Investment Highlights

• We maintain HOLD on Top Glove with a lower fair value (FV) of RM4.45 (vs. RM5.24/share previously). Our FV is based on a reduced PER of 17x on CY22F FD EPS, incorporating an ESG-adjusted discount of 3% for our rating of two stars (Exhibit 7).
• Our current PER of 17x (previously 20x) is slightly below -1 standard deviation of Top Glove’s pre-pandemic 5- year PER of 24.7x. We believe that share price will only start reflecting a PER closer to average as glove ASP starts to stabilise. We reduce our PE assumption due to the following reasons:

1. Uncertainties over the lifting of the US Customs and Border Protection’s (CBP) sanctions. The recent glove seizures stand in stark contrast with the company’s seemingly convincing progress towards resolving the issue.
2. A shrinking US customer base, post-sanctions. Even with re-entry into the high-premium US market, we believe that it would be challenging for Top Glove due to its previous ban as the group’s market share may have been taken by peers that currently remain operational in the US.
3. A lasting but gradually decreasing volume of local cases, following a reintroduction of the lockdown. The local lockdown, while harsh, is an effective means of controlling cases until the effects of vaccination efforts kick in, repressing sentiment-driven upward price fluctuations.
4. Similarly, countries have grown more cautious and are more equipped to handle future surges. Japan, India, France and Turkey have since reported significant reduction in case numbers over the past few months. Following a year into the pandemic, the respective governments have demonstrated effective means in dealing with these surges (though noticeably only when the situation becomes dire). In future, we expect such governments to react swifter and decisively in avoiding identically rampant scenarios.

• Thus, in the absence of lasting rerating catalysts, we expect a slow and steady decline in Top Glove’s share price over the course of the next three quarters. While the eventual lifting of US sanction will likely cause a notable sentiment-driven upswing, we believe that it too will peter in the face of waning average selling prices (ASP) and general glove demand.

• Top Glove’s 9MFY21 core net profit of RM7.26bil made up 85% and 74% of our and consensus forecasts respectively. This is in line with our estimates and as such, we maintain our FY21/FY22/FY23 forecasts.

• We believe that another sharp earnings decline will occur in the following quarter for the following reasons:

1. The MCO 3.0-imposed 60% workforce limitations disrupting production. We assume this will be somewhat offset by Top Glove’s sizeable inventory.
2. Sharper declines in ASP as non-US markets are heavily competitive. These markets are currently saturated by Chinese and emerging players (which are similarly likely to fall short of the CBP’s requirements).
3. Lower overall demand from western countries as a result of vaccination efforts. As an indicator, glove lead times, formerly 6 months long in the past quarter, have since subsided to 30–50 days. Top Glove no longer provides spot orders.

Financial Results

• Top Glove’s 3QFY21 revenue fell by 22% QoQ to RM4.2bil, underpinned by a fall in sales volume and ASP. Similarly, the poor sales dragged core net profit to RM2.0bil (-29% QoQ) in 3QFY21. Net profit margin was squeezed to 49.2% (-4.4 ppt QoQ) in 3QFY21.
• Sales volume shrank by 4% QoQ and 9% YoY to 14.6bil pieces in 3QFY21, despite a higher production capacity and a lack of factory outbreaks in the scale of past quarters. This is primarily due to lower sales in the north America region (-68% QoQ).
• However, we reckon that the poor sales situation is exacerbated by two other factors: higher number of order cancellations and buyers adopting a wait-and-see approach, problems which its peers are also facing. Potential buyers adopt a wait-and-see approach for glove prices to drop, while stronger order cancellations signify stronger bargaining power from the customers. In the coming quarters, we doubt that any resultant potential surge in sales from this approach would be able to offset the continual declines in ASP.
• Top Glove recorded a fall of ~21% QoQ in blended ASP to US$65/1,000 pcs (Exhibit 2) in 3QFY21. We predict a drop of US$5.00 in each month for the next quarter, in line with market prices. In contrast, Top Glove’s peers that are still operational in the US are expected to have their earnings peak in the coming quarter, alongside reporting their best ever glove ASP.
• Top Glove declared a total dividend payment of 18.0 sen/share for the quarter, bringing the total up to 59.7 sen/share thus far (Exhibit 3). As with the last quarter, a special dividend of 20% has been declared for 3QFY21 in addition to Top Glove’s usual dividend of 50%.

Other Updates

• The group has not made changes to its expansion plans, and is still on track to meet its goal of 111bil pcs per annum capacity by end-2021F (Exhibit 4).
• Top Glove is still proceeding with its HKEX listing, which will take place after its issues with the CBP are resolved. In addition to less uncertainty, we believe the group intends to ride the price upswing upon the lifting of the sanction for a more positive listing outcome. The revised listing of 793.5mil new shares (making up only 53% of the originally planned listing volume), is anticipated to raise up to RM4.2bil. We have already adjusted our EPS calculations to consider future share base increments.
• In the past year, Top Glove has made considerable progress in migrant workers’ welfare. The group has submitted its appeal to the CBP in May and is awaiting further clarification. Top Glove is now shifting its focus towards strengthening its environmental and governance framework – striving for zero-carbon emission factories, reduced gas and water consumption. We maintain our 2-star ESG rating on Top Glove until the sanctions in the USA have been lifted.

Source: AmInvest Research - 10 Jun 2021