Highlights

Top Glove - Thinking for Tomorrow

Date: 02/08/2018

Source  :  UOBKayHian
Stock  :  TOPGLOV       Price Target  :  7.80      |      Price Call  :  SELL
        Last Price  :  4.83      |      Upside/Downside  :  +2.97 (61.49%)
 


Like many other manufacturers, Top Glove is embracing Industry 4.0 applications. With rising cost pressures, these initiatives will be rewarding over the long haul. Separately, the dispute with Adventa Capital has escalated, but if given a choice, management prefers an amicable solution. Nevertheless, Top Glove remains as the second priciest proxy to the sector. Also, the stock is trading at +2SD to its five-year forward PE. Maintain SELL and target price of RM7.80.

WHAT’S NEW

  • Management update. We met up with management recently and this note highlights the key takeaways, which also touched on some of Top Glove’s Industry 4.0 initiatives.

STOCK IMPACT

  • With consistent cost pressures from various areas, Top Glove has been mitigating the impact through: a) product mix improvement (higher proportion of surgical gloves), b) innovation (further reduction of glove weight), and c) productivity gains from automation of manufacturing lines via Industry 4.0 applications. New technologies being adopted include: a) vision camera system (to replace workforce involved in glove quality inspection), b) SCADA system (automate production line control), c) immersion burners (a more efficient heating system), d) mold holders with lower heat absorption to reduce energy loss, and e) auto insertion of gloves into boxes.
  • Growing tension with Adventa Capital. While the legal dispute with Adventa Capital is still on-going (note the Mareva injunction in Malaysia was unsuccessful, but is now under appeal), Top Glove has opted to lodge a police report on them last week, claiming criminal breach of trust. Although the situation has somewhat escalated, management is still hoping for an amicable solution outside of court or any third-party interference. Top Glove maintained they have strong evidence against the vendors of Aspion. Management shared that M&A activities moving forward will be done with more care and stringent scrutiny, despite profit guarantees and warranties being part of any deals.
  • Impairment amount still undeterminable. We believe a potential one-off impairment charge on Aspion is in the cards. That said, there is still no clarity on this matter. We understand the segregation of goodwill and intangibles exercise is on-going, therefore the financial impact cannot be reliably determined at this juncture. Assuming the impairment charge is RM640m (overvaluation figure), we estimate Top Glove's book value per share of RM1.77 as at 3QFY18 may decline by 28%.
  • Expansion plans intact. With Aspion on board, Top Glove is now capable of producing up to 57.5b gloves p.a.. The expansion timeline for Factory 32 (early-19) is unchanged while Factory 31 has commenced operations last month. When fully running, Top Glove’s enlarged manufacturing capacity will balloon to 64.9b gloves p.a. (+13%). The new lines are for nitrile gloves, which should raise capacity mix in this space to about 40% from 30% currently. Management intends to achieve a 50:50 nitrile-to-latex glove production split by 2020. In addition, the company has kick-started its condom business in June but has yet to commercialise the product.
  • Speed bumps ahead? Going forward, there is a rising threat of slower demand as we observe tapering forward orders. Top Glove shared that it has 40-45 days of sales backlog, implying they are sold out until Aug-Sep 18; this is shorter than 1QFY18's level of 60 days (but similar to 2QFY18’s). Two possible reasons are: a) supply recovery in China as capacities restart after 2017's environmental clampdown, prompting price-sensitive F&B customers to switch back to using vinyl gloves (more economical), and b) customers adopting a wait-and-see attitude since more nitrile glove supply capacity will be coming onstream in the near term.

EARNINGS REVISION/RISK

  • No change to our forecasts. Key upside risks include: a) recovering the RM715m from Adventa Capital, b) market share gains, c) more bona fide sizeable value-accretive M&As, and d) US dollar appreciating markedly vs the ringgit.

VALUATION/RECOMMENDATION

  • Maintain SELL and target price of RM7.80, based on 18x 2019F EPS. This is +0.5SD above its 5-year forward mean PE of 16x but below the sector's 26x. The premium is fair as: a) Top Glove has been making steady headway into the generally faster-growing nitrile glove space, and b) despite the negative development at Aspion, the group is still touted as the no.1 surgical glove player globally. That said, the discount to the glove sector is warranted, considering its relatively stretched balance sheet (net gearing of 0.8x vs peers' average of 0.1x). Likewise, our PE-ROE regression analysis suggests pegging the stock at 18-20x forward PE.
  • Post-bonus issue, our target price would be RM3.90, excluding the potential dilution from full guaranteed exchangeable bonds conversion into new Top Glove shares pending more details of the exercise.

SHARE PRICE CATALYST

  • Supply-demand imbalance structurally driving up ASP.
  • More meaningful bona fide M&As contributing to higher inorganic growth.
  • Innovative product offerings to disrupt the marketplace.

Source: UOB Kay Hian Research - 2 Aug 2018

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