We came away from Top Glove’s 1Q16 analysts’ briefing feeling positive on its prospect, which is 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 the briefing include: (i) 1Q16 results explained, (ii) volume growth targets of 10-15% in FY16E and capacity increased by 17% to 52.4bn pieces over the next two years, and (iii) to conclude the acquisition of a rubber latex company by end FY16. The PER valuation of Top Glove (19.6x FY17E PER) has lagged behind its peers such as Kossan (22x FY17E PER) and Hartalega (30x CY17 PER), which we believe is unwarranted. Top Glove at 19.6x FY17 earnings is still trading at an average 23% discount to Kossan and Hartalega’s CY17 PERs. Maintain OUTPERFORM. Our Target Price is RM15.60 based on unchanged 22x FY17 EPS (above its 5-year historical mean average of 18x).

1Q16 results explained; surge in nitrile gloves volume. Top Glove’s 1Q16 post results briefing shed some light on the 15% yoy and 1% QoQ sales volume growth and higher YoY net profit growth (+>100%). 1Q16 revenue was driven by higher sales volume (+15%) which grew across the board, led by nitrile (+54%), latex (+15%), and vinyl (+15%) which more than offset the lower surgical segment (-42%), albeit with a smaller base. In tandem with growing demand, nitrile gloves accounted 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, 1Q16 net profit rose >100% YoY due to: (a) higher mix of nitrile gloves and high utilisation rates for both nitrile (90%) and latex (80%) gloves, (b) margins expansion emanating from more efficient production lines and automation of old lines, and (c) a 31% USD appreciation against MYR. In terms of geographical markets, Europe (31%), North America (29%) and Asia (19%) continued to dominate overall sales. Management reiterated that Top Glove has continued to make progress and in-roads into China, Iran, Russia and India. QoQ 1Q16 volume growth came in at only 1% due to maximum utilisation for nitrile of which the new lines totalling 2b pieces are coming on-stream in Feb 2016, which will see higher volume growth in 3Q and 4Q16. Interestingly an estimated 20- 30% of volume in 1Q16 was from new customers.

Top Glove targeting 10-15% volume growth in FY16. Top Glove is targeting a 10- 15% volume growth which is inline with our 10% assumption. We believe a 10% volume growth in FY16 is achievable due to the solid demand where Malaysia’s exports fof rubber gloves rose 30% in 9M15. The 1% QoQ volume growth in 1Q16 was due largely to full utilisation for nitrile gloves which new capacity of 2b pieces is coming on-stream by Feb 2016. 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 Feb 2017. The two plants; namely F27 (Lukut, Port Dickson) and F30 (Klang), will focus on producing 2.0b and 4.4b pieces of nitrile gloves, respectively. F6 plant (in Phuket, Thailand) will cater for the production of latex gloves (1.4b pieces). With an estimated operating cash-flow averaging RM520m p.a over the next two years and net gearing of 0.01x as at 30 Nov 2015, funding is not an issue.

News-flow on acquisition could be positive to share price. Top Glove is targeting to acquire at least one rubber-related business acquisition by end FY16 of which they have shortlisted three candidates. We understand that Top Glove acquisition targets are gloves related including printing, packaging, chemical and formers (rubber glove mould).

Stock under-appreciated, unwarranted PER discount valuation to peers. Our Target Price is RM15.60 based on unchanged 22x FY17E EPS (above its 5-year historical mean average of 18x). Top Glove’s historical valuation at peak earnings averaged between 23-27x PER. The PER valuation of Top Glove (20x FY17E PER) has lagged behind its peers and it is trading at an average 23% discount to Kossan (22x FY17E PER) and Hartalega (30x CY17 PER). We consider the underperformance 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 latex-based 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 - 7 Jan 2016