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Rubber Value Chain: Time to buy downstream names (DBSV)
Time to buy downstream names
• 3Q11 data show slower EU/US consumption, but Chinese/Japanese NR demand pick up
• Expect margin pressure on downstream operators to ease from 1Q12 onwards
• Recent marketing trip reveals limited exposure to downstream names
• Top picks: JA Wattie and Hartalega; cautious on mid stream processors/logistics counters over next 12 months
Latest NR data in line. IRSG’s October bulletin revealed a recovery in Japanese consumption (+3% q-o-q following disruption in 2Q11 post-earthquake) and return of Chinese buyers (+26%), as rubber prices eased in 3Q11. However, US and EU consumption fell 16% and 13%, respectively, following strong 1H11 data. Rubber output in major producing countries saw a seasonal rebound (wintering ended in 2Q11 in Thailand), by 22%-96%. With demand and consumption numbers in line, we are retaining our forecasts for the rest of the year. We expect TSR20 prices to average US$4,675/MT in CY11, implying US$4,241 in 4Q11.
Hartalega and JA Wattie are top picks. We like the downstream segment and our top pick is Hartalega. It is both cost and capital efficient, with superior margins (28% vs 16% industry average) and ROE (36% vs 22% industry average). Its dominance in the nitrile market (c.25% share) and innovative R&D also give it strong pricing power. A weaker price outlook also does not deter our choice in JA Wattie - its strong volume growth (FY10-13F FFB and rubber CAGR of 46% and 11%, respectively) would still translate into 3-year earnings CAGR of 39%.
Downstream under-owned. Our recent marketing trip to Jakarta, HK, KL and Singapore revealed limited ownership in downstream rubber glove makers. We see this as an opportunity to increase exposure, as we expect recent margin pressure from high rubber prices to ease in 1Q12. We expect CY12F NR prices to drop 9% y-o-y as supply moves from 172k MT deficit to 183k MT surplus with rising supply from trees planted during 2005-07.
Still cautious of mid stream processors/logistics counters. Despite its strong business model and balance sheet, we are cautious of GMG in anticipation of 17.1% y-oy decline in 2012 core profit (due to lower rubber prices). For Goodpack, we see slower rubber trade flows from decelerating GDP growth and higher leasing costs crimping profit growth over the next 12 months.
Takeaways from marketing trip
We recently went on a marketing trip to Hong Kong, Jakarta, KL and Singapore. The following are key takeaways and feedback.
Moving to supply surplus next year
Investors we met were generally positive on rubber demand from emerging markets, but were surprised by our view that the natural rubber (NR) market would shift from deficit of 172k MT in 2011 to 183k MT surplus in 2012. The incremental rubber supply would come from 788k ha of rubber trees that were planted during 2005-07, which should start maturing from 2012 onwards (rubber trees take 6-7 trees to mature and produce latex). Our surplus expectation resulted in our below consensus NR (TSR20) price of US$4,675/MT.
Tightness in Synthetic Rubber
Our audience was generally unaware of the current tight synthetic rubber (SR) market, which is due to reduced supply of butadiene, the key material used in the production of synthetic rubber. A major development in the industry is the discovery of shale gas in the US, which had depressed natural gas prices there. This caused petrochemicals crackers to switch feedstock to ethane (natural gas derivative) from naphtha (crude oil derivative). As the butadiene yield from ethane is 4 times less than that derived from naphtha, butadiene supply shrank. The resultant tightness in the SR market provides support to NR prices, and hence, we do not expect NR prices to collapse despite our expected surplus in NR next year.
Top picks – JA Wattie and Hartalega
Given our expectations of lower NR prices over the next 12 months (CY12 TSR20 price of US$4,251/MT from US$4,675 for CY11), we prefer downstream glove makers in the rubber value chain. We should see the full impact of lower NR prices starting from 1Q12 – that would reverse some of the margin pressure from high rubber prices this year.
We like the downstream segment of the value chain, and our top pick is Hartalega (the world’s largest nitrile glove producer). Our choice is supported by the following:
1. Hartalega is a cost efficient producer, as demonstrated by its superior operating margins (28% versus 16% industry average). The competitive advantage stems from its ability to develop in-house equipment which enables the group to produce up to 30-35k gloves per hour versus peers’ 15- 18k gloves per hour.
2. The group has strong pricing power due to its lead in the nitrile glove market (c.25% share).
Despite expectations of softer rubber prices, we also like JA Wattie an Indonesian upstream planter due its strong production profile (3 year FFB CAGR of 46%, and rubber 11%). The strong volume growth expectations will support 3-year earnings CAGR of 39%.
NR demand and supply outlook
Recovering Chinese and Japanese consumption
Preliminary 3Q11 data from IRSG (International Rubber Study Group) reveals a recovery in Japanese consumption post Mar11 earthquake (+3.2% q-o-q, +0.3% y-o-y). Demand also recovered in China following a drop in NR prices and rebuilding of inventories in the quarter (+25.9% q-o-q, +3.5% y-o-y). This contrasts a slowdown in the US and EU following very strong consumption in 1H11.
Seasonal production boost with end to wintering period
Rubber production increased q-o-q in 3Q11 by 22%-96% in most of the rubber producing countries due to end of wintering period in 2Q11. However Indonesia’s production fell 9% as planted areas south of the equator entered the wintering period.
DBS Vickers 4Q11F outlook
With overall 9M11 global consumption and production close to our projections for CY11, we are maintaining our current supply/demand forecasts.
We expect production to increase q-o-q in 4Q11 as most rubber producing countries approach peak production season. On the demand side, we see 3Q11 trends continuing into 4Q11, recovery in China and Japan offset by slower growth in the US and EU.
In terms of prices, we expect 4Q11 TSR20 price to average US$4,241/MT to meet our CY11 average of US$4,675.
Source/转贴/Extract/Excerpts: DBS Vickers Research