar refinery and distribution in Malaysia, they had no problem getting supplies at fair price as they have large trading desks for supplies of these raw material for sugar. Now Felda is the largest supplier of processed sugar in Malaysia after buying these stakes from the Kuok's family - see what happened to prices of sugar over last few years.

Going back to rubber - The biggest question for these companies which are buying land is what can they do better with the cash reserves that they have. Branding, distribution, expansion OR buying land for cultivation? I guess the biggest question now is whether for gloves is there such importance in the need to have very strong brands in rubber gloves. Condoms - we have seen it in Durex! In gloves, probably Kimberly Clark is one of the strongest.

There may be in gloves as branding may bring confidence in the buyer's perspective of quality. When there is a strong brand, the pressure to pricing may be reduced. However, one thing I know is that condoms it is a B2C consumer business where branding is very very important - see Apple, Coke, Toyota, even Kimberly Clark's Kleenex or Kotex. B2B business such as rubber gloves where they are selling to healthcare companies, the need for branding is not that prevalent - important still but not that much.

Additionally, sitting here I am also wondering - if these companies start to create their very own strong brands, what happens to being OEM as that's what they do best now? Buyers may opt for other suppliers as they have started to compete directly against the likes of Kimberly-Clark, Ansell and several other brands. These are players who have very strong network at the healthcare space. Will this be a strategy where the companies are shooting themselves on their foot?

I guess there are many questions which we do not have the answers in terms of strategy where these rubber gloves players are going on their own to create the raw material supplies themselves. It may not be the wrong move judging from some of the examples in other industries that we have seen before.

Do you think now is the right time to buy Top Glove?

It is no surprise that Top Glove has high ambitions as it has been proven in their past records. It is mentioned in the article by EdgeDaily that this largest glove manufacturer is planning to triple its production capacities over the next 15 years while planning to increase its global market share to 50%. Doable? A bit overoptimistic I would think but it is not an impossible task.

I have mentioned in the past that if we want to buy glove manufacturers, one may not need to look beyond Top Glove and Hartalega. My reasoning is simple. In a mature industry which has decent growth, look for company that has size, strong balance sheet, reach and ability to scale. Both Top Glove and Hartalega have that. I am not discounting other players like Supermax, Kossan, Latexx Partners etc. but chances are that the dominance would probably be by the 2 companies. Only thing is that we do not know latex gloves or nitrile gloves would be the preference. The way I look at it industry players themselves do not know as they are preparing production lines that are switchable.

Anyway, over the last 6 months, prices of latex has tapered down as it was over speculated few years ago. At one point of time the price was so high that costs of production for latex gloves was higher than nitrile gloves, an unprecedented event. We will not know the future of these raw material however, but I believe these players would be more ready in future in the event any of the raw material shot up in price again.

With the recent price of raw latex reducing to below RM7 per kg, I am just wondering whether it is time to buy Top Glove again. Prices of these raw material however should not be a consideration for any long term investors. The main concern is the strategy.

Over time, it may not be the prices of latex or petroleum that is to cause concerns to these players but what I am more concern of is whether there can be a glut in terms of supplies as well as the increasing labor costs. Hence, these players will have to convert their plant to embrace automation much more than before as Malaysia and Thailand are introducing minimum wages almost at the same time.

On the concern for glut in supplies of rubber gloves, I am just worried as every time I read about the industry news, these players are preparing themselves for massive expansion. Can the demand be taking so much?

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!

Sold TopGlove

Got chicken out. Sold Top Glove. Made some 4+%. Wonder why their pricing is not as elastic as I thought they would be.



Its revenue dropped 5%, year on year from RM509.9 million to RM491.5 million. This is a surprise to me as it shows that their unit sales dropped substantially (although this stats is not provided) - my reasoning is that since price of rubber increased more than 40% over the last 1 year, they should be able to increase the pricing of latex gloves by at least 20% to 25% since raw material consists of 60% of costs.

Management of Top Glove in their press release mentioned that they have been impacted greatly by the depreciation of USD and increase in raw latex.

Would make a come back once the position is more assured. I still believe this is a good stock. Should have looked at longer term but I believe in the short run it will have some price pressure due to the weak result for 2Q11. Hence became greedy and took profit.

Meanwhile, I become interested in AEON as it dropped a bit - don't know why, it has no relation to the tsunami in Japan as this stock is only its Malaysian operations.

Serious Investing!

Why do I buy Top Glove?

When I decided to make a purchase on Top Glove at RM4.98, several reasons as below caused those decisions to be made:

Macro level

1. Malaysia is a top rubber gloves producing country with our own technology as well as raw materials supply. Although there are inherent competition from Thailand and Indonesia, we are still a leading country due to mainly the quality of our product. Name me any industries that we are good at except for probably another commodity industry i.e. Palm Oil!;
2. As far as I know there is no substitute for latex gloves and nitrile gloves i.e. syntetic rubber gloves;
3. Demand for gloves will naturally be on the uptrend due to demand for better health facilities from emerging countries. Currently, the top gloves importing countries are US and EU. Supermax will show you that percentage of export contribution to other emerging countries are on the up. Ultimately, this is a no brainer thing unless science has found an alternative product;
4. Besides prices of latex and raw material for nitrile gloves, all the players are on a level playing field except for quality, economies of scale, size etc. Now we head towards micro level, why Top Glove?

Micro

1. It is the largest player by quite a far margin in terms of both revenue and profit;
2. It has the healthiest balance sheet (net cash of >RM340 million) as compared to its other listed competitors Supermax, Hartalega, Kossan and Latexx Partners which has larger debt;
3. If you read Top Glove's report, they have this tendency to having eagerness to eliminate competition. Example recently when the latex gloves industry was hit by high latex prices, in their report "Nevertheless, this adverse situation will possibly lead to further consolidation among the industry players and Top Glove is in a good position to further enlarge its business when the opportunities arise." I believe as any industry matures, the competition will substantially reduce. Top Glove is on the right track by virtue of its size, balance sheet and ability to absorb any negative impact on its business. At the end of the day, the glove industry will have fewer players with a handful of them with larger market share collectively;
4. Top Glove has proven to be the most successful in growing big in terms of capacity, revenue and profit. Why do I need to choose another alternative competitor if it has already proven to us that it is the most successful;

Where are the dangers?

1. If I am buying short term, volatility will affect the performances of these glove makers especially those large latex gloves producers. I believe Hartalega is the least affected due to their large proportion of produce are nitrile gloves;
2. Report from Supermax says that nitrile gloves are in fact cheaper than latex gloves at this moment due to the high price of rubber. (Now this is news to me. Will the industry change to nitrile gloves?) While it may opt for a higher percentage of nitrile gloves, I believe there will not be total change. Currently, I believe the high price of rubber is due to speculation largely as in other commodities. The world now has a huge craze over commodity speculation largely due to people like Jim Rogers whom I believe hyped up commodities too much. This is bad for ordinary people like you and me. Well this is another day's story;
3. While Top Glove is the largest player, it is not the most efficient in terms of profit margin.

I believe on both sides i.e. macro and micro, Top Glove over time will be the winner.

Serious Investing!

TopGlove - drop to a level I think we can pick up now

A friend called few days ago and asked about Top Glove - it has now dropped to RM5.20. Wow, did not know that. C'mon Top Glove is a fantastic stock. It has good management. They know how to build a winning company. It has dropped because of price of rubber has increased to an all time high.
TopGlove is a rubber glove company which has 30% of the glove market share. You should look at their performance over the last 10 years. Better than any of their competitors - Kossan, Supermax, Hartalega.
The price is now interesting. I am excited.