Macquarie Equities Research (MQ Research) upgraded Top Glove’s target price (TP) to RM20.50 based on the increased assumption on Top Glove’s average selling price (ASP) by 10-15%, resulting in a 54%/44% increase in FY20E-22E earnings. Also, ahead of Top Glove’s earnings results scheduled to be released next week, MQ Research expects a better-than-expected 3QFY20 and an even stronger 4Q20.

Conclusion

• MQ Research reiterates an Outperform rating on Top Glove with an increased target price of RM20.50 based on a higher CY21 price-to-earnings (PE) ratio of 40x vs RM12.30 on a 32x PE before. The strong pricing power and lower customer concentration risk provide Top Glove more flexibility to raise the average selling price (ASP), and now the company is looking to increase guidance, indicating upside risk to consensus estimates. As MQ Research views gloves as a staple within the medical sector, MQ Research thinks the valuation is undemanding and looks more attractive than consumer staples, which trade at a >40x PE with lower earnings growth of ~10% vs Top Glove: 27%.

Impact

• New and more aggressive ASP strategy. Shortages have led to stronger pricing power for glove manufacturers. Based on MQ Research’s checks, Top Glove increased its June and July order deliveries higher than initial guidance of 5% per month. In addition, Top Glove implemented a new capacity allocation strategy for the remainder of 2020 – 10% for spot orders, which has at least a 2.5x-3x higher ASP, and increased its exposure to smaller distributors, which allows more upside risk to the ASP in this period. As such, MQ Research raises its FY20E-21E ASP assumption by 10-15%.

• Expect good 3QFY20 results but 4QFY20 to be stronger. 3QFY20 results will start reflecting the COVID-19 orders and the total ASP increase of 10%-15% in March-May order deliveries. However, MQ Research expects 4QFY20 will be even stronger on the back of the more aggressive ASP increases and its new capacity allocation strategy. MQ Research expects the 2HFY20 earnings before interest tax, depreciation and amortization (EBITDA) margin will be expanded to 33%, the highest since its listing. MQ Research’s 2HFY20 implies a quadruple in net profit vs 1HFY20 (Fig1).

• Multiple re-rating due to strong quarterly earnings. History has shown that Top Glove’s share price tracks quarterly earnings. MQ Research believes the next re-rating catalyst is strong 4QFY20-3QFY21 quarterly earnings. The stock is likely to re-test its peak PER valuation of 40x. MQ Research believes consensus has not baked in its latest strategy. MQ Research’s  FY20E-21E are 83-88% ahead of consensus.

Earnings and Target Price Revision

• MQ Research raises its FY20E-22E earnings per share by 54%/44% to reflect a higher ASP.

Price Catalyst

• 12-month price target: RM20.50 based on a PER methodology.
• Catalyst: quarterly results, further ASP increases.

Action and recommendation

MQ Research reiterates an Outperform on Top Glove with a higher target price of RM20.50.

Source: Macquarie Research - 5 Jun 2020