Top Glove (TOPGLOV)’s 2QFY20 post-results briefing highlighted that 2HFY20 earnings is expected to be explosive, underpinned by mid-to-high teens volumes sales growth and boosted by better-than-expected margins emanating from higher ASPs. The share price could, however, be capped by the conversion of exchangeable bonds into new shares at RM6.10 per share. Upgrade FY20E/FY21E net profit by 9% each. TP is raised from RM5.95 to RM6.50 based on 32x CY20E EPS. Reiterate MP.

Higher volume and ASPs in 2HFY20 with production running 100%. TOPGLOV’s 2QFY20 post-results briefing highlighted that management is confident of achieving higher volume sales in 2HFY20 following the COVID-19 pandemic. Management highlighted that requests for huge volumes of gloves to the tune of 400m to 500m pieces are coming from countries including Spain, France, Italy, Germany, Saudi Arabia. Correspondingly, management is confident of mid-teens growth in volume sales since orders have been secured up till August 2020. The initial Movement Control Order (MCO)-led supply chain hiccups have normalised. The group production floor is running at 100% where 50% of workers are running operation with two shifts. Additionally, the group is raising ASPs by 3-5% or between USD0.30 to USD0.50 per thousand pieces which is not excessive per unit cost.

Longer delivery lead times. Solid industry numbers and longer delivery lead times are indicating that demand will outstrip supply at least over the medium-term. The Malaysian Rubber Glove Manufacturers Association has forecast a 20% growth to 230b pieces in 2020. TOPGLOV robust demand has led to longer delivery lead times (the moment order was placed to delivery) has risen to between 80 to 100 days as compared to 40 to 50 days (3 months ago).

Subsequent quarters’ earnings to be driven by higher volume sales, ASPs and strengthening USD vs MYR. Initially in the early stage of the virus outbreak, sales orders came mainly from China, Hong Kong, Singapore and South Korea. TOPGLOV has in recent weeks also received strong orders from Europe, US and other countries. With current utilisation levels at >90%, the group is able to further ramp up production close to 100%, to meet the surge in demand. It has new capacity coming on-stream with F2B and F5A having commenced operations, which will add 3.2bn pieces of gloves per annum. Ceteris paribus, each 1% increase in volume sales and ASP will raise our FY20E and FY21E net profit by 1% and 1.2%, respectively.

Capacity expansion include: Factory 7A (operational by end-1Q 2020; 0.4bn pieces), Factory 2B (operational by 1Q 2020; 0.7b pieces), Factory 5A (operational by 1Q 2020; 2.5b pieces), Factory 40 (Phase 1 operational by 2Q 2020 and Phase 2 operational by 3Q 2020; 2.7b and 2.0b pieces), Factory F41 (2Q 2020; 4b pieces) and Factory 8A (by 4Q 2020; 3.5b pieces) to boost the group’s production capacity in 2020 by 11.8b gloves per annum to 81.9b (+17%).

Raised FY20E/FY21E net profit by 9%/9% after taking into account higher growth for volume sales from 12%/13% to 15%/16% and PBT margin from 9% to 11%.

Reiterate MP. TP is raised from RM5.95 to RM6.50 based on unchanged 32x CY20E EPS of 20.3 sen (at +1.5SD above 5-year historical forward mean). The share price could be capped by the conversion of exchangeable bonds. Recall, back in 2019, Top Glove issued USD200m in convertible bonds as part of their debt restructuring. The bonds can be converted into new shares at RM6.10 per share.

A key upside risk to our call is better-than-expected volume sales and margin.

Source: Kenanga Research - 27 Mar 2020