Yesterday, Top Glove announced that its 3QFY19 net profit fell 36.5% year-on-year (YoY) to RM74.7mil, below Macquarie Equities Research’s (MQ Research) expectations. Nevertheless, MQ Research believes that the current earnings drag is only temporary and foresees better earnings outlook in the next quarter due to several factors. Top Glove’s Outperform rating is maintained with an unchanged target price (TP) of RM5.02.

Event

• MQ Research maintains an Outperform rating on Top Glove with an unchanged TP of RM5.02 based on an unchanged price-to-earnings ratio (PER) of 25x. Although 3QFY19 was below expectations, MQ Research believes the worst is over as latex prices have stabilised since May and price competition in the nitrile segment is not intense as Jan-March. In fact, nitrile glove demand picked up in June with a longer order lead time of 45 days now. MQ Research advocates investors switch out of Hartalega to Top Glove, given its more resilient strategy with a wider product mix and better earnings outlook.

Impact

• Weaker 3QFY19, misses. 9MFY19 results only make up 66% and 63% of MQ Research’s and consensus FY19E earnings, respectively. As MQ Research expected, this quarter is dragged by higher latex input costs. However, the negative impact was greater than MQ Research expected. With the 23% increase in latex input costs, latex glove gross profit (GP) margins dropped 3-4ppts to 14% in 3QFY19. As such, group earnings before interest, taxes, depreciation and amortisation (EBITDA) margin declined 3.6ppts to 12.8%, its five-year low. Nevertheless, overall sales volume was relatively stable with an increase of 9% YoY and 2% QoQ in 3QFY19.

• Expect earnings recovery in 4QFY19. The natural rubber (NR) price has stabilised at RM4.80-RM5.00 range since May, as the rubber trees’ winter period (Feb-May) is over and demand of natural rubber from China remains weak. This could potentially put pressure on latex prices going forward. With stabilised latex input costs and the latex glove average selling price (ASP) adjustment in March-May, which came into effect in May-July, MQ Research expects latex glove margins to recover in 4QFY19. Apart from the latex glove segment, nitrile glove order lead time has gradually improved back to its usual range of 40-45 days. MQ Research checks show the lengthening order lead time was also experienced by other glove manufacturers.

Earnings and Target Price Revision

• After incorporating lower margin assumptions for latex gloves, MQ Research cut FY19E earnings per share (EPS) by 10%. MQ Research is 4-14% below consensus. MQ Research’s bear and bull case valuations are RM3.52 and RM6.44, respectively.  

Price Catalyst

• 12-month price target: RM5.02 based on a PER methodology.
• Catalyst: Weaker Ringgit against USD, next quarterly earnings.

Action and Recommendation

• Maintain Outperform with an unchanged 25x PER-derived TP of RM5.02.

12-month Target Price Methodology

• TOPGV MK: RM5.02 based on a PER methodology

Source: Macquarie Research - 19 Jun 2019