9M19 PATAMI of RM290.5m (-12.5% YoY) came in below expectations at 62%/63% of our/consensus full-year net profit forecasts. The negative variance from our forecast is due to lower-than-expected ASPs and margins. As such we cut our FY19E/20E net profit by 12%/8%. Correspondingly, we downgrade our TP from RM5.10 to RM4.70. Hence, downgrade from OUTPERFORM to MARKET PERFORM.

9M19 PATAMI of RM290.5m (-12.5% YoY) came in below expectations at 62%/63% of our/consensus full-year net profit forecasts. The negative variance from our forecast is due to lowerthan-expected ASPs and margins. An interim dividend of 3.5 sen per share was proposed in this quarter as expected.

Key result highlights. QoQ, 3Q19 revenue rose 3% due to higher sales volume (+2%) and ASP (+0.8%). However, 3Q19 PBT fell 35% due to a mismatch between higher latex price (+22%) and ASPs, competitive pressure and time lag in passing cost through as PBT margin fell 3.9ppt to 6.9% compared to 10.8% in 2Q19. This brings 3Q19 PATAMI to RM74.7m (-29.4%) due to a lower effective tax rate of 8.6% compared to 15.0% in 2Q19.

YoY, 9M19 revenue rose 21% due to higher sales volume (+15%) and ASPs (+2.7%). However, PBT eased by 8% mainly attributed to a sharp upward movement in the 3Q19 natural rubber latex price (+22%). This led to a mismatch between input material cost and ASP, which coupled with intense competition, adversely impacted bottom line. As a result, 9M19 PATAMI was lower 12.5% to RM290.5m due to the higher effective tax rate of 16.0% compared to 11.9% in 9M18.

ASP hike to mitigate the effect of higher costs. Post the 3Q19 results briefing conference call, we understand that subsequent quarters’ earnings to gradually improve, driven by cost pass-through via hikes in ASPs, favourable USDMYR forex, normalised margins, sustained demand growth for rubber gloves and efficiencies derived from internal production processes.

As an indication, this quarter’s higher ASPs could well indicate that price competition has abated, which should augur well for Top Glove’s earnings in subsequent quarters. Due to the lag effect in passing cost through, as a result of higher natural gas and raw material (latex), Top Glove had since conservatively raised ASPs by between 5-8%, which should contain high operating costs and put brakes on further margin compression in subsequent quarters. Recall, while pricing adjustments were made accordingly, there was a time lag of two months before the cost increase could be shared out with customers.

Downgrade our FY19E/FY20E net profit by 12%/8% due to the lowerthan-expected results.

Downgrade from OP to MP. Correspondingly, our TP is downgraded from RM5.10 to RM4.70 based on an unchanged 25.5x FY20E revised EPS (+1.0SD above 5-year historical forward mean). We believe the stock is trading at rich valuations of 30x and 27x FY19E and FY20E EPS, respectively, compared to net profit growth averaging 5% per annum over the next two years. As such we downgrade our call from Outperform to Market Perform. Note that the share price has risen by 10% since our last upgrade in April 2019.

A key upside risk to our call is the better-than-expected margin.

Source: Kenanga Research - 19 Jun 2019