We came away feeling positive from Top Glove’s 4Q16 postresults analysts’ briefing that subsequent quarters’ earnings are set to gradually improve, driven by cost pass-through via hikes in ASPs, abating price competition and sustained demand growth for rubber gloves. The key takeaways from the briefing include: (i) 4Q16 results explained, (ii) capex plans, and (iii) raising ASP to mitigate the effect of higher costs. Maintain OUTPERFORM. Our Target Price is RM6.10 based on an unchanged 20x FY17E EPS.

4Q16 results explained; ASPs +7% QoQ.The main takeaway from the briefing is that Top Glove managed to raise ASPs (+7% QoQ) which is an early indication of price competition abating. The briefing shed some light on the 4% QoQ sales volume growth which grew across the board, led by nitrile (+10%) and latex powder free (+16%) and vinyl (+21%) and surgical (+107%), albeit with a smaller base which offset lower latex powdered (- 18%). In FY16, nitrile gloves accounted for 32% of total product mix and continued to gather momentum compared to 28% in FY15. In terms of profitability, 4Q16 net profit rose 5% YoY despite higher raw material latex prices (+11%), natural gas (+3%) and minimum wage (+7%). In terms of geographical markets, Europe (33% vs. 28% in 4Q15), North America (28% vs. 30% in 4Q15) and Asia (18% vs. 18% in 4Q15) continued to dominate overall sales. The single-digit 4Q16 volume growth was due to maximum utilisation for nitrile while the new Lukut, Port Dickson plant is only expected to start contribution in 1Q17.

ASP hike to mitigate the effect of higher costs. As an indication, this quarter’s higher ASPs could well indicate that price competition has abated which should augur well for Top Glove’s earnings in subsequent quarters. Due to the lag effect in passing cost through as a result of higher natural gas and raw material (latex), Top Glove had since conservatively raised ASPs by between USD0.20 and USD0.25/1000 pieces, 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 delayed incoming capacities, which has been reinforced by this quarter’s Top Glove’s higher ASPs. We expect and were guided that PBT margin is expected to normalise to between 15% and 17% (from 4Q16 10%) going forward. For illustrative purposes, assuming a revenue of RM680m (five quarters’ average is RM700m), normalised pre-tax profit of 16%, and effective tax rate of 20% (five quarters average), net profit is RM86m/quarter. Sustained weakness of Ringgit (RM) vs. US dollar (USD), is positive to rubber glove players including Top Glove and could also see margins improvement in subsequent quarters.

Capacity expansion plans, raising capacity by 26% to 58.8bn pieces over the next three years.Management has earmarked an estimated capex of RM150-200m per annum for building of new factory and production lines. We have factored this capex guidance into our earnings model. Top Glove has plans to raise production capacity by additional 12.2bn pieces of gloves to 58.8b (+26%). The two plants; namely F27 (Lukut, Port Dickson has been completed in Aug 2016) and F30-Klang (commercial production by April 2017), will focus on producing 2.0b and 4.8b pieces of nitrile gloves, respectively. The F6 plant (in Phuket, Thailand targeted commercial production by Nov 2016) will cater for the production of latex gloves (1.4b pieces). Separately, the Group recently acquired a factory in Klang (Factory 31) estimated to produce 6b pieces of gloves per annum with Phase 1 targeted to be operational by mid-2017.

Maintain OUTPERFORM. Target Price is RM6.10 based on unchanged 20x FY17E EPS. The PER valuation of Top Glove (16.3x FY17E PER) has lagged behind Hartalega (25.1x CY17E PER). The valuation gap should narrow when we consider that Top Glove has higher level of total capacity and net profit compared to Hartalega.

Source: Kenanga Research - 19 Oct 2016