TOPGLOV’s 9MFY23 results disappointed due to a lower-than expected sales volume. It reiterated that a challenging and competitive business landscape will persist throughout 2023. We widened our FY23F net loss by 26% but keep our FY24F profit forecast. We trim our TP by 2% to RM0.88 (from RM0.90) and reiterate our UNDERPERFORM call.

TOPGLOV disappointed with a fourth consecutive quarterly loss. Its 9MFY23 net loss of RM464m already exceeded our full-year net loss forecast of RM450m and the full-year consensus net loss estimate of RM461m. The variance against our forecast came largely from a weaker-than-expected sales volume and cost escalation.

QoQ, 3QFY23 revenue fell 14% due to lower sales volume (-21%) which was partially cushioned by a 6% increase in its average selling price (ASP). At the EBITDA level, it remained in a loss situation of RM48m compared to a loss of RM54m in 2QFY23 due to: (i) excessive industry capacity leading to reluctance of customers to commit to sizeable orders and hold substantial stocks on expectations of further price decline, (ii) margin erosion as costs remains elevated including natural gas and electricity tariff and labour, and (iii) reduced economies of scale, particularly, poor cost absorption, as its utilisation rate which we believe had continued to remain weak at low 30%. As a result, 3QFY23 losses came in narrower at RM131m compared to RM165m in 2QFY23 due to tax credit recognised in 3QFY23 arising from unabsorbed tax losses, capital allowance and reinvestment allowance. No dividend was declared in this quarter as expected. YoY, 9MFY23 revenue fell 61% due to lower ASP (-23%) and volume sales (-54%) bringing 9MFY23 losses to RM464m.

The key takeaways from the analyst briefing yesterday are as follows:

1. TOPGLOV believes that selling prices have bottomed out (at USD20 per 1,000 pieces which is our FY24 assumption) and hence will attempt to raise prices by another 3-5% in subsequent quarters. However, the group sees resistance, with only a handful of customers agreeing thus far. Moreover, due to the current competitive pressure emanating from massive oversupply and low industry utilisation averaging 30%-40%, price hike attempts may result in customers switching to other producers, particularly, Chinese manufacturers that are still selling at USD17-18 per 1,000 pieces.

2. The group is hopeful for gloves replenishment activity to pick up in 2HCY23 premised on depleting customers inventory. We are sceptical for sales volume to increase in subsequent quarters, taking our cue from industry’s guidance for persistent oversupply in the market. Taking stock, the group has received mixed response in terms of customer inventory levels. Some customers are still stuck with high inventories while others are beginning to slowly re-stock. Generally, there is no urgency for buyers to place sizeable orders or hold substantial stocks as supply is plentiful and readily available.

3. TOPGLOV reiterated that current business landscape remains challenging and competitive and only hoping to be EBITDA positive rather than returning to the black but short stop of committing a timeline.

4. In view of the increasingly challenging business landscape, the group will continue to emphasise better cost management, improve operational efficiencies and scale up automation initiatives. The measures employed include decommissioning obsolete production lines and temporarily halting production of 17 out of its 49 factories, in light of the softer global glove demand. The decommissioning of production lines eases the Group’s production capacity by 5b pieces of gloves, bringing its total production capacity to 95b pieces of gloves.

Outlook. Based on our estimates, the demand-supply situation will only start to head towards equilibrium in 2025 when there is virtually no more new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum, underpinned by rising hygiene awareness. MARGMA projects 12%-15% growth in the global demand for rubber gloves annually from 2023, following an estimated 19% contraction to 399b pieces in 2022. It believes the supply-demand equilibrium will return in 6-9 months. However, we beg to differ, expecting the overcapacity situation to persist at least over the next 12 months. We project the demand for gloves to rise by 15% in 2023, which is consistent with MARGMA’s forecast. However, this will do little to ease the overcapacity situation as the global glove production capacity will grow another 12% to 574b pieces during the year, as more capacity planned by incumbent and new players during the pandemic years - enticed by super-fat margins that had evaporated - finally come on-line. This will result in the excess capacity rising by 4% to 116b pieces from 112b pieces in 2022. The overcapacity still persist which means low prices and depressed plant utilisation will continue to plague the industry in 2023.

Forecasts. We widen our FY23F net loss forecast by 26% to RM568m (from RM450m) as we reduce our utilisation assumption to 30% from 35%. However, we keep our FY24F profit.

We reiterate our UNDERPERFORM call but nudge our TP down slightly by 2% to RM0.88 (previously RM0.90) based on 1.4x FY24F BVPS, at a 20% discount to the sector’s average of 1.7x seen during the last downturns in 2008-2011 and 2014-2015 as we believe the current downturn could go down in history as one of the deepest ever. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 3).

Key risks to our recommendation: (i) the industry turning the corner sooner on stronger-than-expected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (ii) industry consolidation reducing competition among players, and (iii) epidemic and pandemic occurrences.

Source: Kenanga Research - 19 Jun 2023