Top Glove - Still Costs An Arm & A Leg

Date: 04/10/2018

Source  :  UOBKayHian
Stock  :  TOPGLOV       Price Target  :  8.20      |      Price Call  :  SELL
        Last Price  :  4.77      |      Upside/Downside  :  +3.43 (71.91%)

  • Despite some mixed signals and save for the potential one-off impairment relating to the overvaluation of Aspion, we expect a better overall core showing in 4QFY18. This takes into consideration:
    1. lower raw material prices,
    2. strong US dollar, and
    3. commissioning of 30 new lines at Factory 31.
  • All in all, we raise our FY19-20 earnings projections by 4-6% but keep that for FY18 unchanged. However, valuations remain rich and this is our key reason for a tactical bearish call. Maintain SELL but lift our target price to RM8.20.

What’s New

Drop in latex prices a boon.

Between June to August, average latex prices were soft, declining 19% y-o-y and 5% q-o-q to RM4.38/kg. This in turn should benefit Top Glove as 50% of its production revolves around natural rubber gloves; we estimate that every 1% drop in raw material cost could increase its earnings by 3%. That said, we foresee latex prices creeping up to the RM4.50-5.00/kg range in 4Q18.

We noticed the natural rubber inventory in Qingdao (main source of raw materials for China’s tire output) has fallen 8% ytd and could prompt some replenishment activities.

Booster from forex tailwinds.

  • The ringgit has been on a weakening trend against the US dollar in recent months but it is still nowhere near the RM4.50/US$ level back in early- 17 (currently: RM4.14/US$, +3% q-o-q/-6% y-o-y). The forex assumption we are using to project our financial estimates is based on an average of RM4.18/US$ over the next 1-2 years (raised from RM4.08/US$). We believe this would have already captured the potential upside risk from forex tailwinds.
  • Our calculations show that every 1% depreciation of the ringgit vs the US dollar could beef up Top Glove’s earnings by 7% (this analysis excludes the shared cost savings mechanism with customers which will consequently moderate any significant gain in profit margins).

Rising threat of demand tapering?

Management shared it is still seeing only 40-45 days of forward orders, shorter than Dec 17's level of 50-60 days. Generally, we remain concerned about:

  1. rising competition where more nitrile glove supply capacity will be coming on-stream in the medium term, and
  2. the vinyl glove undersupply situation in China is easing with capacities restarting after 2017's environmental clampdown, prompting price-sensitive F&B customers to switch back to more economical glove offerings.

Update on lawsuit.

We think the legal dispute with Adventa Capital is going to be a long drawn-out fight.

More recently, Top Glove obtained a new interim Mareva injunction (premised on fresh message evidence) to freeze and prevent dissipation of assets worldwide against the vendors of Aspion. The next court hearing takes place on 29 October. Besides, there could be a material one-off impairment in the upcoming 4QFY18 results pertaining to the overvaluation for the purchase of Aspion.

Recall that Top Glove is seeking an amount of RM640m.

Stock Impact

4QFY18 results preview.

Top Glove is slated to release its 4QFY18 results sometime in mid-October.

Despite some mixed signals and save for the potential one-off impairment, we expect a better overall performance with quarterly revenue coming in at ~RM1.2b and core profit of between RM130m-140m (+2-10% q-o-q/+61-74% y-o-y). This is premised on the back of:

  1. lower raw material prices,
  2. strong US dollar, and
  3. commissioning of 30 new lines at Factory 31.

Recall that Top Glove registered top- and bottom-lines of RM1.1b and RM127m in 3QFY18 respectively with lesser impact from the above-mentioned developments.

Earnings Revision / Risk

No changes to our FY18 earnings forecast, but we have revised up our FY19-20 estimates by 4-6% on higher US dollar forex assumption (+3% to RM4.18/US$ from RM4.08/US$).

Key upside risks include:

  1. recovering the RM640m from Adventa Capital,
  2. market share gains,
  3. more bona fide sizeable value-accretive M&As, and
  4. US dollar appreciating markedly vs the ringgit.

Valuation / Recommendation

Maintain SELL but with a higher target price of RM8.20 (from RM7.80) as we have raised our earnings forecasts.

For the valuation methodology, we are still employing the same price multiple, pegging Top Glove to an unchanged 18x 2019F PE. This is +0.5SD above its 5-year forward mean PE of 16x but below the sector’s 29x. The premium is fair as:

  1. Top Glove has been making steady headway into the generally faster-growing nitrile glove space, and
  2. 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).

Post-bonus issue, our target price would be RM4.10, 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 - 3 Oct 2018

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