• Top Glove's earnings were below expectations as ASPs dipped while volume recovery was weaker than expected against softened industry dynamics. The lifting of the US export ban should gradually result in improved US sales but overall utilisation rates may remain subdued due to muted industry prospects.
• Against the backdrop of an industry downcycle and possible disappointment to expectations, we do not rule out further downside. Maintain HOLD on Top Glove with a lower target price.

Top Glove's 1QFY22 Earnings Below Expectations Amid Deteriorating Dynamics

• Top Glove’s 1QFY22 (Sep 2021 to Nov 2021) core net profit of RM186m (-70% q-o-q, -93% y-o-y) was below our and consensus expectations. 1QFY22 earnings accounted for 10% of both our and consensus full-year estimates. The negative deviation is due to softer-than-expected volume sales and ASPs. Both incidences are attributed to customers remaining cautious over replenishing orders, awaiting lower ASPs and increased glove supply in the market.
• Top Glove also reverted its dividend policy to a 50% payout on a semi-annual basis from a 70% payout on a quarterly basis that it adopted during its period of windfall earnings.
• ASPs dip but soft volume recovery weighs further. Revenue contracted by 25% q-o-q (- 67% y-o-y) to RM1,584m in 1QFY22. This was attributed to blended ASPs declining by 32% q-o-q (nitrile declined 37%). This was amid the US$/RM rate gaining 0.8% q-o-q and volume growing 11% q-o-q. Notably, volume growth was off a low base, as utilsation rates for the quarter remained subdued at 55%. The general softness was due to an influx of supply in the market and customers opting to hold out for lower ASPs before restocking.
• Positively, utilisation rate going forward should gradually improve as Top Glove regains its North American customers it lost during the withhold release order (WRO) by the US Customs and Border Protection. That said, ASPs have continued to slide, with nitrile ASPs currently at US$25-30/’000 pieces or -20% vis-à-vis 1QFY22.
• Costs decline but margins still weighed by lower ASPs. EBITDA margin softened to 19.0%, or -18.0ppt against lower ASPs. This was cushioned by lower raw material cost, namely latex and nitrile cost, which declined 8% and 19% q-o-q respectively. However, natural gas cost was more expensive for the quarter. Top Glove's 1QFY22 core earnings declined further by 70% q-o-q because of a higher effective tax rate of 21.8% (4QFY21: 13.4%) due to provisions for the prosperity tax.
• Going forward, latex is expected to increase due to LaNina while nitrile cost is due to decline to US$1.08/kg or 47% from September’s price in tandem with lower demand. That said, margins will continue to normalise further against lower ASPs.

Capacity Expansion Intact for Now

• Positively, despite ASPs normalising, Top Glove’s outlook on capacity expansion of 162b by 2024 remains intact. ASPs are due to reach pre-pandemic market equilibrium in early-22. This is our base assumption at this juncture. That said, we do not rule out margins being compressed to below that of pre-pandemic levels off the back of increased production capacity in the market and further deferred capacity expansion by both Top Glove and its peers going forward.

Hong Kong Listing Still Intact

• Top Glove is expected to resume its pursuit of its Hong Kong listing by early-22. The issuance of new shares and the subsequent dilution are 7.9% and 9.0% should the overallotment option be fully exercised. There may be a dilution to our target price, but the exact quantum will be determined when details for the listing are finalised.

Top Glove - Earnings Revision

• We cut our FY22/23/24 earnings forecast for Top Glove by 60%/1%/1% respectively, off lower ASPs and volume assumptions. Key downside risks include:
  1. softer volume sales, and
  2. disruption to its production or supply chain caused by the COVID-19 outbreak.
• Maintain HOLD call on Top Glove with a lower target price of RM1.75 (from RM1.85). Despite the sharp cut to FY22 earnings, our target price for Top Glove does not decline in tandem as our SOTP-based valuation is derived from the present value of 2022 dividends + 2023 earnings pegged to 19x, -1 standard deviation to its 5-year P/E mean.
• While Top Glove is faced with industry downcycle headwinds, much of the downside is increasingly priced. However, we do not rule out further disappointment given lofty consensus estimates and potential deferred capacity and dampened utilisation rates.

Source: UOB Kay Hian Research - 13 Dec 2021