Sunday, 17 January 2021

THIS FISH IS UNDERCOOKED : JP MORGAN'S BEARISH REPORTS ON GLOVES


 

The 6 January 2021 report on gloves by JP Morgan caused a bit of a stir in the markets. Following up on an earlier December 2020 report, the assigned target prices were as follows : TOPGLOV at RM3.50 , HARTA at RM8.50 and KOSSAN at RM3.80.

These prices are of course at deep, deep discounts to not only their prevailing share prices, but also the assigned target prices set by Malaysian research houses. 


 

Without completely discounting the merits of JP Morgan’s argument at face value, we did some basic research to see if their claims actually hold up. 

To keep it simple, here are the main assertions made by JP Morgan: 

1) The amount of testing done for COVID is correlated with global gloves demand. The data shows testing has peaked in most countries, hence global gloves demand should fall.

2) Glovemakers should be priced at 18x earnings, as opposed to around 30x, which tends to be the ballpark figure for the ‘bulls’ (some of the local and international research houses). 

It’s really a view towards complete normalisation of gloves demand post-COVID, which is of course the consensus view. It's just the valuations that differed.

Our view is that JP Morgan’s analyst premised his entire argument on the supposed correlation between testing and gloves demand. 

This is where the thesis has flaws, because instead of proving such a correlation, the data was simply utilised to validate the rest of his presumptions. 

In other words, we (the reader) are gently asked to take JP Morgan's word that there is actually causation. Without proof or any attempt to demonstrate the validity of the assertion, aside from a neat-looking chart.

Another way to look at it is to look deeper into the data itself, and just add a bit of common sense. Comparing data sources would be a start.

This article highlighting the problem of testing data in the US is illuminating. Here’s an insightful excerpt:


Or we can also look at The Atlantic’s data tracking project, which shows that actual, reported daily testing is currently averaging 2 million per day across US states and territories. This figure (as of 15 January 2021) is at the upper end of the historical range.

So is this a peak or the start of another uphill climb? We don't know, and we don't have empirical data to suggest that things are getting better. It doesn't seem to be.

 

OK then, what would drive gloves demand other than testing? 

How about COVID related hospitalisations : more of it, and a higher frequency of it? That figure grew too, from 30,000 back in October to around 130,000 as of 15 January 2021.

We tried looking for a plateau, but our search was in vain.

You know  what else hasn’t plateaued aside from testing and hospitalisations? Confirmed daily cases. Deaths. And this is just for the US. 

Many developed nations are struggling to cope too. Germany, the UK, Sweden and South Korea are among countries that reported record high daily COVID deaths. Just last week.

If there is no empirical proof for this gem of a line below, the weight of their argument becomes just a little bit questionable. Perhaps the analyst fell in love too hard with the linkage.


It was quickly followed by this sentence which kind of invalidates their own thesis.


Besides India, Canada, Russia and the UK?

Last time we checked, more than two billion people live in these countries. A quarter of the world's population.

If they have not shown signs of decline in testing, why should the analyst cherry pick the ones that did and wonkishly link it to the ‘less testing, global demand will drop’ thesis? How ingenious!

Our view is that there was no ‘smoking gun’. This report was not meant to convince, except perhaps the analyst himself

We don’t know what kind of efforts JP Morgan’s star analysts undertook aside from diligent browsing of the Bloomberg terminal. Did they talk to any of the management? 

Did they talk to MARGMA to perhaps get a better understanding of the global gloves supply and demand? Weren't they the ones who said ‘there are no official data, it is thus difficult to track stock levels’ ?

Or were they content with analysing the outcome of TOPGLOV's directors reelection vote and provide this schoolboy interpretation here at the last sentence?

Hello, why else would there be dissenting votes? 

Maybe there's a correlation between global COVID testing data and Dato' Lim Han Boon's reelection chances as director. We leave it to JP Morgan's quants to figure this out.

NOT JUST UNDERCOOKED, NOW THE FISH STINKS A BIT...

In an 11 January note, JP Morgan provided an update less than a week after the 6 January report. It was more of the same, highlighting that gloves are ‘not needed’ while administering vaccinations. 

On the weight of this gospel, boom, there goes worldwide gloves demand… in JP Morgan's view of the world, it expects every single country, hospital, healthcare worker to ditch gloves overnight when it comes to vaccinations.

Naturally all this begs some very valid questions:

Who is this report really written for? Investors who seek a better understanding of Malaysia’s glovemakers? People who want to make informed investment decisions?

Or was it meant to serve JP Morgan’s clients who are keen to take the short bet? In case you didn’t notice, they issued two bearish reports during the first 11 days of 2021, just when (purely coincidental, we’re sure) regulated short selling activity was reinstated by Bursa Malaysia. Point number 4 below:


 

CGS-CIMB's fund flow report

And gosh, we wonder who facilitates a substantial proportion of these foreign fund flows.

 Standard disclosure in JP Morgan's research reports


THE PERIL OF TOP-DOWN ANALYSIS

The analyst who prepared the report was hired in August 2020. The historic gloves rally has lasted longer than he has at JP Morgan.

For an individual with substantial ASEAN research background, it would be tempting to simply look at Malaysia from a macro lens first and foremost. So the temptation would be to look at macro data to try and make sense of the industry dynamics.

Top-down analysis is to look at the big picture first. In can be the macro conditions, then narrowed down to the country, sector, and company. And yet these reports are seemingly skewed to macro only.

It would certainly be tempting to craft an all-encompassing thesis that conveniently overlooks the fundamentals merits of the individual companies.

This is not right because these companies are the biggest glovemakers in the world. A superficial look really doesn't tell much.

Imagine if someone lumps the FAANG stocks into one basket and presents a thesis that 'if everyone consumes the internet less next year, the FAANG stocks are all equally screwed'.

For an example of the kind of legwork JP Morgan presumably did not undertake, take this throwaway passage on TOPGLOV which has nothing to do with their main thesis, but all to do with arriving at the RM3.50 target price :


Google could have been their best friend. As we have mentioned before in detail, TOPGLOV does not need new capital to fund its capex. It has already done a Sukuk. The previous Singapore dual listing involved the issuance of zero new shares. Some simple searches would have unearthed all these.

There’s a caveat to the above. If TOPGLOV’s recent aggressive share buybacks becomes a constraint on their capex endeavours, then yes, they may need to issue new shares for the HK listing. But we have not heard anything of this sort yet, and we try not to make too many over-the-top assumptions unless new information crops up…

Also, assigning fair values for three companies at exactly the same P/E ratios (18x) is the height of laziness. 

There was no consideration for the companies’ earnings trends and/or trajectories, individual strengths (and weaknesses), and – just as important for us – the stocks’ respective historical trends. 

Forget about things like product mix, client mix, pricing strategy, business model,raw material costs, and who makes more nitrile gloves than latex or whatever else, because clearly these little things do not matter much for JP Morgan.

For example, in the pre-COVID years, HARTA almost always fetched the most premium valuation on a P/E basis because they were the highest-volume nitrile glove producer who enjoyed higher margins. 

People who have been in the market for a few years would also recall that TOPGLOV  actually struggled for a while (not just from capacity constraints, but also a suboptimal product mix) before building up capacity. It then overtook HARTA in terms of profitability and market capitalistion.

Analysts who haven't covered Malaysia for at least five years, or analysts who predominantly assumes the top-down view, may miss all the above. 

Aside from half-baked assumptions, and the danger of falling in love with your own half-baked assumptions, we have learned precisely nothing from these reports, which is the most frustrating thing.

We would have welcomed an even-headed, well-researched, credible report with thought provoking assumptions on the bearish side. We are not never-say-die glove bulls, and considering opposite viewpoints is the best way to learn and to be self aware.

Unfortunately that’s not the case here.