Top Glove (TOPG) reported a weaker than expected set of 1HFY19 results. PATAMI of RM215.8m (+0.6% yoy) fell short of both our and consensus estimates, delivering only 40% and 43% of our respective forecast. Apart from a higher tax rate, the weakness was attributed to weaker contribution from its China operation. Excluding its China operations, PBT would have increased by 14.3% instead of the recorded 8.5%. We have reduced our EPS estimates to factor in the recent performance, and lowered our TP to RM4.90. Upgrade to BUY on valuations.

China Operation Impacted by Competition

We believe that Top Glove’s China operations was negatively impacted by the change in the recent environmental regulation, which has allowed some manufacturers to resume production despite using coal as a heating source. The increase in the availability of capacity has driven vinyl glove ASPs lower, which is hurting Top Glove’s profitability, as TOPG has converted some of its lines to natural gas to meet previous regulation targets. Its China operations made a EBIT of RM1.3m in 1HFY19, which is significantly lower than the RM6.3m recoded in 1HFY18.

Volatility in RM Caused Weakness Qoq

Due to the limited capacity gain in 2QFY19, overall, sales volume grew by 1% qoq, as capacity remain unchanged at 60.5bn pcs and utilisation remained at around 90%. Apart from the weaker China operation, the Malaysian operations also suffered a reduction in profitability due to the strengthening of RM against the US$. As the order lead-time is around 1- month, Top Glove and other manufacturers are exposed to the volatility of the currency. Subsequent price revisions have reflected the currency movement, but still lags current spot price due to volatility.

Upgrade to BUY on Valuation

We have cut our EPS forecast for FY19-20E by 13%-15% to factor in the weaker performance from its China operation, the lower than expected interest cost savings, and the lower profitability from the volatility of the currency. Apart from the EPS cut, we have also lowered our TP to RM4.90, as we lower our PE multiple to 24x (+1SD) from 27x and roll forward our valuation base to CY20E. The cut in PE multiple is to reflect the risk related to its China operation.

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 - 25 Mar 2019