Top Glove’s 1Q14 post results briefing left us feeling largely lukewarm regarding its prospects going forward. All in, FY14 will see Top Glove focusing on production efficiency and efforts to: (i) mitigate margins erosions arising from electricity tariff hike and (ii) minimise overall cost. The key takeaways from Top Glove’s 4Q13/FY13 post results briefing include: (i) Topline contribution in 1QFY14 was driven mainly by higher sales volume of nitrile gloves, but bottomline was dragged down by rationalisation of its China operations, (ii) ASPs hike of USD0.20 per 1,000 pieces was implemented to mitigate the effect of the electricity tariff hike, and (iii) RM180m capex allocated for FY14. Looking ahead, Top Glove is expected to face difficulties depending on ASPs to defend market share due to its product mix, which is skewed towards the challenging latex-based gloves market. Going forward, growth is expected to be driven by capacity expansion involving an additional 2.2b pieces of gloves, or by 5% by Aug 2014 to a total capacity of 46.1b, largely for nitrile gloves. Although all new capacities are earmarked for nitrile gloves, Top Glove’s capacity will still be natural-rubber-centric latex:nitrile = 70:30). Maintain our MARKET PERFORM rating and TP of RM6.10 based on 16x CY14 EPS.

1Q14 results explained; earnings dragged down by rationalisation in China operations. Top Glove’s 1Q14 post results briefing shed some light that provides further explanation to the 10% yoy sales volume growth and higher losses at its China operations. 1Q14 revenue was driven by higher sales volume (+10%) which grew across the board on the back a 37% surge in nitrile gloves followed by latex powdered (+9%) and latex powdered-free (+1%), which more than offset the lower surgical (-45%) segment. 1Q14 product mix tilted favourably towards nitrile at 24% (1Q13: 16%) with the remaining balance of 76% from latex gloves. We see this as a step in the right direction due to the strong demand for nitrile gloves and Top Glove is targeting nitrile gloves to account for 30% of overall product mix. Separately, Top Glove has, since 1 Jan 2014 shut down its plant in ZhangJiaGang City and is consolidating its Chinese operations into F15 in Xinghua City after new regulations prohibited the usage of coal as an energy source in the former. To recap, 1Q14’s performance was dragged down by weak contributions from China (RM5.2m losses) as Top Glove started scaling down production in anticipation of the closure. We understand that Top Glove is looking to dispose off its ZhangJiaGang plant (low-yielding vinyl glove plant) sometime in 2Q or 3Q 2014. The book cost for ZhangJiaGang stood at RM11m as of 31 Aug 2013, which works out to 1.8 sen/Top Glove share. Since this piece of land was acquired in 2005, the current market price may be more than double its net book value. The closure costs are expected to be offset by gains from disposal of ZhangJiaGang plant.

ASPs hike of USD0.20 per 1,000 pieces to mitigate the effect of the electricity tariff hike. Top Glove has raised its rubber glove average selling prices (ASPs) by USD0.20/1000 pieces to mitigate the effect of the recent hike in electricity tariff. Ceteris paribus, the hike in electricity tariff is only expected to hit Top Glove earnings by 2-3%. We are not overly concerned since rubber gloves players including Top Glove are generally able to pass on the cost increase judging by past experience during electricity and natural gas tariff hikes. Electricity accounts for an estimated 20-30% of fuel costs which in turn make up 10% of total production costs of rubber gloves players. Natural gas accounts for the remaining 60-70%.

Earmarked an average RM180m capex in FY14. Management has earmarked for an estimated capex of RM180m in FY14 for: (i) building of new factory and production lines (RM100m), (ii) the planting of rubber trees in Indonesia (RM30m), and (iii) Top Glove’s corporate building (RM50m). We have factored this capex guidance into our earnings model. Looking ahead, Top Glove is expected to face difficulties in using 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 2.2b pieces of gloves, or by 5% by Aug 2014 to a total of 46.1b, largely for nitrile gloves production.

Source: Kenanga