We came away feeling positive from Top Glove’s 3Q17 post results briefing as subsequent quarters' earnings are set to gradually improve, driven by re-stocking activities following lower input latex cost underpinning lower ASPs. The key takeaways from the briefing include; (i) lower ASPs to boost re-stocking activities, (ii) 3Q17 results explained, (iii) continuous efficiency improvement to boost cost savings; and (iv) venture into condom business. Reiterate OUTPERFORM and TP of RM6.10 based on unchanged 20x FY18E EPS.

Lowering ASPs in tandem with falling latex input price. We expect volume sales to surge following the lower average input latex cost. In tandem with falling raw material latex price, we expect Top Glove to lower their ASPs. ASPs could be lowered to between USD2.00 to USD3.50 per thousand pieces or an average of between 6% to 16% (input latex cost has fallen by an estimated 25% YTD 2017). Presently, nitrile has a lead time of 60 days indicating strong demand. Recall, while pricing adjustments were made accordingly, there was a time lag of two months before the cost reduction could be shared out with customers. We expect and were guided that PBT margin is expected to normalise to between 12% and 14% (from 3Q17: 11%) going forward. For illustrative purposes, assuming a revenue of RM850m per quarter, normalised average pre-tax profit margin of 13%, and effective tax rate of 19%, net profit is RM89m/quarter.

3Q17 lower volume sales explained. The briefing shed some light on the lower QoQ sales volume growth (-5%) which was across the board, led by nitrile (-4%), latex powder free (-14%) and latex powder free (- 5%) due to higher raw input latex cost, which saw buyers staying at the sidelines. Only vinyl (+17%) saw positive growth albeit with a smaller base as a result of shortages from production in China (due to environmental issues such as pollution, which led to players there scaling back). Demand for nitrile continued to remain solid with nitrile and latex product mix ratio of 37% : 63%. In terms of geographical markets, Europe (29% vs. 34% in 3Q16), North America (32% vs. 29% in 3Q16) and Asia (21% vs. 17% in 3Q16) continued to dominate overall sales.

Cost saving initiatives to further enhance competitiveness and efficiency. In its quest to staying efficient and contain any possibility of margins erosion, Top Glove is undertaking to build its chemical dispersion and filler plants and packaging facility. Total cost savings from these initiatives are estimated at 2%-4% of total production cost. We have factored these two ventures into our earnings model.

Venture into condom business. The group plans to venture into the condom business over the next twelve months targeting twenty production lines with an initial investment of RM20m. We believe this pleasant news is positive and inline with Top Glove’s core business.

Outlook. Looking ahead, Top Glove’s earnings will be underpinned by the completed Factory 6 in Dec 2016 (Thailand; 1.4b pieces). Beyond Factory 6, expansion plans include the construction of 3 new manufacturing facilities in Klang, namely Factory 30 (operational by July 2017), Factory 31 (operational by Jan 2018) Factory 32 (operational by Dec 2018), Factory 33 & 34 (recently acquired). Upon completion, these factories will boost the Group’s total number of production lines by an additional 128 lines and production capacity by 11.7b gloves per annum gradually over a period of between end 2018 and FY19.

Maintain OUTPERFORM. TP of RM6.10 is based on an unchanged 20x FY18E EPS. The PER valuation of Top Glove (18.0x FY18E PER) has lagged behind Hartalega (30.8x CY18E PER). The valuation gap should narrow considering that Top Glove has a similar level of net profit compared to Hartalega. Key risks include higher-than-expected raw material cost and lower-than-expected ASPs.

Source: Kenanga Research - 21 Jun 2017