We came away feeling positive about Top Glove’s long-term prospects with its M&A momentum gathering pace following two announced acquisitions over the past nine months. We expect the stock to be re-rated as more M&A deals are keys to longer term earnings growth prospects given their sheer size. We raise our PER rating from 20x to 21.5x based on +1.5 SD above the 5-year historical mean to better reflect its growth pursuit via acquisitions. Reiterate OUTPERFORM while TP is raised to RM7.10 from RM6.60 based on 21.5x FY18E EPS.

M&A gathering momentum with two announced acquisitions. Judging from Top Glove’s synergistic acquisitions over the past nine months, we would not be surprised if more M&A deals are announced. Recently, Top Glove announced the following:- (i) In Oct 2017, it entered into an agreement to acquire 100% stake in Eastern Press Sdn Bhd for RM47.4m cash with a net profit guarantee of RM4.5m which is expected to be completed in Feb 2018. Eastern Press is the major supplier of packaging material to Top Glove. The proposed transaction is expected to provide the Group with synergistic benefits, enabling it to improve its supply-chain coordination, thereby allowing for flexible planning and better delivery time in relation to the supply of packaging material for its glove products and (ii) in May 2017, it acquired two rubber glove assets with machineries, equipment & fixture and fittings for RM39m with a combined production capacity of 2b pieces of latex gloves.

Venture into condom manufacturing. The group plans to venture into the condom business targeting twenty production lines producing 1bn pieces with an estimated capex of RM50m which is expected to be ready in two years. The first two lines are expected to commence production somewhere in 2018. For illustrative purposes, assuming ASP of USD5 per 144 pieces, 90% utilisation rate and a net profit margin of 10%, this venture could generate a total net profit of RM13m or 3% of our FY18 forecast.

4Q17 higher volume sales to continue gathering momentum. The briefing shed some light on the higher YoY sales volume growth (+13%) which was across the board, led by nitrile (+11%), latex powder free (+18%) and latex powdered (+6%). 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).

Positive outlook. Given their sheer size, we are expecting margins to improve going forward due to ongoing enhancements in the manufacturing process, which has enabled the Group to manage costs more efficiently, reduce wastage and upgrade glove quality. These include initiatives to reduce downtime and conserve heat energy, electricity and water. Looking ahead, the group’s expansion plans include the construction of two new manufacturing facilities, i.e. Factory 31 (operational by Mar 2018) and Factory 32 (operational by Dec 2018), which upon completion will boost the Group’s total number of production lines by an additional 78 lines and production capacity by 7.8bn gloves per annum. By Dec 2018, Top Glove is projected to have a production capacity of 59.7bn (+15%) gloves per annum.

Maintain OUTPERFORM. We raise our PER rating from 20x to 21.5x based on +1.5 SD above 5-year historical mean to better reflect Top Glove’s pursuit to grow via acquisitions. TP is raised to RM7.10 from RM6.60 based on 21.5x FY18E EPS. The PER valuation of Top Glove (19.4x FY18E PER) has lagged behind Hartalega (31.8x CY18E PER). We reiterate that 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-thanexpected volume sales.

Source: Kenanga Research - 19 Oct 2017