Rubber Sector Rubber value chain: Position for consolidation - DBS

· Natural rubber (NR) asset prices are driven up the value chain on scarcity. Take positions in upstream and processors
· Motorisation, rising hygiene standards in emerging markets, mining, logistics, travel are driving demand
· But supply response is slow due to conversions to oil palm, long gestation period and erratic weather
· Top picks: KL Kepong, Goodpack and Hartalega. We also like JA Wattie and Sri Trang

Value chain to reverse up. Driven by decent margins, new
Chinese and Korean tyre brands have emerged over the last decade, causing fragmentation in global tyre makers. At the same time, high raw material prices allow only well-funded processors to survive. Hence, rising demand and continued consolidation in NR processing should improve margins of planters and processors.

Market is ignoring volume growth from consolidation.
NR prices have corrected from the high of US$5,745 – leading to a similar 6-12% drop in processor stocks prices. However, with sticky long term NR prices expected to stay above US$3,500, we believe the market is ignoring the potential volume growth from consolidation.

Mind the gap. We believe the huge gap between rubber (US$46b annual value) and palm oil (US$56b annual value) listed counters (i.e. c.US$16b vs c.US$96b capitalisation) reveals tendency for more M&A activities going forward.

Overlooked sector. We believe investors should position themselves in upstream planters and processors as scarce value of rubber assets are driven higher up the value chain.
We like KL Kepong for upstream exposure, Sri Trang as a leading processor, and Goodpack for its dominance in rubber logistics. GMG Global is initiated with a Hold rating, as we believe our favourable view is already priced-in. Further downstream, we like Hartalega for its ability to gain market share relative to its peers.