Top Glove Corporation - Uptick In Nitrile Demand, But Competitive Pressure In Latex Gloves

Date: 08/08/2019

Source  :  KENANGA
Stock  :  TOPGLOV       Price Target  :  4.50      |      Price Call  :  HOLD
        Last Price  :  4.60      |      Upside/Downside  :  -0.10 (2.17%)

We are neutral on TOPGLOV’s prospects. Although we are positive on growth in subsequent quarters underpinned by uptick in nitrile demand driven by re-stocking activities, the group is plagued with competitive pressure from low margins latex gloves. We cut our FY19E/FY20E net profit by 4% each. Our TP is cut from RM4.70 to RM4.50 based on 25.5x FY20E revised EPS. Reiterate MP.

Uptick in nitrile demand and longer delivery lead times. We understand that the robust demand for nitrile has led to longer delivery lead times (the time taken between order and delivery) which has risen to between 45 to 50 days as compared to 30 to 40 days. Due to the easing cost of input latex raw material, we expect margins recovery in 4Q19. However, looking ahead, the keen competition in the latex segment could negatively impact latex gloves margin.

ASP hike to mitigate the effect of higher costs. Due to the lag effect in passing cost through as a result of higher natural gas and raw material (latex), we expect Top Glove to raise ASPs in an effort to contain high operating costs and put brakes on further margin compression in subsequent quarters. Note that 3Q19’s sharp PBT margin erosion (-3.9% pts QoQ; -5.3% pts YoY) was due to price competition and delays in cost pass-through for natural gas and latex. Recall, while pricing adjustments were made subsequently, there was a time lag of two months before the cost increase could be passed on to customers. Furthermore, we gather that nitrile glove competition has subsided on the back of delayed incoming capacities, which could ease downwards pressure on ASPs.

Slow recovery in Aspion. Generally, Aspion is improving but we expect flattish FY19 as the unit is unable to take full advantage of the strong surgical demand. All in, we still see low risk of Aspion’s related impairments.

Leveraging on technology to reduce cost. In an effort to mitigate rising cost and reduce reliance on labour, TOPGLOV is embarking on more automation in the production processes including: (i) an artificial intelligence system to detect and remove defective gloves, (ii) automated warehouse management system, and (iii) automated glove packing system (expected to commence by mid-2019). The total saving is estimated at 5% of our FY20E earnings.

Expansion plans. Top Glove’s capacity expansion includes: Factory 32 (Phases 2 commence production by 4Q 2019 ; 1.2b pieces), Factory 33 (operational by 3Q 2019; 1.2b pieces), Factory 2B (operational by 4Q19; 0.8b pieces), Factory 5A (operational by 1Q 2020; 2b pieces), Factory F40 (Phase 1 operational by 1Q 2020 and Phase 2 operational by 3Q 2020; 3.8b pieces), Factory F41 (operational 2Q 2020; 4b pieces) Factory F42 (operational by 4Q 2020 delayed from 3Q 2020; 4.8b pieces), and Factory 8A (operational by 4Q 2020 delayed from early 2020; 2.8b pieces) which will boost the group’s total production capacity by 20.6b gloves per annum to 83.3b (+33%).

Downgrade our FY19E/FY20E net profit by 4% each to take into account lower margins in the latex segment.

Maintain MP. Correspondingly, our TP is cut from RM4.70 to RM4.50 based on 25.5x FY20E revised EPS (at +1.0SD above 5-year historical forward mean). Although we are positive about its growth in subsequent quarters ahead underpinned by uptick in nitrile demand, the group is plagued with competitive pressure from low margins latex gloves and a slow recovery at Aspion.

A key risk to our call is lower-than-expected sales volume and ASPs.

Source: Kenanga Research - 8 Aug 2019

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