We came away from Top Glove’s 1Q15 post results briefing left us feeling largely lukewarm on its prospects going forward. The key takeaways from Top Glove’s 1Q15 post results briefing includes: (i) lower YoY 1Q15 results explained, (ii) raising capacity by 11% to 50.4bn pieces over the next two years, and (iii) management is targeting a 10% net profit growth in FY15. Overall we believe growth will be muted as 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. Maintain our MARKET PERFORM rating and TP of RM4.92 based on 16x CY15 EPS.

1Q15 results explained; surge in surgical gloves volume. Top Glove’s 1Q15 post results briefing shed some light that provides further explanation to the 4% yoy sales volume growth and lower YoY net profit growth (-3%). 1Q15 revenue was driven by higher sales volume (+4%) which grew across the board on the back of a one-off >100% surge in surgical gloves albeit low base followed by latex powdered (+6%) and nitrile (+4%), which more than offset the lower latex powder free (-6%) segment. The one-off surge in volume for surgical gloves is unlikely to be repeated in subsequent quarters whereby Top Glove has won a tender to supply surgical gloves which was reflected in 1Q15. 1Q15 saw nitrile production hit a high utilisation rate of 85%. Top Glove is targeting nitrile gloves to account for 30% of overall product mix (24% as at 1Q15). We see this as a step in the right direction due to the strong demand for nitrile gloves. In terms of profitability, 1Q15 net profit came in 3% lower due to a) lower nitrile gloves margin due to competitive pressure; and b) negative impact from electricity and natural gas tariff hike. However further downwards in profitability was mitigated by a) improved rubber gloves margins whereby ASPs for nitrile was lower than natural rubber. The lower input raw material rubber prices fell faster compared to the past several months which boosted rubber glove margin, as the ASPs of rubber gloves has not dropped as much as the raw material price. We believe this was due to little or no new supply from rubber gloves manufacturers over the last two to three years and in turn less competitive pressure; and b) turnaround of China operations following the consolidation of its China plants.

Raising capacity by 11% to 50.4bn pieces over the next two years. Contrary to earlier guidance of scaling back production few quarters ago due to concerns of oversupply, Top Glove is now moving ahead to expand nitrile capacity expansion due to the continuing strong demand for nitrile gloves. Management has earmarked for an estimated capex of RM150m in FY15 for building of new factory and production lines (estimated RM70-90m) and Top Glove corporate building (RM40-50m). We have factored this capex guidance into our earnings model. In terms of new gloves capacity, Top Glove has plans to raise production capacity by additional 5.8bn pieces of gloves to 50.4b (+11%) by Sept 2016. The two plants namely F6 (Phuket, Thailand) and F30 (Klang) will focus on producing 1.4b and 4.4b pieces of latex and nitrile gloves respectively. With an estimated operating cashflow averaging RM250m p.a over the next two years, funding is not an issue. For illustrative purposes, assuming 7% net profit margin, ASPs of RM85/1000 pieces and utilisation rate of 75%, this new capacity could generate a total net profit of RM34m or 17% of our FY16 forecast.

Targeting 10% net profit growth in FY15, automation in placed except packaging. Management is targeting a 10% net profit growth in FY15 on the back of a 10% volume growth. We are not overly optimistic on a 10% net profit growth due to 1) spare capacity in latex based gloves leading to downwards ASPs pressure and 2) higher cost emanating from wages, salaries and fuel. Separately, Top Glove’s investment in production automation is slowly bearing fruits with an estimated 1,000 reduction in workers despite higher production capacity. Some of the automations put in place include the (i) automated mechanical stripping system (removing gloves off hand moulds) and (iii) glove puller and stacker system. The only process which is not automated but currently on a trial run is the automation of packing (insert gloves into box). We understand that once the trial run is completed and successful, the full implementation would take place somewhere in CY15.

Source: Kenanga