Investment Highlights

• We maintain our HOLD call on Top Glove Corporation (Top Glove) with an unchanged fair value (FV) of RM0.60/share. This is pegged to a target FY24F PE of 27x, 2 standard deviation below its FY18-19 pre-pandemic median of 31x given the present average selling price (ASP) uncertainty amid elevated operating costs. There is no ESG-related FV adjustment based on our unchanged 3-star rating.

• Our forecasts are maintained following a recent meeting with management. These are the salient highlights:
  • During the International Rubber Glove Conference Exhibition 2022 in early Sep this year, Top Glove gathered that endcustomers’ rubber glove stock level has passed its peak albeit sitting at a high 6-7 months. Hence, we expect there could be a meaningful stock replenishment activity by mid-2023 (4QFY23F).
  • However, the group’s plant utilisation rate (PU) has been declining from 52% in 2QFY22 to 35% in 4QFY22 (Exhibit 1) amid end-customers’ peaking inventories, which we think is counterintuitive.
  • Top Glove attributed this to inventory clearance from smaller glove makers exiting the industry by offering extremely low ASP. Additionally, we believe competitive pricing from Chinese glove makers contributes to the low PU.
  • The group’s PU in Sep was running at 36% which was mostly meeting Oct orders (vs 35% in 4QFY22) despite a 5% increase of ASP in Oct. This implies no significant demand destruction postprice adjustment.
  • In terms of ASP, Top Glove guided that nitrile and latex rubber gloves are still declining at a quantum of US$0.50-1.00/1K pcs MoM in Sep, which is consistent with the quantum of decline we observed over the past 3 months (Jun-Aug).
  • However, the overall ASP in Sep was able to maintain at US$24/1K pcs, mainly supported by strong demand for surgical gloves in tandem with the resumption of elective surgeries in the healthcare sector. The 5% increase in ASP could bring Top Glove’s Oct ASP to US$25/1K pcs. Nevertheless, we retain our view that the group’s ASP increase may not be sustainable given the low PU in the industry.
  • Under the scenario of ASP at US$23.5-24.5/1K gloves, Top Glove guided that the breakeven PU is 60%. Hence, we believe that the group could be making a Sep net loss of RM5-6mil. For FY23F, we expect losses could continue in the first 3 quarters at a decelerating momentum and breakeven by 4QFY23F when restocking activities emerges.
  • Currently, we understand that China’s nitrile gloves are selling at US$15/1K pcs (not inclusive of the 7.5% USA import tariff), which is at a 25% discount to Malaysian nitrile glove ASP of US$20/1K pcs in Sep. We opine that such a material discount could allow Chinese glove makers to further secure more market share from Malaysia and keep Malaysian PU low over the next 3 quarters (Exhibit 3).
  • Top Glove shared that some Chinese players like Intco Medical Technology and Zhonghong Pulin Medical are able to continue generating profit despite under such compressed ASPs due to the use of coal as a source of fuel as compared to natural gas in Malaysia. For illustration, the cost of natural gas to produce 1K units of gloves is double the cost of coal. Notably, fuel costs account for 12% of Top Glove’s FY22 total production costs (Exhibit 4).
  • In FY22, there was an RM229mil inventory write-down due to lower ASPs. Top Glove guided that the current rubber glove stocks are all new with 5 years of shelf life. Hence, we believe the risk of inventory write-off due to product life expiry is minimal at this juncture.
  • Separately, the group has halted dividend payout for the time being in order to preserve cash holdings, which is consistent with our zero dividend assumption in FY23F.
• In addition, we paid a visit to Top Glove’s largest male hostel Zone 8 in Klang. We were told various improvements have been made since late 2020 to enhance foreign workers’ quality of life on top of complying with Act 446 effective in Sep 2020. The salient requirements under the Act for a dormitory includes: (a) a minimum sleeping area of 3 square metres per worker, (b) maintaining a ratio of 15 workers per 1 bathroom/toilet, (c) providing a mattress ≥ 4 inches thick, a pillow and a blanket to each worker, (d) providing a locked cupboard for each worker to keep valuables (ie. passports) which can be accessed at any time.

• Hence, the major improvements we observed include: (a) larger spaces: 16 workers/room as compared to 25 workers/room in the previous 2 years; (b) enhanced ventilation system: added more ceiling and ventilation fans; (c) increased washroom capacity: 15 workers/washroom as compared to 28-29 workers/washroom previously. Lastly, the group provides independent parties’ helplines (ie. Impactt) to allow foreign workers to make complaints.

• In addition, the hostel has wire transfer facilities for the workers to transfer funds to their home countries. We also noted that the hostel provides a gym, a canteen and facilities for workers to buy and cook their own food. In terms of ESG, we believe the accommodation facilities comply with ILO standards.

• The stock currently trades at a FY24F PE of 31x, which is at parity to its FY18-19 pre-pandemic median. However, we believe this remains fully valued given that the ongoing ASP uncertainty and elevated costs could remain unabated over next 3 quarters while the group does not offer any FY23F dividend yield.

Source: AmInvest Research - 7 Oct 2022