Revenue grew +34.5% YoY to RM1.26bn on higher volumes sold (+19% YoY) in which, 71% of the volume growth was attributed to the nitrile segment. Improvements in technology for nitrile production resulted in lower weight and cost per piece without compromising quality. Top Glove has achieved nitrile gloves weighing only 2.2 grams. With the recent downtrend in oil price, we can expect ASP for the nitrile segment to face some downwards pressure. For this very reason we prefer Top Glove as the other players are Nitrile heavy in their product mix (Kossan 77%, Hartalega >95% vs. Top Glove’s 47%). Maintain TP of RM6.26, we upgrade to a BUY (from Hold) given yesterday’s sell down.

Developed markets. Revenue grew +34.5% YoY to RM1.26bn on higher volumes (+19% YoY) attributed namely to strong sales growth to developed countries. 71% of the volume growth is attributed to developed markets with Western Europe (+37.7%), North America (+28%) taking centre stage in the growth YoY driven by the nitrile segment followed by Japan (+15.2%).

Shift in mix. Swing to nitrile from developing market was namely attributed to tapering demand for powdered gloves from the USA which has also seen a number of countries following suit. Simultaneously, continuous improvements in technology for nitrile production, resulting in lower weight and cost per piece without compromising quality, further enabled this substitution from NR gloves. Note that the group has achieved nitrile gloves weighing only 2.2 grams. We understand that these gloves are sold to the USA, targeted mainly to the F&B sectors.

Gearing. Debt restructuring is on schedule, with the convertible bonds expected to be issued by 1QCY19. The restructuring should result in interest savings of c.RM24m per annum. The debt restructuring will enable Top Glove to tap on a lower fixed yield for the duration of the bond vis a vis the syndicated loan which is based on the position of Libor.

Taxes. The balance of the unutilised tax allowance of RM99m is available at subsidiaries with a lower profit base; whilst the group has exhausted tax incentives for subsidiaries with higher profit base in 1Q19, thus resulting in a higher effective tax rate (21.3% vs. 13.1% in 1Q18). Future earnings growth will come from these new entities that still enjoy the reinvestment allowance and tax allowance. Moving forward the effective tax rate should remain below the 20% level.

Outlook. We note that capacity expansion in 2019 sector wide will be purely nitrile based. This phenomenon could precipitate into unwelcomed ASP pressure from the nitrile segment. Moving forward, nitrile will constitute c.55%-60% of product mix by volume. With the recent downtrend in oil prices, we can expect ASP for the nitrile segment in to face downward pressure in the coming quarters. For this very reason we prefer Top Glove as the other players are more nitrile heavy in their product mix (Kossan 77%, Hartalega >95 vs. Top Glove’s 47%). We note that NR gross margins range between 20%-21%, whilst Nitrile gross margins hover around 18%.

Forecast. Unchanged.

Upgrade to BUY, TP: RM6.26. Our TP is based on FY20 earnings pegged to a PE multiple of 28x, a 25% discount to Hartalega’s 1SD above 3 year mean PE (37x). We note that the onslaught of capacity expansion sector wide in 2019 may welcome downward pressure on ASP especially from the nitrile segment. We prefer Top Glove for its more balanced product mix. Yesterday’s sell down presents a timely opportunity to collect. We thus upgrade the stock from a Hold to a BUY.

Source: Hong Leong Investment Bank Research - 19 Dec 2018