Top Glove - Headwinds Likely to Drag Earnings in the Near Term

Date: 16/04/2019

Source  :  UOBKayHian
Stock  :  TOPGLOV       Price Target  :  4.10      |      Price Call  :  HOLD
        Last Price  :  4.60      |      Upside/Downside  :  -0.50 (10.87%)

  • Sustained competition and spike in latex prices impacting latex gloves are likely to weigh on Top Glove’s near-term earnings. Furthermore, industry expansion in Malaysia could be deferred should the demand-supply imbalance persist.
  • Positively, over the longer run, Top Glove will pursue a meaningful automation drive which is expected to reduce labour dependency.
  • Maintain HOLD. Target price: RM4.10. Entry price: RM3.70.

What’s New

Automating labour away.

  • Top Glove Corporation Bhd is embarking to further automate production lines to reduce the reliance on labour. It aims to digitalise and automate via Industrial Revolution 4.0 implementation through the application of IoT, robotics and automated real time manufacturing system. This initiative would be crystallised into three key processes.
    • First, automation of glove packing will be gradually implemented, commencing mid-19.
    • Following which, machine vision will be used to detect, remove defective gloves and readjust machine calibrations.
    • Automation at its warehousing will gradually start after the first initiative.
  • We expect the new packing technology to be implemented in the new factories. The technology requires an extension to production lines, which may not fit existing older production lines. This should cut headcount by 10%, which currently makes up close to 10% of total cost.

Double whammy to impact 3QFY19?

  • We expect Top Glove to see some headwinds and possibly lower q-o-q earnings in 3QFY19. This is likely to stem from stiffer competition in the latex glove space and a sudden spike in latex prices. The double whammy is likely to offset a recovery in nitrile ASPs.
  • Sri Trang Agro-Industry (SGX:NC2) is said to be highly competitive, given the new influx of capacity. The Thai company has ambitiuos expansion goals, adding 23% and 30% capacity (or 3.2b and 5.4b pieces) for 2018 and 2019 respectively.
  • Additionally, latex prices have surged 30% q-o-q following the International Tripartite Rubber Council’s (comprising Thailand, Indonesia and Malaysia which account for 70% of the world’s natural rubber production) aim to curb exports in a bid to prop natural rubber prices till July. The sudden surge would mean Top Glove will be unable to fully pass through the spike in cost in 3QFY19. The double whammy on almost 40% of latex-derived revenue is likely to more than offset the slight recovery in nitrile ASPs.

Stock Impact

Expansion supply outstrips demand projections.

  • The Malaysian Rubber Glove Manufacturers Association expects global demand for rubber gloves to grow by 11.9% to 300b pieces in 2019. While Top Glove is expected to ramp up production capacity to 69.3b gloves per year by end-19 from 60.5b pieces annually, the effective capacity addition translates to only 2.7 b gloves per year.
  • However, Malaysia’s industry capacity (as represented by the Big-4 consisting of Top Glove, Hartalega, Kossan and Supermax) is expected to grow by mid-teens in FY19-20 respectively. Evidently, this would outstrip current demand projections and result in further ASP softening in the quarters ahead. However, capacity addition may be deferred to balance demand-supply dynamics.

Earnings Revision / Risk

  • We leave our earnings forecasts unchanged.
  • Key upside risks include:
    1. recovering the RM640m from Adventa Capital,
    2. market-share gains,
    3. more sizeable value-accretive M&As, and
    4. the US dollar appreciating markedly vs the ringgit.

Valuation / Recommendation

Maintain HOLD and target price of RM4.10.

  • Our target price is pegged at 22x 2019F PE, slightly below the sector’s 23x.
  • Top Glove is making steady headway into the generally faster growing nitrile glove space. 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 0.9x vs peers' average of 0.1x).
  • Entry price is RM3.70.
  • (Using the exchange rate of RM1 to SGD0.3288, we derive the target price of 1.35 in SGD term)

Share Price Catalyst

  • Supply-demand imbalance structurally further driving down ASP.
  • Competing innovative product offerings to disrupt the marketplace.

Source: UOB Kay Hian Research - 16 Apr 2019

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