Macquarie Equities Research (MQ Research) wrote a report following investors’ queries whether the government may impose a windfall tax on the glove sector. While MQ Research believes a windfall tax is possible, it would unlikely be of considerable size and would unlikely change MQ Research’s positive view on the sector. MQ Research also shared its valuations on the earnings, among others, based on an estimated tax of 10% while discussing about the proposed bonus issue by Top Glove and Supermax.

Event

• MQ Research has been asked by investors, “Could the government impose a windfall tax on the glove sector?” While MQ Research believes the government could, MQ Research also believes that if it does the tax would unlikely be of a magnitude that would cause MQ Research to change its positive view on the sector. MQ Research believes a tax rate up to 10% would still leave MQ Research’s forecasts substantially ahead of consensus estimates. MQ Research sees elevated average selling price (ASP) on the back of an acute shortage in the market continuing to buoy sector earnings and valuations. MQ Research is maintaining its positive view on the sector, with Top Glove as its top pick.

Impact

• Windfall tax possible, but unlikely to be substantial. In MQ Research’s view, a windfall tax of 10% would be palatable to the sector and market. MQ Research estimates a 10% windfall tax on earnings would raise RM790m from the top-four listed companies, which the government could use to cushion the 6% fiscal deficit the government is estimating for 2020. The government imposed a one-off windfall tax of 30% on the return on assets above 9% for independent power producer (IPP) in 2008 and historically has imposed a windfall levy of 1.5–3% on the plantation sector when crude palm oil (CPO) prices came in above RM2,500/tonne and RM3,000/tonne for Peninsular Malaysia and East Malaysia, respectively.

• That aside, the Malaysian Rubber Glove Association (MARGMA) believes the chance that the government will impose a windfall tax is low given that the industry consistently reinvests earnings for capacity expansions and to create jobs for skilled workers, such as engineers. According to MARGMA, the glove industry sees capex of RM0.6–1bn annually for expansion.

• For Top Glove, MQ Research estimates a 10% windfall tax would reduce FY21E earnings by 12% and would require MQ Research’s target PE to rise to 25x from 23x to maintain the current target price of RM30.40 – which MQ Research does not believe is a lofty ask. Even with a 10% windfall tax, MQ Research’s FY21E EPS estimate would still be 20% above consensus.

• For Hartalega, MQ Research estimates a 10% windfall tax would reduce FY21E earnings by 13% and require MQ Research’s target PE to rise to 53x from 51x to sustain the current target price of RM17.00. Even with a 10% windfall tax, MQ Research’s FY21E EPS estimate would still be 25% above consensus.
• Bonus issue increases trading liquidity. Top Glove and Supermax (Not rated) have proposed 2-for-1 and 1-for-1 bonus issues, respectively, which are expected to be complete by 3Q20 and 4Q20. The issue for Top Glove would not have an impact on MQ Research ‘s estimates but could improve trading liquidity. The issues would benefit Bursa Malaysia (BURSA MK, RM8.60, Outperform, TP: RM10.00) (bull-case valuation of RM11.62), as the glove sector collectively accounts for 36% of its total market value currently. (Bursa Malaysia – Go with the flows)

Outlook

• MQ Research reiterates its overweight view on the rubber glove sector.

12-month Target Price Methodology

• TOPG MK: RM30.40 based on a price to earnings ratio (PER) methodology
• HART MK: RM17.00 based on a PER methodology

Source: Macquarie Research - 21 Jul 2020