Turning positive due to better quarters ahead

We are upgrading our call on Top Glove (TOPG) to BUY from SELL, after raising our TP to RM5.20 from RM4.10, as we are expecting better quarters ahead for the sector and TOPG, due to improving demand for Malaysian rubber gloves. We believe that since the US has already started to impose a 15% tariff on gloves from China, buying patterns should start to normalise, as distributors were stocking up on China gloves in anticipation of the tariff hike. Medical gloves imported from China into the US has risen by 45% YTD (Sep) with a 14% market share.

Malaysia is still the market leader, but China has gained ground

Despite the significant gain in market share (sales volume) by the Chinese manufacturers for glove sales to the US (which has risen from 10.2% in 2018 to 14.2% in Sep 19), Malaysia still remains the market leader with a 74.2% share. The gain in market share has nevertheless impacted the overall demand from Malaysian manufacturers like Top Glove, as overall glove imports from the US only grew by 1% yoy for the first 9 months in 2019. Malaysian manufacturers were not the only casualties, as Thailand and Indonesia also recorded 4% and 19% decline in their sales to the US. We believe that Malaysian manufacturers will start gaining market share in the coming months as the 15% tariff on Chinese gloves was implemented since Sep19.

Improvement to start from the 4QCY19

We believe that sentiments on the sector would improve as the recovery in demand starts to be reflected in the manufacturers books starting with their 4Q19 results. Although there are concerns over rising competition from Thailand, given that Sri Trang Gloves (SRI) is aggressively building capacity as they prepare for an IPO in 3Q20, we believe that SRI is unlikely to cut prices further to compete for market share gains as their new capacity will only be ready by 2H20. Rubber glove manufacturers with significant exposure in the latex glove segment such as Top Glove, were impacted by the price pressure.

Upgrade to BUY with higher TP of RM5.20

As we are taking a more positive stance towards the sector and Top Glove’s outlook, we are raising our TP to RM5.20 from RM4.10 based on a higher 31x CY20E PER (+1 SD) from the previous 24x. We believe that at a PER of +1SD, valuations are still palatable due to its decent earnings growth. Key downside risk to our investment thesis are: (i) sharp increase in volatility of RM/US$, (ii) unexpected increase in operating cost, (iii) irrational competition among its peers, and (iv) the removal of TOPG from the FBMKLCI index.

Source: Affin Hwang Research - 15 Nov 2019