August 05, 2021

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Malaysia's Glove Sector & Medline Industries Inc. Blockbuster US$34 Billion Deal

Pic source - Bloomberg


The glove sector is a remarkable industry which have captured the imagination of many investors for the past 1.5 years. As we are now approaching the point of resolution of Covid-19, many of the glove stocks share price have retraced significantly from its peak in 2020. In fact, so much so that most glove stocks currently hover around 50-60% lower from its peak level. 


I have heard all kinds of doom and gloom statements on the glove sector for the past 10 months from its peak all the way down to where it is today. What I find most fascinating is the ever evolving valuation given by research houses throughout the past 1.5 years. As swiftly as the research houses hike the target price of glove stocks, the downgrade came just as quickly. Apart from that, the ever changing rationale used to justify their reports (whether you agree or not, doesn't matter in this context) is by far the most complete and holistic in comparison to any other sectors ever covered by the research houses. Usually, in reports by research houses, they cover some grounds here and there but largely there is a central theme behind it. For example : for semiconductor stocks, it is about the global chip shortage or 5G / AI adoption rate; for the steel sector, it is about the commodity super cycle, for the banking sector, it is usually about the interest rate or overall economic health. However, if we compile all the research houses report for the glove sector in the past 1.5 years, the sheer amount of volume would easily be double that of the next sector and the grounds for justifying an upgrade or a downgrade or revision of TP would be far ranging. Essentially, what it means is that the glove sector is the most widely and deeply scrutinized sector in the whole of Bursa. I believe no one can deny that. 

The biggest debate or challenge is always how do you value a company and specifically, a glove company? This is because of the extraordinary profits from the sector due to once in a century global pandemic that totally distorted the ordinary course of business. The point I am trying to focus on is no one actually knows how to value the glove sector objectively due to the lack of historical precedent in terms of proportion and impact. This is why from the research houses reports, you can see midway through their analysis they can change valuation method from PER based on historical standard deviation to Discounted Cashflow model. On top of that, the valuation multiple attached also changed especially when there is the rollover to reflect the next or following year. Interestingly, there are some research house using year 2024 to forecast the valuation of glove companies. In all my years investing in the stock market, I have not come across anyone who can accurately look beyond 2-3 years (considering the volatility, uncertainty in global business, political and social landscape today it is even harder).

So for investors in glove sector, what is the most important question to ask yourself at this juncture as you start to witness ASP decline reflected in Supermax and Top Glove's results?

I believe it is necessary for investors to grasp the concept of valuation and then look at glove companies from the angle of a valuation standpoint. This is where I have been coming from all this while. When I first decided to invest in glove stocks in 2020 amidst the confusion and frenzy, I was not looking at the short term sentiment but their earnings visibility and exponential cashflow growth. Overnight glove companies became a different animal after toiling for 20-30 years. In the span of 1.5 years, their earning potential exploded and they made more money than they ever did from the past 20-30 years.

They are no longer the same type of company as what they once were. Apart from unbelievable retained earnings which is what I mentioned in the earlier article, glove companies which are well managed have shown they are like a "cash printing machine" during times of pandemic or healthcare crisis. They actually showed the world how much money they can make. From the Covid-19 pandemic, glove companies are not the only beneficiaries. Tech companies for instance were big winners. If we were to compare, I believe tech stocks were even a larger beneficiary due to valuation expansion. However, if we look at actual earnings, none can come close to glove companies, not even tech stocks.

Hence, when I saw the Private Equity (PE) funds consortium [Blackstone, Carlyle Group, Hellman & Friedman, Government of Singapore Investment Corporation (GIC)] coming together to make an acquisition offer of Medline for close to USD $ 34 billion including debt, it validated what I have believed all this while which is the true intrinsic value of healthcare PPE players are worth a huge premium. Although glove is only one part of PPE and only a segment of Medline, the valuation itself shows how valuable the PE Funds value companies along the healthcare supply chain. It is very simple, the healthcare business especially one like Medline which is US largest privately owned medical supplier / distributor & manufacturer has strong cashflow generation ability, healthy balance sheet and cater to the essential need of mankind. It is not a business that will go out of fashion or face dwindling demands. If anything, the need will grow consistently over time with a growing population and increasing hygiene awareness. 

If the future of healthcare supply chain companies are bleak or there is an oversupply with falling ASP impacting the earnings (PPE, glove and others), why would these 4 large PE funds make a mega offer for Medline at this juncture and not wait for the earnings to plunge? Wouldn't they get a better offer later than now? The logic is very simple - These 4 PE funds witness the explosive earning potential of Medline, the importance of the business in this sector and promising future due to the increasing hygiene awareness globally following this global pandemic. They saw earnings visibility and sustainability in the years to come. This Medline M&A deal is the largest Leveraged Buyout (LBO) deal since 2008 financial crisis.

Coming back to Malaysia context, when PE funds want to buy over glove companies, do you think the owners will sell the company for the current lousy valuation that a foreign bank and some research houses is giving towards the glove companies today? Do you think Top Glove is worth RM 3.50, Hartalega RM 8, Kossan RM 3.80? It doesn't make sense right? We must understand, that these research houses and IB are short term in nature, they change their reports based on market sentiment or what funds are doing in a span of 12 months. However, when considering a company's valuation, it is imperative to take into account of their long term fair value. This is among the market inefficiencies that long term fundamentalist investor can take advantage of to build wealth over time. 

Hartalega is one of my favourite glove companies. With regards to Medline acquisition, an important point to note is that Medline is Hartalega's substantial shareholder apart from being their major client (also for other glove companies too). If Hartalega's substantial shareholder is being valued at a premium, what does that mean for Hartalega? Many have argued that glove companies are just commodity stocks which have their cycle or OEM manufacturer that faces large capex cost hence it is not worth much in terms of valuation. I would not want to waste time and effort dispelling such comments because these are inaccurate descriptions. I would want to just point out that Malaysian glove companies have build themselves up to become entrenched within the global healthcare supply chain which is not easily replaceable, not even by China manufacturers. Recent Intco Medical failure in book building and management disposal of shares as shared by Ben Tan have clearly shown that Maybank's earlier research on glove sector oversupply was flawed. Maybank gave too much credit to Chinese manufacturers and downplayed the abilities of local glove player which proved to be a simplistic view as it failed to consider exaggeration and promotion by Intco Medical.  

This is why I am especially confident in Hartalega or Riverstone to some extent Kossan and Comfort. Top Glove problem since last year has been because of CBP Ban. Factors beyond our control, like politics, policies etc are tough to assess. Actually what happened to Top Glove is essentially that. Top Glove is damaged by CBP policy (political or not, I do not want to comment). Otherwise, Top Glove would have performed more sustainably instead of erratically. I believe coming out of this experience with the CBP, Top Glove would become a better corporation in future and as long as they do not give up, eventually they will get their fair dues. 

As far as I know, the glove companies are severely undervalued and investors should take a leaf from the Medline acquisition to give them comfort that the glove stocks are valuable companies. It is not all doom and gloom. At most, patience is required that's all. The glove sector is an integral part of medical supply which will only be more crucial in future as the population grows whether as strategic PPE stockpile or essential medical equipment. I shall leave it to your discretion.

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For link to my new book - "Once Upon A Time In Bursa", please click HERE :


Strategy Note - The Week of Conference of Rulers (...
Top Glove (Q3 FY21) Results Update
 

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This  information should not and cannot be construed as or relied on and (for  all intents and purposes) does not constitute financial, investment or  any other form of advice. Any investment involves the taking of  substantial risks, including (but not limited to) complete loss of  capital. Every investor has different strategies, risk tolerances and  time frames. You are advised to perform your own independent checks,  research or study; and you should contact a licensed professional before  making any investment decisions.

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