Industrial Products: Supermax Corporation Bhd

Introduction
It is principally involved in the manufacturing and marketing of latex gloves. The group was founded by Thai Kim Sim (still present as Executive Chairman) together with his spouse. It has 8 factories manufacturing various types of latex gloves, primarily natural rubber and nitrile gloves.

The total production capacity of the group is approximately 17.6 billion pieces of gloves per year, capturing 12% of the world's demand for latex examination gloves. It is also the second largest rubber glove manufacturer in Malaysia after Top Glove Corporation Bhd which produces around 33 billion pieces of gloves per year with a 23% global market share.

Not forgetting the competitors, Top Glove (33bil pcs), Kossan (14bil pcs), Hartalega (7.6bil pcs) and Latexx (5.5bil pcs). These top 5 alone accounts for 78% of total rubber glove exports in Malaysia for 2010. Will be looking at their financial ratios comparatively in later sections.

Fundamental 

1. Does the company have an identifiable durable competitive advantage?

Economies of scale is already a big advantage for being second largest manufacturer and differing itself from Top Glove's more focused mass production of powder free gloves while Supermax's has 35% of its sales in nitrile gloves - the highest in the industry and exports it to the biggest demand - the United States. 

2. Do you understand how the product/service works?

Predominantly used in health care which is resilient. Other purposes will include food and services industry for hygienic reasons.

3. What is the chance that it will become obsolete (KO) in the next 20 years?

Not a chance. There is no substantial substitute material for rubber in the world yet. 

4. Does the company allocate capital exclusively in the realm of its expertise?

The most significant project under its belt is the new Glove City Project in Bukit Kapar, Klang - new factories starting in 2011 with plans to progressively transfer all its rubber glove production to this area for enhanced operating efficiency. The long term project is slated to be completed in 10 years' time to double existing total capacity to 30bil pieces of gloves p.a.  That is a 7% growth in terms of volume per year.

5. What is the company's financial history and status?

2003 saw the outbreak of SARS and spurred worldwide demand for examination gloves which boosted sales. Ever since it has been falling to its bottom during the subprime crisis in 2009. For 2010 and towards 2011-2012, I am forecasting a sensible 7% to 10% growth in demand volume thanks to emerging markets as this new decade we will see 1 billion people enter the middle class who can afford better healthcare.

Pre-tax profit margin has held its ground at 12%-13% for 5-year and 10-year average. Revenue growth rate has slowed down from 33.47% 10-year avg to 28.52% 5-year avg due to 2009 crisis. Meanwhile we see ROE going up from 17.74% 10-year avg to 20.34% 5-year avg. As a sanity check, they look healthy enough for me.

Below is the 5-year average for the company. Sector is more broadly categorised like Industrial Products while industry is much more specific; for SUPERMX is it Rubber Products. 

• Net Profit Margin: 10.63% vs 10.23% (Industry), 3.72% (Sector)
• Pre-Tax Profit Margin: 12.15% vs 15.38% (Industry), 8.49% (Sector)
• ROE: 19.17% vs 13.71% (Industry), 14.58% (Sector)
• Revenue Growth Rate: 29.64% vs 7.30%, 13.11% (compounded annual growth rate)

ROCE is another view point of the returns to shareholder equity without accounting debt being used as leverage. SUPERMX has been leveraging debt for many years but they do keep it at a reasonable level of not going over DE ratio 1. So far their leveraging has done its job of keeping the company profitable.

Nice growth in EPS which is exponential. On the other hand, its DPS lags a lot as SUPERMX does not have any dividend policy and they have only been dishing out a 15%-17% dividend payout ratio. For current financial year that would roughly be a 3% yield. 

6. Is the company conservatively financed?

Yes, with RM118mil in cash and bank balances in 2009, it gives the company sufficient funds to deal with rising commodity prices like latex and for inventory & receivables. Unlike TOPGLOV they do not have that nice balance sheet with a DE ratio of 0.5 or a capital structure of 30% debt and 70% equity though over the last 3 years they have parred it down from a high of nearly ratio 1. That's half! and they did it during the subprime crisis, not a lot of companies have the will do so especially during bad times. 

7. Is the company actively buying back its shares?

Yes in 2008 they bought back nearly 2mil shares for RM1 million. SUPERMX also granted 1/3 bonus in 2003, 1/4 bonus in 2006 and a 1 to 2 share split in 2007. Most recent a 1/4 bonus in 2010.

8. Is the company free to raise prices with inflation?

Yes and most glove makers have started raising prices but they are able to pass on only a part of increased costs due to normalization of demand. This explains why their margins are falling and is expected to be in the 11% to 13% range as 65% (used to be 55% - latex prices have surged) of the cost of producing gloves come from rubber prices. Furthermore we have the weakening of the dollar which is still expected to further decline in the long run.

9. Are large capital expenditures required to update plant and equipment?

Not really, the only project SUPERMX is undertaking right now will cost RM400 million in Bukit Kapar, Klang a.k.a Glove City over a 10 year period. At the back of an expected revenue of RM1 billion (a first time for the company) for 2010 and decent profit margin, good cash flow & working towards operational efficiency, I see no issues here.

Discounted Cash Flow Analysis

This is tough as revenue growth for such industry varies in a big range. I either take the average revenue growth rate or second guess the rate for year 2011-2013.

Revenue Growth Rate: 25% (historical) or 15% (second guess)

Operating Costs: 88%

Corporate Tax: 25%

Capital Expenditures: RM45 million +2.5%/year

Depreciation: RM30 million +2.5%/year

Working Capital Cost: 0% (receivables turnover of 2.14 months - fast enough to cover)

Discounted Rate: 12%, 11% & 10%

Supermax Corporation has a fair value of anything between RM4.89(12%), RM5.58(11%), RM6.42(10%). The current trading price of RM3.98 is cheap based on my valuation. The share price has recently took some beating due to being overbought and went far ahead of their 2010 earnings. Supermax also announced a drop in Q3 pre-tax profit from weakening US dollars and higher latex prices. It is a correction taking place.

Competitors & Risks

Hartalega differentiates itself from the others by its focus on nitrile gloves 70% in its production while the other 30% for latex gloves. Nitrile gloves command better margin and this is why it has the highest among all at 21.10%. But 75% of its revenue comes from the US where Microflex Corp and Medline Industries alone 50% is derived. This exposes Harta to a major risk in the even of a loss of a major customer. Too scary for me.

TopGlov commands the highest ROE and ROI as it is debt free while Adventa is on the other end. Supermax's appalling ROI is due to its failure in turning around APLI's losses and decided to make a full impairment for its investment and stop its production since Dec 2008. The company has ended this episode and looking forward on its factory expansion plans.

As high-end or premium gloves commands better margin, most manufacturers have been shifting production line to accommodate nitrile gloves. Supermax is charging ahead to have 35% of its line in nitrile & 15% surgical gloves by 2012. Kossan will focus on nitrile and surgical gloves as well. TopGlove will continue to play the volume game as it focuses on producing latex gloves which is roughly 76% of their line, 10% vinyl gloves, 7% nitrile and 5% surgical only. TopGlov is rumoured to be eyeing a takeover of Latexx Partners Bhd. The biggest risk in TopGlov is oversupply which will hit it the hardest since it has the biggest capacity of all the players.

The fact remains clear, the demand is in nitrile gloves. The biggest reason why many and most medical personel uses nitrile is because many people are allergic to latex. Nitrile gloves are also more resistant to puncture making it more suitable for other professions too like food and services. Although nitrile are less comfortable than latex gloves, new production techniques have improved this aspect e.g. Kossan's new gen nitrile gloves. I do not believe there is a lot of difference between what each company is offering, they only defer in their network, production strategy & competitive pricing as you can see the demand is there on all companies, inventories are coming in and out and receivables are still at their historical levels.

It is in my opinion that the risk of oversupply should not be focused, a bigger and more concerning risk is from higher latex prices. Higher commodity price will eat into net margins and together with the weakening of the US dollar (trade currency) it could have an eroding combo effect. I see both to come into fruition 2011 therefore bigger players like TopGlov and Supermax will have better protection due to better economies of scale (Supermax is better as they have more production towards nitrile-synthetic rubber). Niche players who focuses on premium or niche market could also have some protection like Harta and Adventa. 

Conclusion

Malaysia is the world leader in rubber gloves, with a market share of 60%. There were too many players in the 1980s and 1990s and what is left of the them is what I call the big six. The environment still remains competitive as firms in Australia and Indonesia have begun to look into the manufacturing of rubber gloves as well.

The demand for rubber gloves is expected to grow around 7% to 10% per annum backed by better health awareness and standards and the good new is that the demand is relatively recession-proof (2009 crisis as exception as it as the biggest dip since the great depression) because it is predominantly used in the healthcare sector.

Is SUPERMX a good deal right now? The shares have fallen more than 30% since July and heading for a double bottom soon. There is one thing that makes SUPERMX a unique target. They are finalising an American depositary receipt (ADR) programme under which it will list 50 mil shares as over-the-counter (OTC) securities in the US meaning it will be under the visibility of US and international investors without dealing with currency conversions or other cross border transaction costs. Supermax has received approval on 21 Dec 2010. Other companies with ADR programmes are KLK, TopGlove, Sime Darby, Genting and Maybank.

Due to many macrofactors that could impact glove makers' revenue, a trading buy for such a counter like SUPERMX should suffice. Having said so, any investor has to be careful when to enter and when to exit. Investing in rubber glove makers is not for the fainthearted. I have made my fortunes in TopGlov before, could I do it again for Supermax this time? Only time will tell. This time I believe Supermax has more upside unless TopGlov changes its strategy to go more into nitrile. It is risky though, further compounded by the fact I have to time it nicely for the correction taking place now. At least the price has fallen to a more appropriate level.