We came back from Top Glove’s 2Q18 post results briefing feeling positive about demand led by emerging markets contrary to market expectations of a massive industry switch from vinyl to rubber gloves. All-in, we believe positives have been priced in. We maintain our FY18E and FY19E earnings forecasts after since we have had factored in contribution from Aspion into our earnings model. TP is RM9.40 based on 24.5x FY19E EPS. Reiterate MARKET PERFORM.

Demand growth in 2Q18/1H18 led by emerging markets. Contrary to market expectations of a massive industry switch from vinyl to rubber gloves, Top Glove’s 2Q18/1H18 demand growth was led largely by emerging markets that are not predominant vinyl consumers. Specifically, demand growth for natural rubber gloves stems from emerging markets, where healthcare awareness and hygiene standards are rising steadily, particularly Asia (ex-Japan) and Eastern Europe which respectively saw 60% and 40% boost in sales volume for 1H18 compared with 1H17 of which they are not vinyl gloves consuming nations. The briefing shed some light on the higher YoY 2Q18/1H18 sales volume growth (+21%/+19%) which was across the board due to utilisation rate moving from 80% to 90%, led by nitrile (+14%/+15%), latex powder free (+20%/+19%) and latex powdered (+21%/+15%). Only vinyl (-6%) saw negative growth due to environmental issues such as pollution which led to players there scaling back from production in China and shorter working days due to the lunar new year festivities. Demand for nitrile continued to remain solid with nitrile and latex product mix ratio of 39%:61%. In terms of geographical markets, Europe (30% in 2Q18 vs. 26% in 2Q17), and Asia ex-Japan (16% in 2Q18 vs. 12% in 2Q17) continued to dominate overall sales.

Aspion’s to launch Finessis, acquisition to complete in early April 2018. In the briefing, we witnessed the signing of a syndicated credit facility in relation to the acquisition of Aspion which is expected to complete by early April 2018. The integration process between Top Glove and Aspion’s plants are expected to see visible cost savings coming from raw material purchasing. This is because Aspion’s raw material bulk purchasing is less attractive compared to Top Glove’s. Elsewhere, we understand that Aspion’s signature surgical glove under the brand-name Finessis Aegis® is expected to be launched somewhere in 2QCY18. Typically, gross profit margins for surgical glove is about 20-30% whereby we believe Finessis Aegis gross profit margin will be comfortably doubled to 40% based on the higher selling price.

Outlook. Over the next two quarters, Top Glove’s earnings growth is expected to largely depend on margin expansion following present high utilisation rate of close to 90%, and since the new capacity is only expected to gradually come onstream in 4Q18. Looking ahead, Top Glove is in the process of constructing two new manufacturing facilities namely, Factory 31 (operational by June 2018) and Factory 32 (operational by early 2019), which upon completion will boost the Group’s total number of production lines by an additional 78 lines and production capacity by 7.8b gloves per annum to 59.7b (+15%). Meanwhile, preparations for Top Glove's condom manufacturing facility have also commenced and the plant is expected to be operational by June 2018. Following the Aspion acquisition, Top Glove is projected to control 40 factories consisting of 34 glove factories and 6 other supporting factories, 693 glove production lines and a glove production capacity of 64.3b gloves per annum.

Maintain MARKET PERFORM. TP is unchanged at RM9.40 based on 24.5x FY19E EPS (+1.5 SD above 5-year forward historical mean). Reiterate MARKET PERFORM.

A key upside risk to our call is higher-than-expected sales volume.

Source: Kenanga Research - 19 Mar 2018