In an announcement to Bursa Malaysia, TOPLGOV confirmed that the U.S. Customs and Border Protection (CBP) has placed a detention order on disposable gloves manufactured by two of its subsidiaries. Concurrently, in a well organised analysts’ briefing last evening, TOPGLOV assured us that it has engaged a consultant to resolve this issue and is confident of resolving it within two to four weeks. In the meantime, due to the acute supply shortage and supernormal demand, TOPGLOV can sell to other countries since the order lead time is >500 days. TP remains at RM32.00 based on 21.5x CY21E EPS. Reiterate Outperform.

US Customs detention order placed on TOPGLOV’s disposable gloves. In an announcement to Bursa Malaysia, TOPLGOV has confirmed that the U.S. Customs and Border Protection (CBP) has placed a detention order on disposable gloves manufactured by two of the subsidiaries namely Top Glove Sdn Bhd and TG Medical Sdn Bhd. In the meantime, TOPGLOV is contacting CBP via its office in the U.S., customers and consultants, to understand the issue better and work towards a speedy resolution which is expected within 2 weeks. The group believes there is a possibility this may be related to foreign labour issues, which have already been resolved, save for one more issue with regard to retrospective payment of recruitment fees by workers to agents prior to January 2019, without their knowledge. However, Top Glove has already been bearing all recruitment fees since January 2019 when the Zero Recruitment Fee Policy was implemented. Over the past few months, the group has been working to establish the correct amount to be paid back to its workers, on behalf of the previous agents. The group estimated the total amount at between RM20m to RM50m or 1-4% of FY20E net profit. In the conference-call, management highlighted that plans are in motion to engage a consultant who had previously helped remove WRP from the detention list, to resolve the issue which is expected within 2-4 weeks. Management understands that the detention is in relation to (i) passport retention – in fact workers passports issue has been returned; and (ii) old recruitment fees highlighted above. These two subsidiaries accounted for TOPGLOV’s 12.5% sales volume to the US (of which total accounted for 25% in the US). In the meantime, the detained shipment can be parked at the warehouse in the free trade zone and if need be can be sold to nearby countries. We expect this issue to resolve amicably in a speedy manner. Moreover, the acute shortage of medical grade disposable gloves globally and the heightened cases in US means the urgency to reach the market place is far more important. In the meantime, due to the acute supply shortage and supernormal demand, TOPGLOV can sell to other countries since order lead time is >500 days.

Heads I win, Tails I win. For illustrative purposes, based on i) total capacity of 78b pieces per annum, ii) assuming the 12.5% of capacity from the two mentioned subsidiaries, iii) ASP of USD40/1000 pieces and USDMYR4.20, and iv) FY21E forecast net margin of 31%, our FY21E net profit is expected to be lowered by 13%. However, assuming the capacity is sold at spot price at USD60/1000 pieces to a new buyer with the rest of the assumptions remained equal mentioned above, our FY21E net profit will be higher by 6%.

Reiterate OP. We had earlier raised TP from RM25.00 to RM32.00 as per our last report on Monday 13th July. The higher TP was based on 21.5x CY21E’s raised EPS of 152.3 sen (vs 36x previously) (at +0.5 SD above 5-year historical forward mean). We lowered our PER rating as we believe valuations are pegged to supernormal earnings; hence, upside to peak earnings should have been factored in. Its merits are: (i) strong management, (ii) resilient earnings base due to its pricing power and its sheer size in capacity in the industry, and (iii) solid earnings growth averaging >100% in FY21 compared to PERs of 14x.

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

Source: Kenanga Research - 17 Jul 2020