We attended Top Glove’s 2Q19 briefing. YTD growth by volume (+18%) came from developed markets, North America (28.1% YoY) and Western Europe (38% YoY). Advancing into industry 4.0, TG is testing the use of vision inspection machines for their QC. We adjust our FY19-21 forecast downward by -3.6% as we recalibrate our tax assumptions upward (from 15% to 18%) based on management guidance. Maintain BUY but with lower TP of RM5.31, based on FY20 earnings pegged to a PE multiple of 26x.

We Attended Top Glove’s 2Q19 Briefing; the Following Are Some of the Key Takeaways:

Recap. 1HFY19 core PATAMI of RM210.1m (+0.4% YoY) accounted for 46.1% of ours and 41.7% of consensus estimates, against a revenue base of RM2.42bn (+27.7% YoY) and EBITDA of RM378.6m (+30% YoY).

Growth. YTD growth by volume (+18%) came mainly from developed markets such as North America (28.1% YoY) and Western Europe (38% YoY), followed by good performance from Latin America (11.6% YoY) and Africa (14.7% YoY). Management highlighted that Aspion acquisition has opened doors to the North American market and they have benefited from being able to cross sell their products. Expect sales from North America to continue to drive topline as the group prepares to enter the Walmart and Walgreens distribution network in the near future.

Weaker ASP. Revenue eased by 8.1% QoQ on the back of ASP pressure due to (i) down trend in raw materials and (ii) competitive pressures. Management highlighted that much of the pressure on margins came from the NR segment QoQ, contrary to expectations that Nitrile would face more ASP pressure. This is due to the downward velocity of NR ASP (-5% QoQ) overwhelming the decline in NR prices (-4.2% to RM3.62/kg) coupled with a weaker USD (-1% QoQ). For the Nitrile segment the ASP revision (-8% QoQ) velocity was offset by the larger quantum in decline of nitrile prices (-14.3% to USD1.08/kg QoQ). Moving forward we can expect NR segment ASP to be on an uptrend offset by downward ASP pressure from the Nitrile segment.

Industry 4.0. Top Glove commenced the testing of vision inspection machines at some of their newer factories to help expedite the QC process. We understand that the group will ultimately roll out a vision inspection machine at each of their 600+ production lines. This is expected to reduce c.600 foreign workers per shift. The group is also targeting to pilot their automated warehouse management systems and auto packaging system by mid-2019. In the long run these initiatives are expected to reduce physical man power by c.17% at their newer factories.

Taxes. The bulk of the unutilised tax allowance (c.RM203m) is available at newer subsidiaries with a lower profit base; whilst the group has exhausted tax incentives for subsidiaries with higher profit base, thus resulting in a higher effective tax rate (18.3% in 1H19 vs. 12.4% in 1H18). Future earnings growth will come from these new entities that still enjoy the tax allowance. Moving forward the effective tax rate should remain within the 18%- 20% level.

Forecast. We adjust our FY19-21 forecast downward by -3.6% as we recalibrate our tax assumptions upward (from 15% to 18%) in line with management guidance.

Maintain BUY, TP: RM5.31. Maintain BUY and a lower TP of RM5.31. Our TP is based on FY20 earnings pegged to a PE multiple of 26x (from 28x) or 0.5SD above the sector mean (see Figure #2). Given the YTD sell down (-25%), risk reward looks attractive as the TG is trading at its 3 year mean (see Figure #1).

Source: Hong Leong Investment Bank Research - 29 Mar 2019