Investment Highlights

• We maintain our BUY call on Top Glove with an unchanged DCF-based fair value of RM5.66/share (WACC: 6.4% and a terminal growth rate of 2.5%). At our fair value, Top Glove’s implied FY20F PE is 27.7x.

• To recap, Top Glove achieved a 27.7% YoY increase in revenue in 1HFY19 while net profit grew 0.6%. Net profit margin dropped 2.4ppt to 8.9% as the group faced higher interest cost and tax expense in 1HFY19. Tax allowances were lower in 1HFY19 due to the expiry of the 3-year special reinvestment allowance.

• The increase in revenue was in tandem with higher sales volume growth of 18% YoY where almost all of its glove types achieved sales volume growth (Latex powdered +3%; Latex powder free +11%, nitrile +40%, surgical +115%). These were offset by sales volumes of TPE/CPE gloves dropping by 1% and vinyl gloves sales quantity declining by 16%. About 76% of the sales volume growth was contributed by the developed markets (i.e., North America, Western Europe and Japan) while the rest was contributed by the developing market. Top Glove has also managed to increase its market share to 23.5% as its latex and nitrile gloves export volume growth of 23.5% exceeded Malaysia’s export growth of 13.2%.

• Top Glove will continue to reduce its reliance on labour as the company increases automation in the manufacturing process. The company continues to focus on its R&D to ensure sustainable growth. The company estimates around 15-20% of reduction in manpower in the factory with its investment in automation in its production lines.

• We believe that the downward pressure on margins in CY19F will continue as there will be an influx of glove supplies from the top rubber glove producers (Top Glove, Kossan, Hartalega). Top Glove plans to increase its capacity by 9.6bn pieces of gloves per annum in FY19E and 10.8bn pieces in FY20F. 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 ASP will be weighed down. It will take 6-12 months for demandsupply to reach an equilibrium. Hence, we opine that margins will only normalize by the end of CY19F. Our net profit margin estimates are 9.3% in FY19F, 9.9% in FY20F and 10.1% in FY21F.

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

Source: AmInvest Research - 29 Mar 2019