Top Glove Corporation - Competitive Pressure In Latex Gloves

Date: 07/10/2019

Source  :  KENANGA
Stock  :  TOPGLOV       Price Target  :  4.00      |      Price Call  :  SELL
        Last Price  :  4.51      |      Upside/Downside  :  -0.51 (11.31%)

We are less sanguine on Top Glove’s short to medium-term prospects post its 4QFY19 results’ briefing. We expect the group’s overall profitability to continue facing competitive pressure from low margins latex gloves and slow recovery at Aspion although cushioned by uptick in nitrile demand. TP is RM4.00 based on 25.5x CY20E EPS. Reiterate UP.

2nd consecutive quarterly earnings disappointment explained.TOPGLOV’s 4QFY19 post-results’ briefing shed some light on the 5% QoQ sales volume decline and flat PBT growth (-1.2%) despite a net profit growth (+7% due to a low effective tax rate of 1.3% vs normalised going forward mid-teens 15%-17%). The lower QoQ sales volume (- 5%) was largely due to lower latex powder-free (-12%) and latex powderered (-23%) buffered by higher nitrile (+12%). Demand for nitrile continued to remain solid with nitrile and latex product mix ratio of 46% : 54%.

Note that PBT margin was flat QoQ in 4QFY19 at 6.8% despite higher ASP due to lower profit contribution from natural rubber glove segment due to lower sales volume in latex gloves and a small loss in the vinyl glove segment. This brings 4QFY19 PATAMI to RM80.1m (+7.2%) boosted by a lower effective tax rate of 1.2% compared to 8.6% in 3QFY19. All in, TOPGLOV was impacted by lower volumes sales in latex and further dragged down by competitive pressure leading to lower margins which we expect to last over the next subsequent quarters.

Slow recovery in Aspion. Despite chalking up a PATAMI of RM19.6m at Aspion (largely due a positive tax of RM16.6m attributable to deferred tax), PBT only came in at a miniscule RM3m on the back of <60% utilisation rate. The group has implemented a rationalisation process at Aspion including reduction of manpower from 3k workers to 2k and renegotiate better average selling prices terms with customers. All in, we still see low risk of Aspion’s related impairments.

Leveraging on technology to reduce cost and maintain margin. In an effort to further mitigate rising cost and reliance on manual labour and hence maintain margins, the group is embarking on automation (expected to commence 2HCY20) in three key areas including: (i) an artificial intelligence system to detect and removed defective gloves, (ii) automated warehouse management system, and (iii) automated glove packing system. The group expect to see automation initiatives to bear fruits in FY21.

Intense competition in latex more than offset uptick in nitrile demand. Looking ahead, the keen competition in the latex segment could negatively impact latex gloves margin. Although earnings are expected to be underpinned by uptick in nitrile demand, the group is plagued with competitive pressure from low margins latex gloves (accounts for estimated 50% of product mix) which could offset the gains in the nitrile segment. The robust demand for nitrile gloves has led to longer delivery lead times of between 45 to 50 days as compared to 30 to 40 days previously.

Maintain UP. Our TP is RM4.00 based on unchanged 25.5x CY20E EPS (at +1.0SD above 5-year historical forward mean). Although we expect uptick in nitrile demand to anchor growth in subsequent quarters, the group’s overall profitability is facing competitive pressure from low margins latex gloves and a slow recovery at Aspion.

A key upside risk to our call is the better-than-expected margin.

Source: Kenanga Research - 7 Oct 2019

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