TOPGLOV’s 2Q19 post-results briefing highlighted that management is undertaking measures to mitigate margin pressure, which is only expected to see fruition over the longer term. We believe all the negatives could have been priced in with valuations trading at a more palatable PER of between mean and +1.0SD fiveyear forward average which appears undemanding. However, the sector lacks positive catalysts over the short-to-medium term. TP is RM4.20 based on 23x FY19E EPS. Reiterate MP.

2Q19 results explained. TOPGLOV’s 2Q19 post-results briefing shed some light on the 1% QoQ sales volume growth and lower net profit growth (-4%). 2Q19 revenue was dragged down by flat sales volume (+1%) due to lower nitrile (-0.5%) and surgical (-4%) but was mitigated by higher latex powdered (+2%) and latex powdered free (+1%). However, 2Q19 net profit was dragged down by external factors, including lower ASPs and weaker MYR against the USD. ASPs for nitrile and latex gloves ASPs fell 8% and 5%, respectively. While MYR appreciated 1% against the USD. 1H19 net profit rose 0.6% YoY due largely to higher volume sales (+18%). Separately, following the expiry of the three years’ special reinvestment allowance in 2018, we expect normalized effective tax rate to be around 17-20%. In terms of geographical markets, YoY volume sales in all markets in 1H19 grew across the board, including Asia (+18.5%), Western Europe (+38%), Eastern Europe (+39.6%), Latin America (+11.6%), North America (+28%), Middle East (+6.8%) and Africa (+14%) that continued to dominate overall sales. The group is upbeat on demand for nitrile and latex gloves in the China market (accounts for an estimated 4% of sale volume) whereby the usage is still low compared to the developed countries.

Leveraging on technology to reduce cost and maintain margin. In an effort to further mitigate rising cost and reliance on manual labour and hence maintain margins, TOPGLOV is embarking on more automation in the production processes. The group is embarking on automation in three key areas, including: (i) an artificial intelligence system to detect and removed defective gloves (trial started in March 2019); (ii) automated warehouse management system (expected to commence in mid-2019), and (iii) automated glove packing system (expected to commence by mid-2019). The total estimated saving is about 10% reduction in manpower or an estimated 5% of our FY20E earnings forecast.

Competitive pressure, demand tapering off. Top Glove has faced lower quarterly sales volume growth for two consecutive quarters. From our channel checks, we gather that competition in the nitrile gloves segment has intensified leading to pressures on ASPs. As such, coupled with the moderating demand and in anticipation of new capacities ramp-ups, we would not be surprised if ASPs come under further pressure over the next two quarters. We understand that over the past six months, delivery lead times (the time frame between order and delivery) have shortened from 60-70 days to 30-45 days, potentially indicating that strong demand is tapering off.

Maintain Market Perform. TP is RM4.20 based on 23x FY19E EPS (+0.5 SD above 5-year forward historical mean). We believe all the negatives could have been priced in with valuations trading at a more palatable PER of between mean and +1.0SD five-year forward average which appears undemanding. However, the sector lacks positive catalysts over the short-to-medium term.

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

Source: Kenanga Research - 29 Mar 2019