We came away from Top Glove’s 4Q15 analysts’ briefing feeling positive on its earnings prospects driven mainly by sustained demand growth for rubber gloves, efficiencies derived from internal production processes and the favourable USD/MYR exchange rate. The key takeaways from Top Glove’s 4Q15 post results briefing includes: (i) 4Q15 results explained, (ii) raising capacity by 17% to 52.4bn pieces over the next two years, and (iii) high utilisation rate while longer delivery lead days indicate solid demand. The PER valuation of Top Glove (17x FY16E PER) has lagged its peers such as Kossan (22x FY16E PER) and Hartalega (25x FD CY16 PER), which we believe is unwarranted. Top Glove at 17x FY16 earnings is trading at an average 25% discount to Kossan and Hartalega’s FY16 PERs. Maintain OUTPERFORM. Our Target Price is RM10.60 based on unchanged 20x FY16 EPS (slightly above its 5-year historical mean average of 18x).

4Q15 results explained; surge in nitrile gloves volume. Top Glove’s 4Q15 post results briefing shed some light on the 8% yoy sales volume growth and higher YoY net profit growth (+>100%). 4Q15 revenue was driven by higher sales volume (+8%) which grew across the board led by nitrile (+15%), latex (+9%), and vinyl (+7%) which more than offset the lower surgical (-24%) segment. In tandem with growing demand, nitrile gloves accounts for 32% of total product mix and continue to gather momentum compared to an average of 25% over the last few quarters. In terms of profitability, 4Q15 net profit rose >100% YoY due to: (a) higher mix nitrile gloves and high utilisation rates for both nitrile (90%) and latex (80%), (b) margins expansion emanating from more efficient production lines and automation of old lines. Case in point is a 34% improvement in manpower efficiency leading to 4.3m pieces of glove per employee produced compared to 2.8 in FY13, and (c) a 21% USD appreciation against MYR. In terms of geographical markets, Europe (30%), North America (30%) and Asia (18%) continued to dominate overall sales. Management reiterated that Top Glove has continued to make progress and in-roads into China, Russia and India.

Solid industry demand and longer delivery lead times to underpin growth going forward. Solid industry numbers and longer delivery lead times are indicating that demand will outstrip supply at least over the medium-term. Case in point is 1H15 when the total exports of rubber gloves, synthetic rubber (SR) and latex-based natural rubber (NR) combined rose 10% YoY to 25.9b pairs. Specifically, Malaysia exported 14.4b pairs of SR or nitrile gloves (+29% YoY) and 11.6b pairs of latex gloves (-2.9% YoY) in 1H15. Separately, the Malaysian Rubber Glove Manufacturers Association (MARGMA) has forecasted a 20% export growth for rubber gloves, which is largely on track with volume growth recorded in 1Q and 2Q of CY2015 for rubber glove makers under our coverage. We understand that the robust demand for nitrile has led to longer delivery lead times (the moment order was placed and delivery) which has risen to between 50 to 60 days as compared to 40 to 50 days (9 months ago) including players like Top Glove.

Capacity expansion plans are on track, raising capacity by 17% to 52.4bn pieces over the next two years. Management has earmarked an estimated capex of RM150- 200m per annum for building of a new factory and production lines. 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 7.8bn pieces of gloves to 52.4b (+17%) by end Dec 2016. The two plants namely F27 (Lukut, Port Dickson) and F30 (Klang) will focus on producing 2.0b and 4.4b pieces of latex gloves, respectively. F6 plant (in Phuket, Thailand) will cater for the production of latex (1.4b pieces). With an estimated operating cashflow averaging RM440m p.a over the next two years and a net gearing of 0.2x as at 30 Aug 2015, funding is not an issue.

Stock under-appreciated, unwarranted PER discount valuation to peers. Our Target Price is RM10.60 based on unchanged 20x FY16E EPS (slightly above its 5- year historical mean average of 18x). Top Glove’s historical valuation at peak earnings averaged at between 23-27x PER. The PER valuation of Top Glove (17.3x FY16E PER) has lagged its peers and it is trading at an average 25% discount to Kossan (22x FY16E PER) and Hartalega (26x FD CY16 PER). We consider the under-performance as unwarranted. The valuation gap should narrow when we consider that Top Glove has similar/higher total capacity and net profit level compared to Kossan and Hartalega. We like Top Glove for: (i) its ability to evolve from purely a dominant latexbased rubber gloves producer into a higher margin nitrile-based products producer, (ii) undemanding PER valuation at discount to peers, and (iii) solid management.

Source: Kenanga Research - 21 Oct 2015