Highlights

Top Glove Corporation - Rich Valuation

Date: 06/09/2019

Source  :  DBS VICKERS
Stock  :  TOPGLOV       Price Target  :  4.50      |      Price Call  :  HOLD
        Last Price  :  4.40      |      Upside/Downside  :  +0.10 (2.27%)
 


  • Despite 6% cut in earnings, we expect strong FY20-21 earnings to be driven by higher sales volume.
  • Improved 4QFY19 expected on better ASP and stable raw material price.
  • Top Glove is trading at rich valuation of +2.5 SD of 5-year mean PE or +2.0 SD of 10-year mean PE.
  • Maintain HOLD with lower Target Price of RM4.50.

Strong Earnings Growth Priced in

  • In spite of the 6% cut in our earnings, we still forecast strong earnings growth for TOP GLOVE CORPORATION BHD (SGX:BVA) at 24% and 13% y-o-y in FY20 and FY21 respectively. This will be mainly driven by an increase in sales volume on rising demand and stable operating costs.
  • Our target price of RM4.50 is based on 23x CY20 earnings per share (EPS), which is equivalent to +1SD of its 5-year mean price-to-earnings (PE).
  • We maintain our HOLD call as Top Glove is trading at a rich valuation of 31.2x FY19 PE, equivalent to +2.5x SD of its 5-year mean PE or +2.0x SD of its 10-year mean.

Where We Differ

  • Our earnings forecast is below consensus as we factor in more conservative average selling prices (ASPs). We expect ASP to improve in FY19 and remain flat in FY20-21.

Potential Catalysts

  • Top Glove could benefit from growing emerging markets that are predominantly latex users.
  • Another key re-rating catalyst would be the faster-than-expected recovery of its subsidiary Aspion Sdn Bhd.

What's New - Earnings Growth Driven by Sales Volume

Despite FY19-FY21 earnings reduction…

  • We have adjusted our FY19-21 earnings forecast downwards by 15%, 6% and 6% respectively to factor in the capacity expansion adjustment, impute the surge in raw material costs in 3QFY19 and longer gas tariff hike pass-through.

… we still expect strong earnings growth for FY20-21.

  • We forecast a strong earnings growth for Top Glove at 24% and 13% y-o-y in FY20 and FY21 respectively after the cut in our earnings. This will be driven by;
    1. increased sales volume on rising market demand (compound annual growth rate (CAGR) of 10% in 2018-2021),
    2. stable raw material price,
    3. improved operational efficiency through digitalisation.
  • The mismatch of latex material price and latex gloves’ ASP is expected to normalise in 4QFY19, which will improve earnings in upcoming quarters.

Slight delay in capacity expansion.

  • In June 2019, Top Glove forecast an additional capacity of 5.4b pieces of gloves p.a. from 2QCY19 onwards, with 3.4bn pieces in 2QCY19 (Factory F32 Phase 1 and F33 new block), 1.2bn pieces in 3QCY19 (Factory F32 Phase2) and 0.8bn pieces in 4QCY19 (F2B refurbishment). However, in its latest update in Aug 2019, it has installed capacity of 3.4bn pieces and part of its capacity expansion has been delayed slightly. Factory F32 Phase 2 is expected to commence operations in 4QCY19, while F2B refurbishment has been delayed to 1QCY20.
  • Expansion plans for CY20 include F2B refurbishment, Factory F5A, Factory F40, Factory F42 (Phase1), Factory F41 (Vietnam), and Factory F8A (Thailand). These expansions will add capacity of 5.4bn and 18.2bn gloves p.a. for CY19 and CY20 respectively, raising Top Glove’s annual capacity to 84.1bn pieces at the end of CY20 (vs 83.3bn previously), adding 32% from current installed capacity of 63.9bn pieces. We have incorporate in the capacity expansion to our earnings forecasts as per management guidance.

Raw material prices to stabilise.

  • Top Glove’s revenue is mainly from latex gloves (40%) and nitrile gloves (45%). Latex material price surged 33% from Feb 2019 to May 2019, while staying range bound since May 2019 as supply picked up post winter.
  • On the other hand, nitrile butadiene rubber material prices were trading sideways in 1HCY19. We expect this trend to continue in 2HCY19 with stable supply and demand. Raw material prices are expected to remain range-bound in 2HCY19 owing to ample rubber supply and slow demand.

Focus on digitalisation and automation to save costs.

  • In the middle to long term, Top Glove is planning to embark on digitalisation and automation efforts via the Industry 4.0 framework involving the application of Internet of Things (IoT), robotics and automated real-time manufacturing systems. This is to reduce the company’s reliance on foreign labour and improve manufacturing efficiency.

4QFY19 results to improve.

  • The mismatch of latex material price and latex gloves’ ASP is expected to normalise in 4QFY19 on stabilising latex material price which has been range-bound since May 2019. This should lead improved earnings in the upcoming quarters despite the cut in our earnings.
  • To recap, Top Glove’s 3QFY19 net profit (-29.4% y-o-y; -36.5% q-o-q) was dragged by the time lag between latex material price and selling price hikes. Top Glove’s latex material price was higher in early 3QFY19, but its selling price hike only came towards the tail end of 3QFY19.

Improved ASPs expected.

  • Major glove manufacturers have scaled down their capacity expansion plans for 2019. New supply may ease and improve ASPs in 2HCY19 compared to 1QCY19. ASPs have trended upward since Jun 2019.

Time lag for gas tariff cost pass-through.

  • On 12 July, Gas Malaysia announced an increase of the average effective gas tariff to RM34.66/MMBtu (+5.3% from RM32.92/MMBtu previously) from 15 July 2019 to 31 December 2019. The gas tariff hike was significantly higher than previous revisions.
  • Previously, glove manufacturers managed to pass-through cost increases with price adjustments lagging by 1-3 months. The quantum of this increase was larger than the previous two gas cost increases (+0.5% for 2HCY2018; +0.7% for 1HCY2019) and may take longer to pass-through.

Valuation

  • We maintain our HOLD call with a lower target price of RM4.50. We reduced our Target Price to RM4.50 from RM4.80 to reflect the earnings adjustment, indicating a 4% downside from Top Glove’s current share price.
  • Our Target Price is based on 23x CY20 EPS, which is equivalent to +1SD of its 5-year mean PE. We maintain our HOLD call as it is trading at a rich valuation of 31.2x FY19 PE, equivalent to +2.5x SD of its 5-year mean PE or +2.0x SD of its 10-year mean. Using the FX rate of RM1 to SGD0.33, we derive target price of 1.485 in SGD term.
  • A key re-rating catalyst for Top Glove would be a faster-than-expected recovery of its subsdiary Aspion.

Source: DBS Research - 6 Sep 2019

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