This episode of Samso Insights is about understanding the business of gloves and whether this is a long-term investment proposition.
The investment dilemma for VIP Gloves Limited (ASX: VIP)
Woken by the rude entry of the COVID-19 pandemic, investors are beginning to understand the dynamics of this simple business model where health and safety drive the market.
So let me explain what we understand about the business of gloves, as part of PPE that aims to protect all workers.
The use of gloves is centered to protect the workplace
When I first covered this sector almost six months ago with A COVID-Proof Stock that is not related to Gold: VIP Gloves Limited (ASX: VIP) the market has undergone a roller-coaster ride.
In the midst of COVID-19, there was a rush for gloves, masks and sanitisers. When the so-called, miracle cure of a "Vaccine" was touted as fast approaching, the bull run came to an abrupt halt.
The opportunity is that there is only one company on the Australian Stock Exchange (ASX: ASX) that manufactures Nitrile gloves. Ansell Limited (ASX: ANN) produces other products so I don't put them in the same category. The other reason is that ANN is not a smallcap company.
VIP has just begun its journey on the ASX and one would ask if this was the best year (Figure 1). It rose to prominence in July after the market woke up to its existence and that was followed by a fall in pricing due to market jitters about the arrival of the vaccine.
Figure 1: The share price chart for VIP Gloves Limited in 2020. (Source: Commsec)
As the world begins to appreciate the timing and the implications for upcoming vaccines, the main market of gloves, in Malaysia, is still turbulent. The main players like Top Glove Corporation Bhd - KLSE: TOPG (7113), Hartalega Holdings Bhd - KLSE: HARTA (5168), Supermax Corporation Bhd - KLSE: SUPERMX (7106) and Kossan Rubber Industries Bhd - KLSE: KOSSAN (7153) have all seen a significant rise of gigantic proportions over the last nine months (Figure 2 and Figure 3).
For those investors that participated in VIP during the last 9 months, all eyes and ears were onto these market participants in Malaysia. Their every move on the share price was going to dictate what VIP would do in Australia as investors look for indicators.
The is no prize for guessing that the sharp rise was due to COVID-19, not only for VIP but for the whole industry. The appreciation of the share price is mainly due to the rush and speculation of supply shortage and increasing demand.
What was interesting is that when the market started to speculate the impact of the coming vaccine, the market did not wait for an answer. Market participants starting to exit quickly and with great volumes.
Figure 2: The share price journey over the last twelve months of the top four glove manufacturers listed on the Kuala Lumpur Stock Exchange (KLSE).
(modified from Investing.com)
You can say that they have all retreated from their highs but I think this is more about profit-taking and the jitters of the market. This whole year is about the unknowns in the market. As most of the speculative money love the volatility, the smart money needs to see direction (perceived) before they leave their money on the table.
As you can see in Figure 3, the gains in these stocks are short of being astronomical, when you look at the history of the four market leaders. The sharp rise has made investors glee with envy about the profits they would have made if they were in the Bursa Malaysia (KLSE). Unfortunately, unless you are well versed with that market, you will find it hard to get access to any of these stocks.
Figure 3: The share price journey from 2012 to 2020 of the top four glove manufacturers listed on the Kuala Lumpur Stock Exchange (KLSE).
(modified from Investing.com)
What is the most interesting is prior to the rise due mainly to COVID-19, you can see that the business of gloves already experienced a generous premium (Figure 4). The charts below indicate that these glove companies were very busy paying dividends and creating capital appreciations.
If one was to look at the company reports during that time, you would see that they were making money and I would say plenty of it. You cannot become an international player in any sector without making lots of money along the way. The top four glove manufacturers on the KLSE have definitely experienced great income generation over time.
Figure 4: The share price journey from 2012 to June 2019 of the top four glove manufacturers listed on the Kuala Lumpur Stock Exchange (KLSE).
(modified from Investing.com)
The BIG Questions - Is this sector a long-term investment proposition?
This is the big question that has created much confusion in the market. I look at the glove sector as a Personal Protection Equipment (PPE) issue. As a geologist and thinking about the Health and Safety (H&S) aspect of our mining industry, the intense level of administration in this sector of the industry is what will drive the use of gloves.
Health and Safety driving the market
If you look at gloves as a means to keep workers safe, one would understand why the use of gloves will be sustained. In the mining industry where the health and safety of workers is the first point of discussion in any meeting, signs like Figure 5 are a common sight when you enter an Australian minisite or a plant.
Figure 5: The common signboard before entering any mine site or plant in Australia. (Source: www.hivismining.com.au)
If anyone understands the strict requirements, there is no way that gloves would not become a common use by workers. You can already see the common use of gloves by emergency workers. Population like you and I will not be the main users. In many aspects of the world industrial revolution, we, the general population do not see what is consumed by industry.
Figure 6: This is a common sight in Australian cities. Staff giving a strong vision of masks and gloves being used. (Source: Bing Photos)
For example, as Australians are fast approaching a "clean" nation in terms of community transmission of COVID-19, the rest of the world are experiencing record daily cases. Cities that were reporting relatively few cases are now reporting a lack of beds. This lack of hospital beds is not limited to the poorer nations, but the more so-called "richer" nations are also experiencing this issue.
As the world begins dealing with a new strain of the virus, I cannot see how demand for gloves will decline. Recently, there are reports that Top Glove and another Tier 1 manufacturer of gloves had to close supply chains as their staff was dealing with COVID-19 transmission within their factories.
Although this is being managed, this is a reminder that the demand for gloves is not going to slow anytime soon.
The future demand may not be "demand" driven, it could be driven by a decreasing supply issue. Any disruption to this supply chain will be catastrophic to the demand logistics.
Then there is the nationalistic movement where the "hoarding" of supply by nations or sectors will create further gaps. Some conspiratory comments were being published on the reasons why Top Glove was targeted by the US government for labour issues. Comments were circulated that the real reason was to get Top Glove to direct their supply towards the US as they were just experiencing an unprecedented rise in Covid-19 cases. True or untrue (Fake News), we the general population will never know.
It is now becoming common practice for the manufacturers to pass all raw material costs to the buyer already. This is a sign that manufacturers are confident that buyers' demand is strong enough to take this in the pricing, which indicates supplier strength in the market.
This is a market where the consumer has no choice but to accept the price. How is this not a great business to be in? I think economists call this an inelastic demand.
These are the reasons why I feel that the lack of supply will drive the sector more than increasing demand. I am not saying that there is no demand increase, I just feel that the supply side is not going to keep up. If the supply side is interrupted, the gap is going to grow rapidly.
There is a paper written by an individual posted on a blog site in Malaysia that has some good arguments that Supply will never exceed demand. I agree with his statement in general and if one is truthful with the state of the world, you would have to say that this virus is going to hang around a lot longer than we would like to believe.
What does this mean for VIP Gloves Limited (ASX: VIP)?
Let's look at the current AUD48.46M market capitalisation of the company. It was around the AUD20M mark in July and rose to over AUD100M before subduing to market forces to be swimming at this range for the last couple of months. As a shareholder, one would be excused for thinking that this is going to end where it started at the 3 cent mark.
The recent months of trading with an obvious seller in the market has troubled many shareholders. One look at a popular forum site will give plenty of colour to their thoughts. Many past and current shareholders are expressing their frustrations on the counter on a daily basis as the share price seemed to be defying negative gravity (Figure 1). How can a company with such promise be not going up?
However, when you look at the released accounts, one would be thinking that this has to be the cheapest stock on the market. Coupled with the comments that I have mentioned above, you would be accumulating this stock with earnest.
Evidence of Sales
The October quarterly report highlighted a sale receipt of AUD6.6M which was the first clue that the company is generating some decent cash flow. The company only started production sales this year and prior to March, they were selling ar ASP (Average Selling Price) that were much lower than the market leaders. So in the build-up, they would have been slower to take advantage of the rising market ASPs as they were still delivering gloves at the old price.
The next sales figures will be interesting as it should cement some resemblance of confirmation of status. Two sets of results that show strong sales growth will be well received by the market, one would think.
In November, the company announced that their order book was full till the end of 2021 and their ASP had increased by 50% in the October to December 2020 quarter. In addition, the expansion of additional lines was coming on stream in December 2020 and April 2021.
Figure 7: VIP has experienced a significant increase in its average selling prices (ASP) for its products over the September 2020 quarter by an average Quarter-on-Quarter (Q-o-Q) increase of 70%. (Source: VIP Limited)
To show more future potential, the company announced that they were looking to build new facilities on an adjacent block of land and are looking to increase its total capacity to 3.5 billion pieces when completed.
Too Much Cash
While shareholders are pondering what is happening to the share price, the company appears to be trying hard to appease all these concerns by announcing a dividend policy. A dividend policy means that they got too much cash or major shareholders are wanting some of that "too much cash".
There appears to be a lack of need to raise more money and that in most cases is a good sign. What it may mean is that the power players can only get in on the show from the market. Let's hope that is the case as it would be a good catalyst for the share price.
In addition to the cash flow from sales, they are about to receive a series of payments from the sale of the land. This will bring another AUD10.3 million into the bank account. They have received AUD3.13 million already and that was used to settle with the bank loan (VIP Gloves Limited Announcement - 31st August 2020).
VIP suffers from an identity crisis in the ASX and I think investors may also have anxiety due to the operations being in Malaysia. What the company need is to allow investors to understand the gloves sector. Investors need to see and appreciate that this has been a money-making business even before Covid-19 (Figure 4). What this "New Normal" has created is a new level of pricing and demand.
The recent announcements which relate to the expansion of more production lines and the recent sales figures should give potential investors some comfort on the viability of the business.
Following the sales and expansion news was the dividend policy. I believe that this will be the game-changer as this will cement confidence that the company is confident with its cashflow.
I would dare say that there are not too many companies on the ASX with a 50M market capitalisation that is distributing a dividend.
The next sales figure should help support the concept that VIP could be "printing money" at this stage.
Another compelling note is that the company is paying down its debts which is a clear message that they are looking to create a positive revenue position.
I am a firm believer that VIP is all about PPE. This business is all about keeping employees safe in the workplace (Figure 8).
The poor state of affairs around the world is not going to slow down the demand. In the coming time when the vaccines take effect, we are certain that preparations for FULL PPE to protect all workers are absolutely necessary.
Figure 9: Britain’s second-largest teaching union says it is locked in an argument with the government over whether personal protective equipment (PPE) should be provided in schools. (Source: www.tes.com)
There are now many questions being asked about the amount of protection that will be warranted for workers (Figure 9). What I can say is that, if the Health and Safety regulations in the mining industry is a measurement of progress, the steps for increasing Health and Safety in the other industries will get louder very fast.
There will be no insurance agency that will not force industries to have "COVID-19" PPE as a standard requirement for workers.
In closing, I believe that the premium in VIP is that it is in the ASX and they are the only way investors can expose themselves in the rubber glove market. For investors, the company is still trying to prove itself as valuable and credible.
To their credit, they have done all the right moves in showing growing sales, showing nett profits, paying off debts, declaring dividends and showing expansions.
As I have mentioned before, with a market capitalisation of less than AUD50M, there are not many, if any, peers that can list all those items.
What investors can blame the company is that there appears to be no Champion leading the company.
This may affect the way the company shares its messages to stakeholders but the business is so simple and profitable, one may be excused of not needing this Champion. However, I do feel this critique is valid and it will do well to have this fixed.
In my opinion, the way its share price has build a holding price at these levels for a decent period of time tells me that a base has been established and the next sustained growth may come in the next accounts that will be out in February or late January. I would suspect similar figures to come out as the last Appendix 4C in October, if not higher.
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