We attended Top Glove’s 4QFY19 briefing and here are some key takeaways. Top Glove plans on enhancing the usage of technology to lessen physical manpower. With FY20 total estimated capital expenditure of RM600m, Top Glove plans to utilize it for automation, building new factories, expanding production capacity as well as M&A. We adjust our FY20-21 forecast downward by -5.5% and -5.8% after factoring in higher interest expense as well as expectations of lower nitrile ASP and margin pressure. We maintain BUY but with lower TP of RM5.02.

Recap. FY19 core PATAMI of RM382.4m (-14.6% YoY) accounted for 96% of ours and 93% of consensus estimates. FY19 dividend of 7.5 sen per share was declared (FY18: 8.5 sen per share). Even though FY19 revenue grew to RM4.8bn (+13.9% YoY) due to higher sales volume (+10% YoY), core PATAMI fell (-14.5%) due to time lag of cost-pass through mechanism and higher depreciation and interest costs.

Growth. FY19 revenue mix was mainly driven by nitrile gloves segment (46%) followed by latex powdered (21%), latex powder free (18%), surgical (12%), vinyl (2%) and cast polyethylene (CPE) and thermoplastic elastomer (TPE) (1%). On the other hand, FY19 sales volume growth showed +10% (YoY) improvement especially thanks to improvement in nitrile (+30%) and surgical segment (+46%), the growth was slightly pulled back by the weaker vinyl (-29%) and latex powdered segment (-5%).

ASP. YoY, ASP for nitrile segment showed an improvement of +6% while NR segment improved slightly (+2% YoY). As for vinyl gloves; the intense competition has resulted in lower ASPs since February 19, nevertheless in the past 6 months, ASP has stabilized and continues to improve. However, while the organic demand for gloves is estimated at 8-10%, Top Glove is expected to increase its capacity to 84.1bn pieces per annum by FY20 (+31.6%), hence we foresee that margin recovery could be prolonged further.

Industry 4.0. Top Glove plans on utilizing technology to further automate and digitalize production lines to reduce reliance on workers and improve quality and efficiency. This is done through implementations of new technology into existing and new factories via; (i) Artificial Intelligence (AI) Vision Camera for online detection and removal of defective gloves (expected to reduce 10% manpower when fully implemented by CY20), (ii) advance auto packing machine (expected 4% reduction in manpower when fully implemented by CY21) and (iii) smart warehouse with AGVs (automated guided vehicle) (expected 3% reduction in manpower when it begins commencement by CY20). Thanks to automation, Top Glove has recorded a 48% reduction (from FY13) of number of workers per million pieces of gloves.

Outlook. Top Glove total estimated capital expenditure for FY20 is about RM600m which will be used for automation, building new factories, expanding production capacity (80% of expansionary capex will be used for nitrile glove segment) as well as M&As. By CY20, Top Glove is projected to have 38 factories with 876 production lines. Top Glove is strengthening their focus on the nitrile glove segment; and has increased its nitrile capacity by 54% over the past 2 years, with plans to grow further. Apart from that, they are putting efforts at diversifying into other business such as condom manufacturing and dental dam.

Forecast. We cut FY20-21 forecast by -5.5% and -5.8% after factoring expectation of lower nitrile ASP due to expected capacity of 84.1bn pieces per annum by FY20 (+31.6% YoY) (above the 8-10% demand growth for gloves), and higher interest expense. ASP recovery in nitrile gloves will be longer than protracted in our view, in light of the continuous capacity expansion (80% of expansionary capex to be used for nitrile segment) expected in FY20.

Maintain BUY, with a lower TP of RM5.02 (from RM5.31). Our TP is based on FY20 earnings pegged to a PE multiple of 26x. We like Top Glove for its diverse product mix and its prime position to chip away market share.

Source: Hong Leong Investment Bank Research - 7 Oct 2019