Investment Highlights

• We maintain our BUY call on Top Glove with an unchanged FV of RM6.35/share, based on DCF (at a discount rate equivalent to its WACC of 6.4% and a terminal growth rate of 2.5%). At our FV, the implied CY19F P/E is 16.3x.

• We continue to like Top Glove for: (1) its expansionary plans; (2) focus and continual efforts in improving quality and operational efficiency; and (3) its position as the largest rubber glove manufacturer.

• Key highlights of 1QFY19 results conference call yesterday are:

1. Top Glove’s demand growth is expected to come mostly from developed markets rather than developing markets.
2. Stronger demand in nitrile gloves saw a bump in the revenue contribution from its nitrile gloves segment.
3. Proposed bonds issuance by 1QCY19 should improve profitability through reduced interest costs.
4. Additional expansion plans are in place to achieve a capacity of 75.3bil pieces per annum by 2020 with more focus on nitrile gloves production.
5. Easing raw material prices will reduce ASPs but with a temporary boost to gross margins initially.

• Top Glove’s demand growth came mostly from developed markets rather than developing markets. About 71% of the growth were driven by developed countries such as those in North America, Western Europe and Japan whereas 29% of the growth came from developing countries such as those in Eastern Europe, Asia and Latin America. Moving forward, we believe that the demand growth will be further driven by increased awareness on the importance of hygienic practices in the developing countries.
• Top Glove has seen a stronger demand for its nitrile gloves which made up 41% of sales volume in 1QFY19 (vs. 36% in FY18), resulting in total revenue contribution of 47%. Moving forward, management believes nitrile glove’s sales volume will reach 50% of total sales volume. As nitrile gloves’ gross margin of circa 17% is slightly smaller compared with natural latex gloves’, we believe there will be a slight EBIT margin compression. Also impeding on margins will be Aspion, which contributed 10% to Top Glove’s top line but with a negative bottom line contribution.
• Proposed bonds issuance by 1QCY19 would improve profitability. Management plans to utilize the proceeds from the proposed guaranteed exchangeable bonds issue of up to US$300mil to pare down its bank borrowings. Based on the illustrative yield of the bonds of 1% per annum, the potential interest savings will be about RM25mil per annum.

• Additional expansion plans in place to reach a capacity of 75.3bil pieces per annum by 2020 with more focus on nitrile gloves production. Top Glove has scheduled an expansion plan to increase its production capacity from circa 60.5bil pieces to 75.3bil within 2 years. Management is boosting its nitrile capacity in tandem with growing demand while incorporating increased automation throughout the manufacturing process and facility optimization initiatives to ensure increased efficiency in its plants.

• Easing raw material prices will reduce ASPs. Nitrile gloves ASPs increased 11% YoY on the back of higher nitrile latex prices (+25% YoY). However, nitrile prices are expected to decline following the drop in butadiene price as seen in Exhibit 2. Therefore, we believe ASPs for its nitrile gloves will decline but with a temporary boost to margins initially before the cost pass-through mechanism finally kicks in.

• Moving forward, we believe there could be some pressure on margins in CY19F stemming from the influx of glove supply of the “Big 3” producers (Top Glove, Kossan, Hartalega). CY19F will see an enlarged supply of gloves by 14%, although the expansion will come at a gradual pace. As this exceeds the organic demand growth expectation of 8-10%, we believe ASPs will be weighed down slightly initially. It will take 6-12 months for demand-supply to reach equilibrium.

• Top Glove’s earnings is expected to be anchored by capacity-led expansions. The company’s FY19F earnings will be supported by Factory F32 which is slated to commence production by 1QCY19 and 3QCY19, with 2.2bil pieces and 1.2bil pieces of capacity respectively. We opine that Top Glove is well positioned to benefit from the expected 8-10% growth in demand for rubber gloves for CY19 as it is currently the largest rubber gloves manufacture with circa 26% of market share.

Source: AmInvest Research - 19 Dec 2018