The key takeaways from Top Glove’s Corporation 4Q13/FY13 post results briefing include: (i) higher sales volume helped offset lower average selling prices (ASP) in 4QFY13, which explained the revenue growth, (ii) potential divestment of low yielding vinyl plants in China, (iii) 90% production automation completed, and (iv) RM200m capex allocated for FY14. Looking ahead, Top Glove is expected to face difficulties in using ASPs to defend market share due to its product mix, which is skewed towards the challenging latex based gloves market. As such we are downgrading our FY14 and FY15 net profit by 2-4% taking into account lower margins in the latex segment which accounts for 75% of the product mix. Correspondingly our target price is downgraded slightly from 6.30 to 6.10 based on 16x CY14 EPS. Maintain our MARKET PERFORM rating. Going forward, growth is expected to be driven by capacity expansion involving an additional 4.2b pieces of gloves, or by 9.6% in June 2014 to a total of 48.1b, largely for nitrile gloves production.

4Q13/FY13 key statistics explained. Top Glove full year FY13 results briefing shed light that provides further explanation to the solid 18% yoy sales volume growth. Generally, FY13 revenue was driven by higher sales volume (+18%), which more than offset the lower ASPs (-16%). Volume in FY13 grew across the board on the back of a higher production utilisation rate of 80% compared to 75% yoy. Nitrile gloves registered the strongest sales volume growth at 65% followed by latex powdered-free (+11%), latex powdered (+8%) which more than offset lower surgical (-18%) segment. 4Q13 product mix tilted favourably towards nitrile at 25% with the remaining balance of 75% from latex gloves. We see this as a positive step in right direction due to the strong demand for nitrile gloves and Top Glove is targeting nitrile gloves to account for between 35% and 40% of overall product mix. In terms of product mix in 4Q13 and FY13, latex gloves accounted for 68% (3Q13: 73%) and 71% (F12: 79%) respectively. Similarly, nitrile accounted for 25% in 4Q13 (vs 18% in 3Q13 and 20% in FY13 vs 14% in FY12). The remaining contributions were made up by vinyl and surgical. Separately, 4Q13 effective tax rate was higher due to the absence of recognition of deferred tax assets and lower deferred tax liabilities. Management guided that going forward normalized effective tax rate would be around 20%, which is in line with our assumption. We understand that the higher PBT margin of 12% achieved in 4Q13 was largely due to a RM6m gain in disposal of short-term securities. Stripping out the gains, QoQ, 4Q13 PBT is still higher (7% in 3QFY13) emanating from greater operating efficiency from new production lines, higher contribution from nitrile gloves and lesser downtime as 90% of the production process is now automated.

Potential divestment of low yielding vinyl glove plants in China to unlock value. We understand that Top Glove is looking to unlock value from its low-yielding vinyl glove plants in China. The potential options are: (i) divestment of both plants and (ii) consolidating both plants into one operations. The book cost for these China operations stood at RM57.8m as of 31 Aug 2013, which works out to 9 sen/Top Glove share and recorded a small EBIT of RM0.7m. We believe if this corporate exercise materialise it makes sense because vinyl gloves business contribution to Top Glove’s bottom line is insignificant of <1% over the last few years and only accounts for 6% of total product mix as at 4Q13. Alternatively, Top Glove is also considering consolidating both vinyl plants into one. The likely scenario is to move its operations from Xin Hua to ZhangJiaGang plant. As of 31 Aug 2012, the net book value of the Xin Hua (Jiangsu province) land is RM16.3m. Since this piece of land was acquired in 2005, the current market price may have more than doubled its net book value.

Production automation 90% completed. Over the last 12 months, Top Glove has invested in automation and computerisation of its manufacturing processes and has gradually reduced its reliance on manual workers to minimise the adverse effect of the minimum wage policy. Some of the automations which were completed, including the automated mechanical stripping system (removing gloves off hand moulds) and glove stacker system. This was shown to us via a corporate video presentation during the briefing. In addition, Top Glove is now in the midst of integrating its various divisions, including procurement, marketing and finance via an enterprise resource planning system with SAP Malaysia.

Earmarked an average RM200m capex in FY14. Management has earmarked for an estimated capex of RM200m in FY14 for: (i) building of new factory and production lines (RM120m), (ii) the planting of rubber trees in Indonesia (RM30m), and (iii) Top Glove corporate building (RM50m). We have factored this capex guidance into our earnings model. Looking ahead, Top Glove is expected to face difficulties in maintaining ASPs to defend its market share due to its product mix, which is skewed towards the challenging latex-based gloves market. Growth going forward is expected to be derived from its capacity expansion involving an additional 4.2b pieces of gloves, or by 9.5% in June 2014 to a total of 48.1b, largely for nitrile gloves production.

Source: Kenanga