Investment Highlights

• We maintain our BUY call on Top Glove Corporation (Top Glove) with an unchanged FV of RM5.12/share based on a P/E of 27x on FY21F EPS. Our PE multiple is based on the 2-year historical forward PE.

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

• Top Glove’s 1QFY20 net profit of RM111.4mil (+1.2% YoY, 39.2% QoQ) was in line with both our and street’s expectations, accounting for 26.6–26.0% of our and street’s full-year earnings forecasts respectively.

• Key highlights of Top Glove’s 1QFY20 results and teleconference briefing are:

• Top Glove’s 1QFY20 revenue shrank 4.2% YoY to RM1,209.1mil on the back of a lower ASP. Sales volume inched up by 0.2% YoY in 1QFY20 mostly led by a 20% increase in nitrile gloves sales volume (latex powdered -24%, latex powder-free +1%, vinyl -30% and surgical -5%).

• The group said that demand growth for latex gloves has been slow in developing countries in 1QFY20 compared with 1QFY19. We believe sales of latex gloves were also impeded by heightened competition from Thailand’s increasing latex glove production. ASP remained subdued for both nitrile (- 8.5% YoY to US$22.70) and latex (-1.1% YoY to US$18.50) gloves due to increased competition, which has placed downward pressures on selling prices.

• The group’s EBITDA fell 5.5% YoY while EBITDA margin slipped 0.2ppt YoY to 16.2% in 1QFY20 (+3.4ppt from 12.8% in 4QFY19). This was largely due to an 8.7% YoY rise in natural rubber price to RM4.13/kg and 6.0% higher natural gas cost. Vinyl gloves also suffered a lower selling price due to increased competition. This resulted in an operating loss of RM1.6mil in 1QFY20 (operating profit of RM1.8mil in 1QFY19).

• Margin corrosion from lower selling prices was largely offset by the group’s nitrile glove sales mix which rose to 49% (42% in FY19) as Top Glove’s nitrile gloves command a slightly higher margin compared with latex gloves. The 14.5% drop in nitrile latex price of US$1.06/kg also helped.
   
• Aspion’s production efficiency, quality and selling price improved in 1QFY20 compared with FY19. It contributed to circa 9.5% and 9.0% to group’s revenue and EBITDA respectively. EBITDA margin improved 6.6ppt to 14.7% in 1QFY20 (8.0% in FY19) due to effective cost controls. Capacity utilisation remains low at below 60%.
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• Top Glove benefitted from a lower effective tax rate of 10.9% (-9.6ppt from 21.3% in 1QFY19) due to the recognition of deferred tax asset and tax incentives. The group expects effective tax rate to remain low at circa 13–15% in FY20F. Our FY20–FY21F effective tax rate estimates are within this range.

• The group’s capacity has expanded by 9.7% since FY19 to circa 70.1bil pieces in 1QFY20 and capacity utilisation rate remained above 90%. This was driven by strong demand as the group’s market share for nitrile gloves from the US, Western Europe and Japan markets grew. The group plans to increase its capacity in CY20F by 16.8% (previously planned expansion of +27.6% YoY). We are positive on the expansion delay as this will alleviate some of the pressure on ASP.

• Moving forward, we believe that Top Glove will continue to face pressures on operating profit margins. This is due to the 14.2% increase in nitrile and latex glove supply in CY20F by top rubber glove producers in Malaysia (Top Glove, Kossan, Hartalega) and Thailand (Sri Trang). This exceeds the organic demand growth expectation of 8–10%. This will be further aggravated by higher labour cost in CY20F following the 9.1% upward revision in minimum wage.

• According to the Malaysian Rubber Board, latex price has risen by 4.8% to RM4.55/kg in Dec 2019 (average of RM4.34/kg in 1QFY20). The group expects latex price to remain high initially due to low yield during wintering season but will decline in 2HFY20 as yield increases. The group said nitrile rubber price is on a downtrend as it fell by 7.5% to circa US$0.98/kg in Dec 2019 (average of US$1.06/kg in 1QFY20). We believe the group will face further margin pressures in 1HFY20 before improving in 2HFY20.

• The group is adding more automation and digitalisation initiatives in its newer factories, which will improve internal and production efficiency. Also, it would reduce dependence on human labour (currently 2.55 workers is needed per mil pieces of glove). We believe improved production efficiency, higher automation and reduced natural gas price (- 2.96%) from January 2020 onwards will help mitigate margin pressures from weaker selling prices.

Source: AmInvest Research - 18 Dec 2019