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KUALA LUMPUR: Hong Leong Investment Bank (HLIB) Research is downgrading its forecasts on rubber glove makers as the sector is faced with an oversupply situation coupled with inflationary pressures.

According to the research house, there is a demand-supply imbalance caused by aggressive expansion during the pandemic, which is expected to continue in 2H22.

"In view of the intense competition, especially in the nitrile space, we also expect to see further margin contractions in 2H22 as we believe the glove makers are unable to fully pass on the hike in costs to buyers," it said.

The research house noted that some new entrants are looking to exit the industry given the challenging environment, but it would take the collective effort of industry players to curtail excess supply.

"From what we gather, most of the glove makers are keeping their expansion plans on hold for now," it said.

HLIB added that the high inflationary environment has impacted glove players in the form of cost pressures from higher raw materials, wages and natural gas costs.

It said raw material prices are not expected to ease in 2H22 as latex production climbs post-wintering season coupled with lower demand for nitrile butadiene rubber.

In addition, HLIB expects ringgit appreciation against the US dollar in 2H22, which would be detrimental to glove makers.

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"Owing to the soft demand and intense competition, glove makers now have lesser pricing power and have yet to return to the cost-plus basis model.

"Margin erosions are likely to continue in 2H22 in our view, as the cost hikes were unable to be fully passed on," it said.

HLIB, which has an "underweight" recommendation on the sector, slashed its FY23-24 earnings projections on Hartalega Holdings Bhd by 30% to reflect the anticipated margin erosion.

"Not to mention Hartalega also has the highest exposure to nitrile gloves (c.96% of FY22 sales volume are made up of nitrile gloves), a segment that is facing the fiercest competition at present.

"All in, we lower our TP for Hartalega to RM2.37 (from RM4.21) and our recommendation is also subsequently downgraded to 'sell'," it said.

The research house also cut its earnings estimates on Kossan Rubber Industries Bhd by 18-27% to factor in the expected margin squeeze, and lowered its target price to RM1.44.

However, it maintained "neutral" on the stock given its smaller annual output capacity is likely to fill up sooner with any possible increase in orders.

HLIB revised higher its earnings forecast for Top Glove Corp Bhd by less than 3% for FY22-24 on adjustment to its RM-US$ exchange rate assumption. It maintained "sell" on the stock with a slightly higher target price of 83 sen.

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