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Author: kltrader   |   Latest post: Fri, 5 Jun 2020, 10:20 AM

 

Top Glove - 2QFY20 All Primed to Meet Surge in Demand

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  • Top Glove's 2QFY20 earnings surprised consensus. Flattish volume growth was tempered by high latex cost.
  • Top Glove has ramped up production significantly to meet the surge in demand due to the COVID-19 outbreak. This is amid better ASPs and lower raw material cost as its supply chain remains intact.
  • We continue to like Top Glove but its valuations appear fair in the midst of an unprecedented selloff in the broader market.
  • Maintain HOLD. Target: RM6.05. Entry price: RM5.50.

Results

Within expectations but outlook has improved vastly.

  • Top Glove’s 2QFY20 core net profit of RM116m (+4.4% q-o-q, -9.1% y-o-y) met our and consensus expectations.
  • Earnings accounted for 44% and 48% of our and consensus full-year estimates respectively.
  • Despite meeting incremental demand tied to the COVID-19 pandemic, margins were weighed by a spike in latex cost. We expect volume and margins to significantly improve going forward.

Flattish revenue as latex and nitrile saw mixed fortunes.

  • Revenue growth was muted q-o-q, growing 1.7% to RM1,230m in 2QFY20. While volumes for nitrile grew 2% q-o-q, ASP (+1%) was offset by weaker USD forex (-1%). Nitrile growth was constricted post restocking activities in 1QFY20 as latex gloves grew 11% q-o-q due to market share accretion.

Margins would have improved further had it not been for latex.

  • While ASPs were raised by 1% q-o-q, EBITDA margin only improved by 40bp to 15.8% q-o-q (1QFY20: 15.4%, 2QFY19: 15.7%). Margins improved on the back of higher utilisation and lower nitrile (-5.3% q-o-q), but these were tempered by higher latex cost (+5.8% q-o-q).
  • Meanwhile, Aspion’s performance improved with sales growing by 29% q-o-q.

Stock Impact

Expansion plans intact.

  • Top Glove’s existing production capacity stands at 73.4b gloves/p.a.. Positively, its expansion plans are unhindered by Malaysia’s COVID-19 movement-control initiatives. Over the subsequent quarters, Top Glove expects to grow its capacity by 2.7%/4.6%/4.4% incrementally q-o-q between 2Q20 to 4Q20. This effectively translates to 12.3% y-o-y growth in capacity. The additional capacity would allow Top Glove to meet a surge in demand amid the COVID-19 outbreak.

Running at full steam.

  • Top Glove’s supply chain remains intact during the controlled movement period as well, with Top Glove currently operating > 90% utilisation rate.
  • Apart from the elevated utilisation rate from the usual mid-80s (2QFY20: ~86%), we gather industry fulfilment lead time for glove producers has risen to 4 months from the usual 1-2 months. This has translated to industry ASPs surging 3-5%. In addition, latex and nitrile prices are currently trending by -1% and -1.5% respectively lower relative to 2Q20’s averages.

A lesson from history suggests valuations could be supported by surge in earnings.

  • Firstly, sector profit margins improved to 14.5% from 10.5% in the four quarters after and before the H1N1 outbreak respectively. The improvement in profit margin could exceed our FY20 projections of 9.3% (FY19: 7.7%).
  • Secondly, sector earnings enjoyed three quarters of enhanced q-o-q growth (4.9% to 10.3%) even after vaccine discovery. H1N1 persisted for 16 months, from first suspected human infection to the World Health Organisation (WHO) declaring containment.
  • Thirdly, valuations tracked sector earnings, not vaccine discovery. In terms of valuations, it peaked to 17.8x one-year forward PE (or > +1 SD of 16.3x) in Jul 10. Peak valuations coincided with peak sector earnings in 2Q10. However, we note that valuations were sustained past the approval of the drug vaccine as there was a gestation period for containing the H1N1 outbreak.

Earnings Revision / Risk

  • We upgrade our earnings forecasts by 10%/8%/5% for FY20/21/22 to account for higher ASPs, volume and US dollar assumptions.
  • Key upside risks include:
    1. the US dollar appreciating markedly vs the ringgit, and
    2. more sizeable value-accretive M&As.
  • Downside risks include:
    1. swift containment of COVID-19 outbreak, and
    2. disruption to its production or supply chain caused by the COVID-19 outbreak.
  • That said, Top Glove’s production is spread across 40 sites. Every +1% deviation from our US$4.30/RM, translates to ~6% to our EPS.

Valuation / Recommendation

  • Maintain HOLD and target price of RM6.05. While the COVID-19 breakout has resulted in a surge in demand for medical grade gloves, there has been a spike in risk-off sentiment, suggesting a higher risk premium to valuations. As such, we lower our PE peg from 28.5x 2021F PE to 26x, largely in line with the sector PE mean.
  • While we continue to like the glove sector amid the COVID-19 outbreak, we believe Top Glove’s valuations have well priced in its near-term outlook amid an unprecedented sell-off in the broader market.
  • Entry price is RM5.50.

Source: UOB Kay Hian Research - 21 Mar 2020

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