We are upgrading our call on Top Glove (TOPG) to BUY from Hold, with an unchanged TP of RM12.00, as we believe that the share price correction is overdone. Fundamentals of the company remains largely unchanged, despite overpaying for a recent acquisition. There is also no breach in its debt covenants, and cash flow from its existing operation are sufficient to meet the debt obligations without impacting dividends.

Addressing the Problem Head on

By initiating the arbitration process, TOPG management is now able to take full control of Aspion’s operations and fully integrate the business with its existing operation, which was not allowed previously, due to the profit guarantee arrangement. Management did acknowledge that to achieve a net profit of RM80m from Aspion organically would be challenging initially, but believes that it is still an achievable target over the near-term (the current net profit run rate is around RM3.5m/mth). We believe that management has the ability to achieve the target, proven by its previous track record to turn around glove companies (GMP Medicare).

Correction Overdone, Existing Business Remains Intact

We believe that the share price correction is likely overdone, as the share price has corrected by ~25% or RM3.8bn of its market capitalisation, which is more than what TOPG had paid for the acquisition (RM1.37bn). Based on our estimates, even if TOPG is not able to get a favourable decision, there should be minimal dilution impact to the current shareholders. Management has also indicated that there are no in breach of any financial covenants of the syndicated loan they had obtained for the deal.

Upgrade to BUY With An Unchanged TP at RM12.00

We are upgrading TOPG to BUY, while keeping our TP unchanged at RM12.00 based on unchanged 27x CY19E PER (+2SD), as we believe the share price correction is overdone. We believe the catalyst for TOPG would be in its earnings delivery, which will help investors regain confidence on management. Risk to our call would be sharp movement of the Ringgit, and changes in investor perception on management execution capability.

Source: Affin Hwang Research - 10 Jul 2018