Highlights

• TopGlove is set to release its 4QFY16 result on 12 October 2016. We expect the result to be either flat or marginal QoQ growth in the region of RM60-65m (flat to +6%), bringing full year earnings to RM353m to RM358m, in line with our full year forecast of RM354m but falling short of consensus estimate (circa 5-6% below).

• The flat or marginally QoQ improvement in earnings is on the back of slight recovery in ASP (3% to 5%) but offset by rising production cost (higher latex price from RM3.94/kg to RM4.4/kg and minimum wage hike from RM900/mth to RM1000/mth).

• Despite 4Q16 result potentially matching our expectation, we are adjusting our FY17 and FY18 earnings downward by 7% in view of the i) recovery of ASP in a more gradual manner due to pricing competition, ii) rising production cost, and iii) exceptionally high earnings in 1H16 due to surge in US dollar. EBITDA margin is expected to normalise to 15-16% level (as compared to >20% from 4QFY15 to 2QFY16).

• Share price had recently rebounded from the low of RM4.20 to recent high of RM5.13. At current share price, TopGlove is trading at 1std deviation above its average 5 years P/E band. In view of lack of fresh catalyst and normalisation of margin, we downgrade the stock from BUY to HOLD.

• Average Latex price has also climbed up recently from RM4.2/kg to RM4.6/kg while average nitrile price remains stable at below $1/kg. We expect latex price to stay at this level as the oversupply situation remains due to substantial planting in 2008-2012 period.

• Currently, we have factored in RM4.06/US$ and RM4.00/US$ in our FY16 and FY17 assumptions even though ringgit has recently weakened to RM4.16/US$.

• On capacity expansion plan, F27 Lukut Plant will be fully commissioned in Nov16 with additional 2bn new production capacity for NBR glove. Total capacity is expected to increase by 14% in FY17 after inclusion of partially commissioned F30 factory. Key risk to the expansion plan includes difficulty in securing foreign worker.

Risks

• Further reduction in ASP amid steep competition; Surge in nitrile and latex prices; and Weaker USD against MYR.

Forecasts

• FY17 and FY18 earnings forecasts are reduced by 7% as we factor in slower-than-expected margin recovery.

Rating

HOLD

• Despite the downgrade, we still like TopGlove for its exposure in resilient export market (in view of rising protectionism in global trade) and potentially benefiting from strong USD on higher likelihood of Fed rate hike.

Valuation

• Post earnings forecast adjustment, we downgrade from BUY to HOLD with TP lowered from RM5.27 to RM4.91 based on an unchanged P/E multiple of 18x CY17 EPS.

Source: Hong Leong Investment Bank Research - 10 Oct 2016