We came away from Top Glove's analyst briefing on Tuesday remaining positive on the company as well as the rubber glove sector outlook.  While its expansion plans are  on  track,  the  company  is  continuously  instituting  efficiency  improvements  to boost  profitability.  Given Top Glove's solid  business  model,  aggressive  expansion and the favourable operating environment, we maintain our BUY call and RM6.25 FV.

Still  on  top.  Thanks  to  steadily  easing  raw  material  prices  and  a  stable  USD/MYR exchange  rate  amid  improving  operating  efficiency,  Top  Glove  continued  to  report  strong earnings  in  1QFY13  after  reporting  robust  results  in  FY12.  In  view  of  the  still  favourable operating  environment,  we  continue  to  remain  upbeat  on  the  company  as  well  as  the sector as a whole. Although Top Glove is ramping up its nitrile gloves production capacity, management  is  confident  that  the  natural  rubber  gloves  market  remains  strong  and  US healthcare demand will continue to grow in 2013.

No significant impact from increasing costs. Top Glove has taken the necessary steps to  mitigate  the  impact  of  the  minimum  wage  policy,  which  kicked  off  on  1  Jan  2013.  Its move to automate its plants is almost 50% complete, with full automationtargeted for mid-2013.  Meanwhile,  management  believes  that  Malaysian  rubber  glove  manufacturers  are still  competitive  given  that  the  quantum  of  increase  in  labour  cost  among  other  rubber glove producing countries such as Thailand and Indonesia is even larger.

Staying ahead of the pack. With three new factories coming on stream, Top Glove's total annual  production  capacity  will  hit  45.1bn  pieces  by  August  2013.  These  new  lines  will cater for nitrile glove production. By then, the company would have a better product mix to capture  both  the  natural  rubber  latex  glove  and  nitrile  glove  markets.  Meanwhile,  Top Glove  is  targeting  to  embark  on  the  first  phase  of  planting  with  regard  to  its  upstream venture  in  rubber  trees  plantations  by  October  2013,  with  first  tapping  expected  in  2020. The  company  has  guided  that  the  estimated  investment  cost  would  be  about  RM450m over a 14-year period, with positive cash flow envisaged in Year 10.

Constant quest for improvement. Armed with the world's largest production capacity, Top Glove's strategy is one of focusing on sales volume rather than charging high ASPs to gain premium  margin  from  its  clients.  Each  of  its  clients  takes  up  only  3%-4%  of  its  total production capacity; this gives it a competitive edge that effectively shields its capacity from being  dominated  by  a  single  client.  Moreover,  the  company  is  currently  enhancing operating efficiency by hiring SAP consultants to implement solutions in production, quality management,  sales  and  distribution,  materials  management  and  finance.  With  such  a system in place, Top Glove aims to better arm itself to capitalize on new opportunities and in the process improve its earnings margins.
 
Outlook  remains  positive.  Moving forward, Top Glove aims to strengthen its presence in Japan via clean room gloves and CPE gloves (for the food industry) in order to expand its product  range  and  client  base.  It  is  also  attempting  to  improve  the  revenue  contribution from  its  China  operations,  particularly  in  the  vinyl  gloves  section.  As  management  has pointed  out,  significant  global  demand  will  come  from  China  and  India  while  increasing healthcare  awareness  in  Africa  is  also  another  positive  factor.  All  in,  given  its  strong fundamentals  and  aggressive  expansion  amid  a  favourable  operating  environment  and growing demand, we think that Top Glove's prospects remain bright.

Maintain BUY, FV RM6.25. All said, we are maintaining our BUY recommendation for Top Glove and retain our RM6.25 FV, derived from 18.7x FY13 PE, which is also +0.5 SD of the stock's five-year historical trading band.

Source: OSK