We maintain our BUY call on Top Glove, with a slightly higher TP of RM8.50 based on a 22x FY19E PER, as the reported 1QFY18 net profit at RM105.4m (+44% yoy; +7.0% qoq) is tracking slightly ahead of both our and consensus estimates. We had previously under-estimated the pent-up demand from the glove shortage, as the utilisation rate is now close to 85% compared to its historical average of 80%. Top Glove remains our top sector pick and a top country pick for 2018.

Strong Demand Pushes Utilisation Rate Higher

The biggest positive surprise to us for the quarter was the high utilisation rate at around 85%, which is above its historical average of 80%, despite the new capacity from Factory 30, which has added capacity for around 2.8bn pieces (or +5.7% increase) during the quarter. The peak utilisation rate was slightly above 90%, during the SARS pandemic back in 2002/03. We have revised our utilisation rate assumption for FY18-19E to 83% from 80% to reflect the higher demand.

China, the Gold Mine That Everyone Has Been Waiting for

Most rubber glove manufacturers have indicated that the increase in demand was somewhat related to the disruption in the vinyl glove supply due to China’s strict enforcement against low-value added polluting industries. Assuming that all healthcare operators in China switch to rubber gloves, the incremental demand is estimated to be around 27.6bn pieces or 20% of the current demand, based on the world average of 10 pairs of gloves per person per year (we estimate that people in the US and EU use close to 50 pairs of gloves/year). But the demand would be higher in the first 2 years, as distributors will need to build up sufficient inventory of 3-6 months (or higher) based on their supply agreements and that is not inclusive of vinyl glove usage in other sectors like F&B.

Positive Sentiment Could Surprise on the Upside

We raise our TP to RM8.50 from RM8.00 based on a 22x FY19E PER, on the back of our 2.3%-6.3% earnings forecast revisions for FY18-20E, while maintaining our BUY call and noting that the share price could trade above our TP in the near term, due to positive sentiment surrounding the sector. If Top Glove were to trade at a similar PER multiple to Hartalega (HART MK, RM10.72, HOLD) at 33x FY20E (March y/e), its share price could reach RM12.70, which implies 70% upside potential.

Risks to Our Call

Downside 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 - 20 Dec 2017