Top Glove (TOPGLOV) has entered into a formal purchase agreement to buy the entire 100% stake in Aspion Sdn Bhd for RM1.37b or at 16.9x PER, which is lower than Top Glove’s FY18E PER of 25.6x, implying earnings and value accretion. We maintain our FY18E and FY19E earnings forecasts since we have factored in earnings from Aspion into our earnings model. Share price has run up by 100% over the last 10 months. We believe all the positives have been priced in. Downgrade from OP to MP. TP is RM9.40 based on 24.5x FY19E EPS.

Buying Aspion for RM1.37b. Based on an announcement to Bursa Malaysia, TOPGLOV has officially signed a purchase agreement to buy (following a term sheet proposal to buy in Nov 2017) Aspion Group, a manufacturer and distributor of surgical, medical and medical examination gloves in Malaysia for RM1.37b. Based on a profit guarantee of RM80.9m and RM108.3m in FY18 and FY19 (for Aspion with FYE Oct), respectively, the acquisition PER works out to 16.9x FY18E and 12.7x FY19E. The purchase consideration is to be financed via: i) RM1.23b cash, and ii) remaining RM137m via issuing 20.5m shares at RM6.68/share. Based on the sector 1- year forward PER of 24x, this latest acquisition by Top Glove seems fair, at 30% discount to sector average. The deal is expected to be completed by early April 2018. The RM1.23b cash consideration will be financed via Muradabah (to ensure stock is still in the list of Shariah compliant) and conventional term loans with an estimated 3% finance cost of which we have factored into our earnings model.

Aspion’s profits factored into our FY18E and FY19E forecasts. We have imputed in the profit guarantee into our earnings model (please refer to report titled Earning and Value Accretive Acquisition dated 27 Nov 2017). The only key difference in the term sheet that wasn’t visible in the just-signed acquisition agreement was the incentive payment to the vendor on its key break-through product. Stipulated in the agreement, incentive payments from the sale of surgical gloves manufactured using Flexylon™ polymer technologies which are currently marketed under the brand-name Finessis Aegis® where percentage sharing is 20%, 30% and 50% based on the actual profit from sales of Finessis for each of FY18, FY19 and FY20 (FYE Oct), respectively, due to the vendor. If the actual core profit of Aspion is less than the targeted FY18E profit, the difference will be offset by the Finessis’ profit after tax and the remaining shortfall shall be paid by the vendor; hence, no incentive payment will be payout to the vendor. We understand that incentive payment is expected to be capitalised rather then expensed off in the books.

Lion’s share of the surgical market globally. Post acquisition, TOPGLOV will be the single largest surgical gloves producer globally with an estimated market share of 29%. With the acquisition, Top Glove will be well-placed to expand its surgical glove product offerings to cater to a broader range of medical practice areas, including high risk surgery, micro-surgery, orthopaedics and obstetrics & gynaecology, thereby moving up the value chain. Mr Low Chin Guan, Aspion’s Managing Director will continue to helm its operations over the next two to three years.

Outlook. Looking ahead, earnings growth and contribution is expected to come from the group’s expansion plans including 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 capacity by 7.8b gloves per annum or 15% to 59.7b gloves per annum. Post acquisition, Top Glove is expected to have a capacity of 64.3b pieces per annum. Nearterm headwinds including appreciation of MYR against the USD, gas tariff hikes, and potential higher minimum wage could derail earnings.

Downgrade from OP to MP. We maintain our FY18E and FY19E earnings forecasts since we have factored in profits from Aspion into our earnings model. As its share price has run up by 100% over the last 10 months, we believed all the positives have been priced in. Hence, we downgrade our call from OUTPERFORM to MARKET PERFORM. TP is unchanged at RM9.40 based on 24.5x FY19E EPS (+1.5 SD above 5-year forward historical mean).

A key risk to our call is the deal falling through.

Source: Kenanga Research - 15 Jan 2018