In an announcement to Bursa Malaysia, Top Glove said that wholly-owned GMP Medicare Sdn Bhd has proposed to acquire two rubber glove assets totalling RM39m. This latest corporate development by Top Glove is positive and a step in the right direction which is a mild surprise to market. We roll forward our valuation from FY17E to FY18E. Correspondingly, our TP is raised from RM5.92 to RM6.11 based on an unchanged 20x PER over our FY18E EPS. Reiterate Outperform.

Buying two assets for RM39m. In an announcement to Bursa Malaysia, Top Glove revealed that wholly-owned GMP Medicare Sdn Bhd has entered into two separate sale and purchase agreements to acquire the following two rubber glove assets respectively; 1) Factory (43.3k sq meters land size) erected on freehold land in Seremban with the machineries, equipment & fixture and fittings (RM31.5m) (vs independent valuer of RM50.5m); and 2) Factory (7.7k sq meters land size) erected on leasehold land in Muar, Johor together with the machineries, equipment & fixture and fittings (RM7.5m) (vs independent valuer of RM10.2m). Both factories have a combined production capacity of 2b pieces of latex gloves. This acquisition will only put a small dent to Top Glove’s net gearing of 13% as at 28 February 2017 as well as operating cashflow averaging >RM400m per annum.

Positive news, management delivered again. This latest corporate development by Top Glove is positive and a step in the right direction and a mild surprise to market. The newly announced acquisitions further amplify that Top Glove is committed towards fulfilling its goal to grow not only organically but via acquisition. More importantly, these acquisitions allow Top Glove to have a bigger and direct access to the China market (China sales accounts for 50% to total sales of these two factories). With the latest acquisitions, these plants can immediately contribute to Top Glove’s bottomline compared to a green field rubber gloves plant which takes 12 to 18 months to commence operations.

Potential to add 3%-4% to our FY18E earnings. We understand that currently both factories generate a revenue of RM150m per annum with a net margin of 2-3%. However, with Top Glove’s management quality and track record of cost reduction and plant efficiency coupled with the group bulk purchasing power, we expect net margin for these both factories can only improve. We wont be surprised that plans are in place to upgrade the lines in order to enhance efficiencies and hence improve margins considering that the average age of the lines are about 7 years old. For illustrative purposes, assuming 2b pieces, ASPs of USD21 per 1000 pieces, RM4.30 = USD1.00, 80% utlisation rate and a net margin of 8%, these two factories are expected to record a net profit of RM12m per annum or 3% of our FY18E net profit forecast. We leave our FY17E and FY18E forecasts unchanged for now.

Outlook. Post wintering months of between Dec till April, we expect latex cost to trend downwards and hence volume sales to pick up again as buyers return to the market to replenish. The slower-than-expected new incoming capacities could lead to less intense nitrile glove competition. As an indication, the ASP of Top Gloves has been rising over the past two quarters which suggests that price competition has abated. Over the next two to three quarters, Top Glove's earnings will be underpinned by the completed Factory 6 in Dec 2016 (Thailand; 1.4b pieces). Beyond Factory 6, Factory 30 (4.4b pieces), is being constructed and expected to commence production by May 2017. Concrete plans are also in place for Factory 31 (Klang), for which Phase 1 will commence by November 2017 (previously August) with a production capacity of 2.8b gloves per annum. F32 with a capacity of 4.8b pieces per annum is expected to commence by Dec 2018 which will bring the Group’s total production lines to 632 and a production capacity of 60b (+20%) gloves per annum.

Maintain OUTPERFORM. We roll forward our valuation from FY17E to FY18E. Correspondingly, our TP is raised from RM5.92 to RM6.11 based on an unchanged 20x PER over our FY18E EPS. Key risks include higher-than-expected raw material cost and lower-than-expected ASPs.

Source: Kenanga Research - 22 May 2017