According to an announcement to Bursa Malaysia, TOPGLOV has taken legal proceedings against Adventa Capital Pte Ltd of which the former is claiming for not less than RM714.9m arising from an alleged conspiracy to defraud Top Care and TOPGLOV. This came as a surprise and raises uncertainty over Aspion’s future operations and earnings outlook. We maintain our FY18- 19E NP pending further clarifications from management. TP is RM9.40 based on 24.5x FY19E EPS. Reiterate UP.

Legal action against ex-owner of Aspion for RM714.9m. In an announcement to Bursa Malaysia, wholly-owned Top Care Sdn Bhd has taken legal proceedings against Adventa Capital Pte Ltd as well as Low Chin Guan (previous owner of Aspion), Wong Chin Toh and ACPL Sdn Bhd (“ACPL”) vide a writ. In the writ, Top Glove and Top Care are claiming for an amount of not less than RM714.9m arising from a conspiracy to defraud Top Care and Top Glove, and fraudulent misrepresentations made by Low Chin Guan and Wong Chin Toh in relation to the acquisition of Aspion Sdn Bhd. Top Glove and Top Care are seeking for a Mareva injunction to restrain Adventa Capital from disposing of its assets in Malaysia up to the value of RM714.9m pending disposal of the arbitration at the Singapore International Arbitration Centre of which hearing is fixed on 13 July 2018. Recall, TOPGLOV has in April 2018 completed the acquisition (following a term sheet proposal to buy in Nov 2017) of Aspion Group, a manufacturer and distributor of surgical, medical and medical examination gloves in Malaysia for RM1.37b. The deal comes with a profit guarantee of RM80.9m and RM108.3m for FY18 and FY19 (for Aspion with FYE Oct), respectively.

Risk of a de-rating amidst execution risk at Aspion. This latest news came as a surprise and raises uncertainty over the future operations and earnings contribution from Aspion.

Potential impact to financials. We do not have sufficient details to quantify adverse impact to earnings in relation to uncertainty over the profit guarantee attached to Aspion. For illustrative purposes; i) based on our-back-of-the envelope calculation, assuming we strip out the profit guarantee and assuming normal profits generated from Aspion, our FY19E earnings could be lowered by 12% and our TP lowered to RM8.25 from RM9.40; and ii) assuming TOPGLOV is unable to recoup the claims made, an impairment charge of RM714.9m (assuming worst case) will erode TOPGLOV’s book value by 31% from RM1.77/share to RM1.21/share as at 31 May 2018. However, we are leaving our FY18E and FY19E earnings and TP of RM9.40 unchanged pending further clarifications from management.

Outlook. Looking ahead, Top Glove is in the process of constructing 2 new manufacturing facilities namely, Factory 31 (operational by July 2018) and Factory 32 (operational by early 2019), which upon completion will boost the Group’s total number of production lines by an additional 74 lines and production capacity by 7.4b gloves per annum to 64.9b (+11%). Meanwhile, preparations for Top Glove's condom manufacturing facility have also commenced and expected to be operational by June 2018.

Maintain UNDERPERFORM. TP is unchanged at RM9.40 based on 24.5x FY19E EPS (+1.5 SD above 5-year forward historical mean). Reiterate UNDERPERFORM. The stock is trading at 34.4x and 31.7x on FY18E and FY19E EPS, respectively, which is >+2.0SD above 5-year historical mean.

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

Source: Kenanga Research - 9 Jul 2018