We expect a higher sequential 4Q18 results underpinned by new capacity and margin expansion from the weakened MYR vs. USD to beat our full-year FY18 forecasts. All in, we are less optimistic about the short-to-medium prospects in Aspion as irregularities discovered could prove a setback with the profit guarantees at risk of not materialising. Raised our FY18E/FY19E net profit by 4%/8% in anticipation of a better result. TP is raised from RM8.20 to RM8.85 based on 23x FY19E revised EPS. Maintain UP.

Expect a decent 4Q18 to beat our/consensus full-year forecasts. We expect core 4Q18 PATAMI, which is due to be released by Oct 2018 to be higher sequentially (3Q18 PATAMI: RM117.6m) underpinned by: (i) new capacity expansion at factory 31, (ii) solid demand leading to a higher utilisation rate, and (iii) margins expansion emanating from the depreciation of MYR vs. USD (average +4% QoQ depreciation in MYR against USD) and further boosted by the improvement in manufacturing efficiency, increased automation, and effective cost controls. This implies FY18 PATAMI is on track to beat our/consensus full-year expectations of RM436m/RM442m (9M18: RM332m) as we have assumed a lower 4Q18 earnings of RM104m vs RM117.6m in 3Q18.

Shorter lead time indicating strong demand tapering off. We understand that the production of vinyl gloves in China has resumed and normalised in early 2018. Hence, we understand that over the past six months, delivery lead times (the time frame between order and delivery) has shortened from between 60 to 70 days as compared to 30 to 45 days, potentially indicating that strong demand is tapering off.

Impairment uncertainty and execution risk over Aspion. Recall, wholly-owned Top Care Sdn Bhd has taken legal proceedings against Adventa Capital Pte Ltd as well as Low Chin Guan, Wong Chin Toh and ACPL Sdn Bhd claiming for an amount of RM714.9m arising from a conspiracy to defraud Top Care and Top Glove, and fraudulent misrepresentations made in relation to the acquisition of Aspion. From the interim report given by an independent accounting firm, there is 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 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, 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.

Outlook. Looking ahead, Top Glove is in the process of constructing several manufacturing facilities namely, Factory 32 (operational by early 2019; 4.4b pieces), Factory 33 (operational by March 2019; 1.2b pieces), Factory 5A (operational by Oct 2019; 2b pieces) and Factory 8A (operational by early 2020; 3.2b pieces) which will boost the Group’s total number of production capacity by 10.8b gloves per annum to 71.3b (+15%).

Upgrade FY18E/FY19E earnings by 4%/8%. We are raising our FY18E/FY19E Net Profits by 4%/8% to take into account higher-thanexpected utilisation rate of 85% from 83% previously.

Maintain UNDERPERFORM. Correspondingly, we raised our TP from RM8.20 to RM8.85 based on 23x FY19E EPS (+1.0 SD above 5-year forward historical mean). Nonetheless, we are feeling less optimistic about the short-to-medium prospects in Aspion as irregularities discovered could prove a temporary setback and coupled with the impending legal case, the profit guarantees are at risk of not materialising.

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

Source: Kenanga Research - 28 Sept 2018