• Top Glove's earnings disappointed as ASPs and volume demand weakened amid higher costs. Losses are expected to persist but ASPs may have bottomed with a cost-led revision.
• Industry headwinds continue to cloud Top Glove’s near-term prospects. This is further compounded by its potential removal from the FBMKLCI in the upcoming review.
• However, downside surprise appears to be largely priced in at this juncture. Maintain HOLD call on Top Glove but with a lower target price of RM0.76.

Top Glove's 4QFY22 Below Expectations

• Top Glove's 4QFY22 (1 Jun 2022 to 31 Aug 2022) core net loss of RM52.6m (-444% q-o-q, -108.6% y-o-y) lowered FY22 core profit to RM236.0m (-97.1% y-o-y). This was below our and consensus’ expectations, with cumulative earnings accounting for 79% and 77% of our and consensus’ full-year estimates respectively.
• The negative deviation was due to lowered-than-expected ASPs. Demand-supply remains stubbornly imbalanced and is not expected to reach equilibrium until 2H23. Top Glove has temporarily halted the payment of dividends as it prioritises the preservation of cash. This is merely a safeguard as Top Glove’s balance sheet remains highly robust.
• Revenue heavily curtailed by double whammy. 4QFY22 revenue continued to decline sequentially to RM990m (-32.4% q-o-q, -53.2% y-o-y). This stemmed from ASPs and sales volume declining 5.4% and 35.0% q-o-q while forex was favourable at 4.5%. Nitrile ASPs fell 10% q-o-q. The sluggish volume sales and ASPs can be attributed to:
  1. elevated inventory levels,
  2. customers’ lack of urgency to order as utilisation rates remain sluggish,
  3. aggressive price competition from Chinese glove-makers, and
  4. very low pricing from some exiting glove producers.
• Management expects some further softness in ASPs but at a diminished rate. It has since raised ASPs by 5% for Oct 22 to pass through higher input costs.

Losses But No End in Sight Just Yet

• EBITDA margin barely broke even at 0.6%, dropping 5.2ppt q-o-q. The respective 12.5% and 5.4% q-o-q declines in latex and nitrile costs were unable to offset the lower ASPs, suboptimal utilisation rates (40-45%) and a full quarter of other higher cost, in particular, minimum wage and natural gas tariff (10% q-o-q).
• Apart from that, Top Glove wrote down its inventory value by RM56m in 4QFY22, and cumulatively by RM229m over FY22.
• Consequently, 4QFY22 fell into RM52.6m of losses. While latex and nitrile costs continue to soften off tepid demand, natural gas is expected to increase by 29%, effective Oct 22. Given this backdrop, we expect further losses in the quarter ahead.

Expansion Deferred as Production Remains Underutilised

• The industry utilisation rate of around 50% is unlikely to incentivise the glove producers to expand capacity over the immediate term. Similarly, Top Glove does not intend to expand capacity over 2022-23. The demand-supply equilibrium could be facilitated by natural organic demand growth but accelerated by industry consolidation. The latter could stem from the smaller glove producers and new entrants that have now fallen into losses.
• Top Glove should well weather the downcycle in the industry. Its balance sheet is robust, with a net cash position of RM551m (RM0.07sen per share) and a gearing position of 0.06x.

Top Glove - Earnings Forecast Revision and Recommendation

• We cut our FY23-24 earnings forecast for Top Glove by 74%/8%, off lower ASP assumptions.
• Key downside risks include:
  1. softer volume sales,
  2. further demand-supply imbalance, and
  3. inability to pass through costs.
• Maintain HOLD call on Top Glove but with a lower target price of RM0.76 (from RM0.95). Our target price is derived from a P/E of 31.4x to FY23’s earnings or its +1.5 standard deviation of its 5-year P/E mean. Our P/E peg is appears relatively inflated given Top Glove’s current predicament. However, as earnings normalise in 2024 based on Top GloveGlove’s mean P/E of 23x, a target price of RM1.18 is derived.

• While Top Glove is faced with industry downcycle headwinds, much of the downside is increasingly priced in. However, we do not rule out further disappointment with stiff competition.

Source: UOB Kay Hian Research - 21 Sep 2022