Can the only party in town sustain its run?

PETALINGJAYA: There is only one party on Bursa Malaysia.

It revolves around glove manufacturers that have been having a good run with prices doubling or tripling over a short period of time.

Some research houses called for an upgrade of the sector yesterday on the grounds of an upsurge in earnings. They have turned more bullish on the sector, as the average selling prices (ASPS) have exceeded their expectations and believing that it can be sustained for another year or more.

One research house even stated that profit-taking may be premature, as glove usage would likely remain widespread until a vaccine is found and production achieves global manufacturing scale.

Strong earnings growth, coupled with the fact that most other sectors with safe-haven earnings growth face a multitude of headwinds, leaves the glove sector as the only “party in town”.

Whilst research firms may be right in their analysis after having met the management of companies, there is another view that perhaps it is time to take some money off the table from the glove sector.

Firstly, even if the earnings of glove companies double this year, the forward valuations are still high.

Top Glove Corp Bhd and Hartalega Holdings Bhd are trading at price earnings (PE) valuations of 84 times and 72 times their historic earnings while Kossan Rubber Industries Bhd and Supermax Corp Bhd are at above 40 times PE.

At current prices, the forward valuations of Top Glove and Hartalega are estimated at 47 and 38 times their 2021 earnings. The valuations for Supermax and

Kossan are estimated at 36 and 25 times respectively while Comfort Gloves Bhd is at about 50 times its 2021 earnings.

Would the glove companies be able to double their earnings next year as well?

Secondly, only high growth stocks with consistent and strong earnings growth warrant high valuations. The features of these high growth companies are that they operate in an environment where barriers to entry are high and their demand for their products are consistently growing.

Glove companies do not have barriers to entry such as the likes of Facebook, telecommunication companies and banks. And there are questions on the sustainability of demand when a vaccine is found for Covid-19.

Analysts contend that it was not possible for new players to come into the sector quickly as it would take time for manufacturing plants to be built and machines commissioned to produce gloves of high quality. Also ASPS, are super high now due to demand surge.

However, as what has happened many times previously, when margins are good, others jump into the bandwagon quickly. Even if the entry of new companies is slow, previous experiences suggest that the high ASPS are not sustainable.

Consumers would always start sourcing for new avenues and look at alternatives.

Thirdly, the glove companies are trading at historically high price to book valuations.

Hartalega is at a price to book valuation of 14 times while Top Glove is at 12 times. Supermax and Kossan are at seven times while Comfort is just below six times its price to book value.

The book value of the glove companies largely comprise its assets. The value reflects plant, machinery, assembly lines, land and other assets that make up the production.

While the strong earning is a measure of how well the assets are utilised to churn high profits, the soaring share price also reflects the growing divergence between the market price and break-up value of the company.

At such high valuations, shouldn’t the major shareholders take some money off the table as they would be able to invest in new plants at a far more less expensive prices?

Fourthly, the increasing demand for glove is “event driven”, It is due to Covid-19 pandemic. The vigorous search for a vaccine suggest that a remedy would most probably be found and it could be a “non- event”.

Never before have governments and the private sector worked together to find a vaccine. Never before have we seen advanced economies from the US to the UK and China fight to earn the accolade as the first to find a vaccine for Covid-19.

There are fears that there would be constraints in manufacturing. Such fears are unfounded really. In countries such as India and China, production can be ramped up easily as long as there are no patent issues.

Finally, investors would have seen many such run ups in share prices before. And always, when the dust settles, those who never took some money off the table would be left holding the over-valued stocks.

In the 1990s, timber stocks were the craze due to demand from Japan.

Most would remember Aokam Perdana Bhd that was a penny stock which rose to more than RM31.50. It was a “must-have” stock in the portfolio of fund managers. But the demand did not sustain and timber stocks have yet to recover until now.

Gloves will always be in demand. But the quantity and prices may not sustain. The party has started but guests who leave last will have to clean up the mess.