We came back from TOPGLOV’s analysts briefing feeling less optimistic about the short-to-medium prospects in Aspion as irregularities discovered could prove a temporary setback with the profit guarantees at risk of not materialising. We conservatively cut our FY18E/FY19E CNP by 3%/6% taking into account the partial absence of profit guarantee. We lowered our TP from RM9.40 to RM8.20 based on 23x FY19E revised EPS (+1.0 SD above 5-year forward historical mean). Reiterate UP.

Irregularities discovered and explained. In the briefing, we gathered from management more details that provided further explanation to the claim amount of RM714.9m which consists of overstatement of assets. The due diligence was initially carried via a so-called ‘Virtual Data Room’ where all information is posted into a common platform because there were few bidders and potential bids from competitors. Following the acquisition of Aspion, Top Glove assumed the operations and uncovered irregularities in balance sheet items of Aspion, namely inventories, and plant and machinery. Subsequently, Top Glove conducted its own investigations and hired an independent accounting firm to investigate the irregularities in Aspion’s accounts as well as potential overstatement of the acquisition price for Aspion. From the interim report given by an independent accounting firm, there is currently an overstatement of inventory, plant and machinery in Aspion’s accounts amounting to RM74.4m (which has been adjusted as pre-acquisition in assets in 3Q18). Additionally, the report also states that the acquisition price of Aspion was overstated by RM640.5m (derived from annualising Aspion’s seven months FY18 net profit and a PER multiple of 16x). Assuming TOPGLOV is unable to recoup the claims made, an impairment charge of RM640.5m (assuming worst case) will erode TOPGLOV’s book value by 28% from RM1.77/share to RM1.27/share as at 31 May 2018.

Legal action against ex-owner of Aspion. Recall, wholly-owned Top Care Sdn Bhd has taken legal proceedings against Adventa Capital Pte Ltd as well as Low Chin Guan (the previous owner of Aspion), Wong Chin Toh and ACPL Sdn Bhd. 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. Top Glove and Top Care are seeking for an 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.

Outlook. We believe the stock could be at risk of a de-rating amidst execution risk, uncertainty over the future operations and earnings contribution from Aspion. Top Glove is in the process of constructing two new manufacturing facilities namely, Factory 31 (operational by July 2018) and Factory 32 (operational by early 2019), which 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%).

Conservatively cut FY18E/19E CNP by 3%/6%. We conservatively cut our FY18E/FY19E NP by 3%/6% by partially removing the profit guarantees from Aspion.

Maintain UNDERPERFORM. Correspondingly, we lowered our TP from RM9.40 to RM8.20 based on 23x FY19E EPS (+1.0 SD above 5-year forward historical mean). Apart from lowered earnings, the downgrade in our TP also reflects a lower 1-year forward PER of 23x, from 24.5x (+1.5 SD above 5-year historical mean) previously. This is to account for concerns over execution risk at Aspion.

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

Source: Kenanga Research - 10 Jul 2018