9MFY19 core PATAMI of RM299.5m was below expectations. The results were below mainly due to a spike in prices of natural rubber during the quarter (+22.0% QoQ) and the subsequent lag in ASP revision which affected margins. We expect this to reverse in 4QFY19 given that prices have been revised upward since May (+8.8%). Maintain BUY and TP of RM5.31, based on FY20 earnings pegged to a PE multiple of 26x.

Below expectations: 9MFY19 core PATAMI came in at RM299.5m (-11.0% YoY), accounting for 68.2% of our and 65.1% of consensus estimates. The results were below mainly due to a spike in prices of natural rubber during the quarter (+22.0% QoQ) and the subsequent lag in ASP revision which affected margins. We expect this to reverse in 4QFY19 given that prices have been revised upward since May (+8.8%).

Dividend. Declared first interim dividend of 3.5 sen/share going ex-2nd July 2019.

QoQ. Revenue improved by 2.6% in tandem with volume growth of 2% QoQ. EBITDA declined 23.3% QoQ to RM182.3m, whilst EBITDA margin declined by 4.0 ppts to 11.7% (from 15.7%). This is attributed to a 22% increase in latex prices in 2Q19 and the subsequent time lag associated with passing on the cost to customers (note that latex accounts for 45.0% of production costs for Natural rubber gloves). Core PATAMI declined by 3.1% despite a lower tax expense (8.6% vs. 15% in 2Q19 – due to a write back for an overprovision – we expect subsequent quarters tax rate to normalize on a full year basis c. 18%-19%). In computing our core PATAMI we added back RM15.0m of forex losses.

YoY. Revenue grew 8.1% to RM1.19bn (from RM1.10bn) from higher volumes sold (+9%) whilst ASP was flattish. The volume growth mainly came from the nitrile (+25%) and surgical (+29%) offset by vinyl gloves (-42%). EBITDA declined 20.4% YoY (to RM139.7m) and margins eroded by 4.2ppts due to the sharp spike in natural rubber prices associated with a multitude of factors; (1) wintering season (February to May) (2) the run up to the Thai elections saw rubber prices boosted and (3) the ongoing drought in Thailand. PBT declined 38.7% YoY to RM82.2m due to a higher interest expense (+58.0% YoY) due to M&A and organic expansion. Subsequently, core PATAMI declined 29.7% YoY (to RM89.5m after adjusting for FX losses amounting to RM11.4m vs RM1.2m in 3Q18). A higher effective tax rate (16.0% vs. 12.0% in 3Q18) accentuated the decline.

YTD. Revenue improved to RM3.61bn (+20.5%) attributed namely to higher volumes (+15% YoY). The volume growth mainly came from nitrile (+35%) and surgical (+75%) offset by vinyl gloves (-25%). EBITDA improved to RM518.6m (+11.2%), whilst EBITDA margins declined 0.9ppts (to 14.3%) due to higher raw material prices and competitive pressures. Core PATAMI of RM299.5m (-11.0%) exhibited negative growth YoY due the same above mentioned factors- namely commodity swing and higher finance costs.

Capacity expansion. We understand that F32 1st phase (Nitrile/Latex) and F33 (Latex) are operational and currently producing. In 2HCY19 we will see additional 1.2bn pieces of new installed capacity. This implies that in CY19 TG will increase new capacity to a maximum of 4.6bn pieces or 7.6% YoY, which is well within the range of the annual demand growth (see figure #2).

Outlook. ASP for the latex segment has already been revised upward from May onward (+8.8%) which should normalize margins moving forward, ceteris paribus (c.15%-16% at the EBITDA level). Aspion achieved an EBITDA of RM40.6m and as such, no impairments were necessary. We expect Top Glove to conclude FY19 on a better standing on improved profitability QoQ.

BioGreen. Top Glove recently launched its bio-degradable nitrile examination gloves. The product is proven to decay 10x faster compared to existing conventional nitrile gloves. We understand that it has been well received in developed nations (EU, Japan and USA). Management didn’t share the product’s pricing, however given the recent global enthusiasm on environmental issues and recent rubbish dumping by western nations to Malaysia and alike; we can expect Top Glove to leverage this product to their benefit.

Forecast. We adjust our FY19 earnings downward by 9.3% as we recalibrate our model with higher average latex prices for FY19. However, FY20-21 earnings are unchanged as the ASP price revision in May should help preserve margins going forward.

Maintain BUY, TP: RM5.31. Maintain TP of RM5.31 and our BUY call. Our TP is based on FY20 earnings pegged to a PE multiple of 26x. We like Top Glove for its more diverse product mix and its prime position to chip away market share.

Source: Hong Leong Investment Bank Research - 19 Jun 2019