• We are maintaining our Overweight call on the sector, as we believe the recent decline in share prices is unjustified as the sector is trading at PE valuations below -1SD
• We have already factor in ASPs to decline by 30-35% in 2022, as we believe that ASP would decline progressively instead of a sharp decline over a short period of time
• Despite expecting a profit decline over the next 2 years (2022-23), we believthat the dividend yield for 2021 and 2022 at 5.3% and 9.9% would likely provide some protection against downside risk

Clarity on ASPs Would Help Drive Re-rating

Since the start of the year, the overall market cap of the sector has contracted by 19%, and has underperformed the overall market, which manage to deliver -1.7% Ytd return. There is no doubt that the current ASP trend is not sustainable, as demand would normalised as more vaccines are being administered. However, we are of the view that ASPs would fall gradually and would not revert back to pre Covid19 levels at least for the next 2-3 years. We reckon that ASPs are likely to decline by 30-35% (3%-3.5%/month) in 2021, consistent with Frost & Sullivan’s research report commissioned by TOPG. Although we are expecting overall supply to increase by 20% per annum over the next few years, demand is also expected to grow by 15% outpacing historical growth of 8-10% per annum.

Valuation Gap Against International Peers Have Narrowed

Due to the recent decline in share prices, the valuation gap between the Malaysian glove makers and international players have narrowed quite significantly. As the 2 Chinese listed glove markers are currently trading at 5-7x CY22E PER, the recent decision by TOPG to list on Hong Kong Stock Exchange (HKEX) might help to attract more interest from an enlarged investors base, given the relatively undemanding valuation of the Malaysian players. The Chinese glove makers share price have also outperformed the Malaysian glove makers as they have risen by 2% and 29% Ytd. Intco Medical (30067 SZ) has also recently filed for an IPO application to list on HKEX.

Company Specific Newsflow Has Ruined Sentiment

Apart from the concern about the uncertainty of future ASPs, the recent development of company related newsflow had also hampered investor sentiments on the sector. Our checks indicated that that the order cancellations, the shortening of lead time and the equity fund raising are not related to the outlook of the overall sector but peculiar to TOPG only. Due to TOPG’s dominant market share, there were concern as TOPG might be raising fund in anticipation of an weaker outlook moving forward. We believe these concerns would likely ease moving forward, so long as the overall lead time remains around 12 months. As such, we are keeping our sector Overweight rating unchanged with Hartalega as our top pick.

Post Covid19 ASPs to Remain Above 2019 Levels

Glove Consumption to Increase by 15% Per Annum Till 2025

Based on a report byindependent consulting firm Frost & Sullivan (F&S), commissioned by TOPG, they reckon that the demand for disposable gloves would grow by 15% CAGR for the next 5 years, mainly supported by the rise in consumption from the medical segment. We concur with their thesis, as we believe that the Covid19 pandemic would likely change consumption patterns similar to previous pandemics, given the increase awareness of the importance of PPE. Public policy changes are also inevitable, for example in China, the National Health and Family Planning commission in January 2020 had started to require medical staff to wear disposable gloves when necessary.

ASPs Unlikely to Fall Back to Pre-Covid19 Levels

Our ASP forecast is less aggressive than F&S, as we are only expecting a 30% decline in nitrile ASPs in 2022, while they are expecting ASP to decline by 37% in 2022, post a peak ASP in 2021. Although we expect ASPs to start falling by early 2022, F&S reckons that prices would only start to decline by mid-2022. Despite expecting an increase in supply, they believe that ASPs are unlikely to fall back to pre-Covid19 levels within the next few years, which is similar to our ASP assumptions. New competition is inevitable, but we believe they would likely focus in the non-medical segments in the early years, as it takes time to build a reasonable track record before penetrating the medical segment.

China Manufacturers Are Not a Threat to Supply Demand Balance

Anticipating robust demand growth post covid-19, China manufacturers have also set up plans to increase their production capacity within the nitrile segment to benefit from this. We believe that most of these manufacturers have decided to enter the nitrile segment due to its better margins, despite most of their current production being in the vinyl segment. The decision to switch over was likely spurred by their diminishing margins, as overcapacity has limited manufacturers ability to raise ASPs, despite the rising cost. Previously, the China government had limited the usage coal as fuel/heat source to improve its air quality, which forced manufacturers to switch to the more expensive natural gas in 2017. However, as the China government has eased some of this restrictions, the cost pressure is likely to have ease as well. We believe that given the improving demand and rising ASPs, the China manufacturers might not follow through on their nitrile expansion targets, as margin have recovered. We expect most of the demand for vinyl gloves to likely come from the non-medical segment, as the Covid19 pandemic has helped to open up new venues for glove usage

Sentiment Is Driving Valuation Not Fundamental

A Closer Look at International Peers’ Valuation

We believe that the recent decision by TOPG to list on the HKEX, would have spurred investors to take a closure look at the valuation of its international peers, which are currently trading at a slight discount relative to the Malaysian names. However, the valuation discount has narrowed significant recently, after the sharp decline in share prices. The China listed glove makers are currently trading at 5-7x CY22E PER (based on Bloomberg estimates), while the Malaysian glove makers are currently trading at 6-13x CY22 PER (average 11x).

We believe that the Malaysian glove makers are unlikely to trade on par with its International peers, as the Malaysian glove makers are still able to deliver higher dividend yield and better ROEs. As such, we are not expecting a further PE multiple de-rating for the Malaysian glove players. Interestingly, both the China glove makers share price performance have outperformed its Malaysian peers, delivering a 2%- 29% Ytd return in comparison to its Malaysian peers, which delivered a negative Ytd return of 14%-25%.

At -1SD PER, There Is Significant Upside to Current Share Price

We believe that the uncertainties in the market with regards to future ASP is largely driven by sentiments rather than fundamentals, as current sector valuations are already trading below -1SD of 2022 PER. Even by pegging the stock to the -1SD historical average valuation, there is substantial upside (28%-113%) from current share price. As such, we believe that current valuations are too cheap to ignore, and maintain our Overweight call on the sector. Hartalega remains our preferred pick for the sector, as we are expecting the large-cap glove name to re-rate followed by the smaller-cap ones.

Making Sense of Top Glove’s HKEX Listing Proposal

TOPG’s Current Proposal Is Dilutive to Current Shareholders

Based on the current proposal where TOPG plans to issue up to 1.495bn (over allotment) of new shares, and hopes to raise up to HKD14.95bn (RM7.7bn). Based on its current share base, the potential dilution could be as much as 18.65%, if all the shares are taken up, or 16.22% should the over-allotment option not be exercised. Certainly, if TOPG’s share price is to sustain above RM5.15/share, TOPG can reduce the size of the offering, which will limit the dilution of existing shareholders. Nevertheless, the majority shareholder would also be diluted post the IPO.

TOPG Selling Shares at Discount Might Cause Uneasiness

Although TOPG’s proposed HKEX listing might help to increase its reach to new investors, TOPG’s valuation might not be that attractive relative to its international peers, and may need for its new shares to be offered at a discount, creating an overhang for its share price. Intco Medical Technology (300677 CH, Non-rated) have also filed for an IPO application recently, to list on HKEC, and TOPG might face competition if both IPOs are launched back to back. We believe that the current corporate exercise might create uneasiness for investors, given its need to build up its balance sheet, while increasing dividend payout and continuing to buy back its own shares

Building a War Chest for Potential M&A

Although TOPG mentioned that around 40% of the funds raised will be utilised as capex for TOPG’s capacity expansion for the next 2-3 years, we believe that TOPG could have funded the capex with their current cash flows and balance sheet. By annualising the 1QFY21 profit with a 70% dividend payout ratio, TOPG would be able to generate around RM2.8bn of cash in FY21. Apart from that TOPG has close to RM3.8bn cash in its balance sheet. We reckon that TOPG might be building a war chest for potential M&A in the near term, as there are no other apparent reasons to dilute existing shareholders.

Source: Affin Hwang Research - 8 Mar 2021