Topglove’s market capitalisation witnessed a RM2.59bn or 17.6% crash to RM4.73 (17 Jan) since announcing its 1QFY19 results (17 Dec) amid concerns over lofty valuations, waning USD boost, demand-supply imbalance, pricing competition and overcapacity in a myriad of costs, as well as the negative prospects for Aspion as the irregularities discovered/ impending legal intervention. In our view, we opine that those risks are overblown and could have been largely priced in after the recent slump, as valuation is undemandi ng at 21.5x FY20 P/E (22.1%/2.7% below 2Y/5Y average of 27.6x/22.1x), supported by the structural positive long-term prospects.

Capacity expansion in 2019. We estimate that the top 4 in the glove industry will have increased capacity by c.15% in 2019 (with majority being Nitrile capacity). We do note that a short term imbalance is expected to manifest in 2019 with the increased supply outstripping the expected annual demand growth of 8%-10%. However, in view of the oligopolistic industry structure, we do not rule out the possibility of glove player’s eventually expanding capacity in a more gradual manner to avoid price competition. Moreover, as Malaysian glove makers’ are better equipped with higher efficiencies and economies of scale, which should bode well for them to capture a bigger piece of our estimated global glove demand growth.

Minimal impact from strengthening RM vs USD. We are not overly concerned about the recent strengthening of ringgit vs USD (2.1% from 52W high of RM4.202) and cost increases (e.g. gas and minimum wage hikes). In our view, this will be more than offset by the recent soft raw material prices (45-50% of total production cost) such as nitrile butadiene prices and ongoing cost efficiency efforts.

Top Glove is our sector top picks. HLIB prefers Top Glove for its more balanced product mix (Natural Butadiene Rubber (NBR): Natural Rubber (NR); 47%:53%) relative to the other players who are more nitrile heavy (Kossan: 77%, Hartalega: >95%). Note that NR gross margins range between 20%-21%, whilst Nitrile gross margins hover around 18%. Meanwhile, the inclusion of Top Glove into the KLCI components will further provide the sentimental anchor to valuations.

Values resurfaced after recent rout. Despite prevailing overblown risks, we view that the erosion in Topglove’s market capitalisation could have largely priced in after the recent slump, as valuation is undemanding at 21.5x FY20 P/E (22.1%/2.7% below 2Y/5Y average of 27.6x/22.1x) supported by the structural positive long-term prospects.

Potential downtrend reversal. The recent Doji and spinning top patterns at the bottom coupled with the tick-up in MACD histogram suggest that base building activities are underway, pending further share price recovery. A decisive breakout above RM4.89 (10D SMA) is likely to lift share prices higher towards RM5.02 (23.6% FR) and our LT objective at RM5.27 (38.2% FR). On the flip side, key supports are situated at RM4.61 (27 Jan low) and RM4.50 psychological level. Cut loss at RM4.47.

Source: Hong Leong Investment Bank Research - 18 Jan 2019