Top Glove’s 4Q18 post-results briefing highlighted that management is confident of achieving higher earnings for Aspion over the medium to long-term, given the group’s track record, capability, and experience in turning around loss-making glove factories. However, short-to-medium prospects in Aspion could prove a setback due to the irregularities discovered. TP is RM8.85 based on 23x FY19E EPS. Maintain UP.

FY18 results explained, Aspion’s earnings dragged down by impact from USD-denominated debt. Top Glove’s FY18 post-results briefing shed some light on the 26% YoY sales volume growth and higher YoY net profit growth (+33%). FY18 revenue was driven by higher sales volume (+26%) which grew across the board, led by nitrile (+27%), latex powdered free (+24%), latex powdered (+23%) which more than offset the lower surgical segment (+76%), albeit with a smaller base. In tandem with growing demand, nitrile gloves accounted for 32% of total product mix and continued to gather momentum compared to an average of 25% over the last few quarters. In terms of profitability, FY18 net profit rose 33% YoY due to: (a) higher mix of nitrile gloves and high utilisation rates for both nitrile (90%) and latex (80%) gloves, (b) 20% gas energy savings, which minimised the impact from a 24% gas tariffs hike, and (c) higher ASPs and volume growth. However, excluding Aspion’s contribution and funding cost, FY18 revenue only increased by 17% but PATAMI rose to 37% implying that earnings was dragged down by Aspion. We understand that Aspion’s lower earnings were dragged down by impact from USD-denominated debt. Excluding currency impact from USD-denominated debt, Aspion contributed 4% or RM17m (6 months contribution) to overall Top Glove’s bottom-line in FY18. In terms of geographical markets, volume sales in all markets grew across the board, including Asia (+58%), Western Europe (+35.8%), Eastern Europe (39.6%), Latin America (+21.8%), Middle East (+38.7%) and Africa (+35.3%) continued to dominate overall sales.

Aspion’s net profit contribution of RM80m now taking 4 to 7 years. Management is only expecting Aspion’s net profit contribution initial target of RM80m now taking 4 to 7 years compared to the initial profit guarantee of RM80-100m (profit guarantee appears less likely following the recent legal case) for FY18 and FY19. We believe this is a setback to Top Glove over the medium term in terms of longer payback period and funding cost incurred for the acquisition of Aspion for RM1.37b.

No impairment charge arising from the acquisition of Aspion. The group has done impairment test from the goodwill of RM1.2b arising from the acquisition of Aspion and no impairment is required. Management assessed the recoverable amount of Aspion Sdn Bhd based on its value- in-use, which in turn is determined based on cash flow projections or discounted cash flow (DCF method, zero terminal growth) of Aspion Sdn Bhd compared to the PER method used in the acquisition. In short, as long as the DCF parameters used for the recent impairment testing is conservative, this reduces the risk of a negative charge provided Top Glove is able to meet its own financial forecast.

Outlook. Looking ahead, Top Glove is in the process of constructing several manufacturing facilities namely, Factory 32 (Phases 1 and 2 to be completed early and end-2019, respectively; 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 9.8b gloves per annum to 69.1b (+14%).

Maintain UNDERPERFORM. TP is RM8.85 based on 23x FY19E EPS (+1.0 SD above 5-year forward historical mean).

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

Source: Kenanga Research - 18 Oct 2018

Source: Kenanga Research - 18 Oct 2018