YTD, Top Glove Corporation (TOPGLOV) has fallen by 19% triggered by oversupply concerns, intense competition and lower ASPs. However, we believe this is just a temporary rough patch and all the negatives have been priced in. Hence, we roll forward our valuation base from FY19E to FY20E. Our TP is raised from RM4.20 to RM5.10. Upgrade from MP to OP.

Pressure on ASPs, but rough patch temporary. In the last two years, the sector has become a victim of its own success. The frantic pace of capacity expansion has resulted in a mild excess supply for rubber gloves leading to ASPs compression and flattish or lower profits over the past two quarters. However, we take comfort that this is nothing more than just a temporary rough patch. However, with the rubber gloves players becoming aware of the intense competition since four months ago; over the last few months, they have implemented any of these measures; (i) slowed new capacity expansion, (ii) more measures to maintain margins, including automation and other cost reduction initiatives, and (iii) intensifying sales efforts to penetrate emerging economies. Typically, the past two oversupply cycles lasted about 6-9 months. Having experienced various cycles of oversupply, we believe players, including TOPGLOV, are pro-active in carrying out measures to mitigate competitive pressure. As such, theoretically, the ASPs pressure problem in the sector should fully sort itself out within another quarter.

Oversupply concerns appear overplayed, ASPs pressure contained. We believe signs of a prolonged oversupply appear overplayed judging by past oversupply experiences where players’ new capacity expansions are expected to be delayed and staggered. Case in point is Top Glove’s effective new capacity in CY19 is now only estimated at 2.6b to 3.0 pieces compared to 4-5b previously due to a more co-ordinated expansion. Interestingly, ASPs pressure is well contained ranging between USD21-23/1,000 pieces as compared to the previous down-cycle in 2016 ranging between USD19-USD21/1,000 pieces.

Leveraging on technology to reduce cost. In an effort to mitigate rising cost and reduce reliance on labour, TOPGLOV is embarking on more automation in the production processes including: (i) an artificial intelligence system to detect and remove defective gloves; (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 saving is estimated at 5% of our FY20E earnings forecast.

Outlook. Looking ahead, Top Glove’s capacity expansion includes namely: Factory 32 (Phases 1 & 2 to commence production by 2Q and 3Q 2019, respectively; 3.4b pieces), Factory 33 (operational by 2Q 2019; 1.2b pieces), Factory 2B (operational by 4Q19; 0.8b pieces), Factory 5A (operational by 4Q 2019; 2b pieces), Factory F40 (operational by 1Q 2020 and 4Q 2019; 3b pieces), Factory F41 (operational 2Q 2020; 2b pieces) Factory F42 (operational by 4Q 2020 delayed from 3Q 2020; 4.8b pieces), and Factory 8A (operational by 3Q 2020 delayed from early 2020; 3.2b pieces) which will boost the group’s total production capacity by 20.4b gloves per annum to 80.9b (+33%).

Upgrade from MP to OP. We roll forward our valuation base from FY19E to FY20E. Correspondingly, our TP is raised from RM4.20 to RM5.10 based on 25.5x FY20 EPS (at +1.0SD above 5-year historical forward mean). We like TOPGLOV because: (i) its “highly automated production processes” model is constantly improving, and (ii) Aspion is showing positive signs of improvement.

A key risk to our call is lower-than-expected sales volume and ASPs.

Source: Kenanga Research - 23 Apr 2019