Delayed Orders

Top Glove’s 3Q FY17 earnings of RM78m came in slightly below our preview range of RM80-85m. The key deviation was attributed to the 5% qoq decline in volume, as buyers delayed their purchases due to the higher ASPs. However, 4Q FY17E earnings should trend stronger with order replenishments, and buoyed by lower raw-material prices. We reaffirm our BUY call and TP of RM6.50.

Volume Decline Due to Delayed Orders

Top Glove’s 3Q FY17 revenue rose a marginal 2% bolstered by the higher ASP revision, as volume fell on delayed purchases and the impact from a lack of capacity expansion during the quarter. We understand that given the sharp revision in ASPs (+9% qoq), most buyers delayed their orders in anticipation of a fall in raw-material prices in 4Q FY17. As such, volume shrank 5% qoq. We see this as a one-off event and merely a timing issue, and expect 4Q volumes to expand strongly on inventory replenishment, as well as the addition of new capacity (Factory 30; capacity of 2.8bn gloves).

Raw Material Increase Crimped Margins

3Q FY17 core earnings of RM78m were slightly below our expectations of RM80-85m (see Abating competition, 7 June 2017), largely due to lower volumes in the quarter. Earnings were also hit by the time lag in cost-pass through from the rise in raw-material prices, which crimped margins. In 3Q FY17, average natural rubber latex prices climbed 19% qoq to RM7.06/kg, while those for nitrile butadiene rose 24% qoq to RM1.34/kg. The Ringgit also strengthened by 2% qoq vs. the USD, which led to margin pressure.

Sequential Earnings Recovery in Sight for 4Q FY17E

We look for a sequential earnings recovery in 4Q FY17E for 3 key reasons: (i) higher volume growth on order replenishment; (ii) margin expansion from the fall in natural-rubber price; and (iii) higher organic capacity growth from the consolidation of 2 factories purchased and the commissioning of Factory 30 with an annual capacity of 2.8bn gloves.

Reaffirming Our BUY Rating

We maintain our strong earnings outlook for Top Glove driven by capacity expansion and a higher nitrile contribution. We reaffirm our BUY call and 12-month target price of RM6.50, based on a CY18E PER of 18x. Top Glove remains our top sector pick for its growing nitrile mix, strong volume expansion and relatively compelling valuation. Risks to our call would be a sharp appreciation of the Ringgit and a higher-than-expected increase in raw-material prices.

Source: Affin Hwang Research - 19 Jun 2017