9M16 PATAMI of RM295.4m (+66.9% y-o-y) came in at 71%/74% of our/consensus full-year net profit forecasts, respectively. However, we consider the results as below expectations due to lower-than-expected ASPs arising from intense price competition. Hence, we downgrade our FY16E and FY17E net profits by 6% after taking in account of lower ASPs. Correspondingly, our TP is downgraded from RM7.00 to RM6.68 based on unchanged 20x FY17E revised EPS.

Key Result Highlights

QoQ, 3Q16 revenue fell 3% to RM672m due to higher volume sales (+5%) and lower ASPs (-2%). However, PBT margin declined by 8-ppts from 19% in 2Q16 to 11% in 3Q16, no thanks to price competition largely in the nitrile segment, strengthening of MYR against USD (average +6 % QoQ), and higher price of raw material latex (+14%). As a result, PBT fell 44% to RM73.7m. Correspondingly, 3Q16 PATAMI fell 40% to RM62.5m. A DPS of 6.0 sen was declared, which is within our expectation.

YoY, 9M16 revenue rose 20% boosted by higher sales volume (+14%) which offset the lower ASPs (-13%). However, strengthening of MYR against USD in 3Q16, higher raw material prices (latex) and intense price competition capped further margins expansion. PBT margin in 9M16 was 17% compared to 20% in 1H16 due to the weaker 3Q16 as explained above. This brings 9M16 PATAMI to RM295.4m (+66.9%).

Outlook. Due to the lag effect in passing cost through as a result of higher natural gas and raw material (latex), Top Glove had since raised ASPs, which should contain high operating costs and put brakes on further margin compression in subsequent quarters. Recall, while pricing adjustments were made accordingly, there was a time lag of two months before the cost increase could be shared out with customers. Furthermore, we gather that nitrile glove competition has subsided on the back of slower new incoming capacities, which could ease downwards pressure on ASPs. We expect PBT margin to normalise between 13% and 16%.

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 expected commercial production by end March 2016) and F30-Klang (commercial production by Feb 2017)), will focus on producing 2.0b and 4.4b pieces of nitrile gloves, respectively. F6 plant (in Phuket, Thailand targeted commercial production by Aug 2016) will cater for the production of latex gloves (1.4b pieces).

Downgrading FY16E and FY17E net profits by 6%. We downgrade our FY16 and FY17 net profit forecasts by 6% to take into account lower ASPs.

Maintain Outperform. Correspondingly, our Target Price is lowered from RM7.00 to RM6.68 based on unchanged 20x FY17E revised EPS (+1.5 SD above 5-year historical mean of 17x). Top Glove’s historical valuation at peak earnings averaged at between 23-27x PER. The PER valuation of Top Glove (14.7x FY17E PER) has lagged behind Hartalega (20.1x CY17E PER). We consider the under-performance as unwarranted. The valuation gap should narrow when we consider that Top Glove has higher level of total capacity and net profit compared to 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 team.

Source: Kenanga Research - 16 Jun 2016