• 2Q17 below expectations

• Revenue driven by increase in sales volume and ASPs

• Earnings marred by increase in raw materials price

• Gradual improvement in profit margins a positive sign

• Capacity expansion timeline extended

• Maintain NEUTRAL with a revised TP of RM5.11

2Q17 earnings below expectations. Top Glove registered 2QFY17 revenue and earnings of RM851.5m and RM83.1m respectively which is below ours but broadly within consensus earnings estimates. During the quarter, improvements were seen on a quarterly sequential basis with revenue and earnings registering a decent growth of +8.4% and +13.3% respectively. Meanwhile, on a year-over-year basis, revenue grew by +22.7% while earnings slipped by -20.6% premised on higher production costs during the quarter which include higher raw material prices.

Revenue driven by increase in sales volume and ASPs. During the quarter, the improvement in revenue was attributable to the sales volume registering a decent growth of +9%yoy. However, the volume eased by +1%qoq due to shorter working period in the month of February. In addition, the better revenue was also driven by the increase in average selling prices (ASPs) undertaken by Top Glove back in October and December last year. Furthermore, we opine that the more favourable USD exchange rate during the quarter at RM4.45/USD vs RM4.27/USD in 1QFY17 assisted in the revenue growth as well.

Earnings marred by increase in raw materials price. Despite registering a healthy sales volume growth, earnings during the quarter was marred by the increase in raw materials prices. During the quarter, the average latex price surged to a five-year high of RM5.95/kg, which is an increase of +33%qoq and +72%yoy. Meanwhile, the average price of nitrile also increased to USD1.08/kg, an increase of +10%qoq and +12%yoy respectively.

Improvements in profit margins continue. We note that the improvements in terms of profit margins continue quarter-over-quarter despite the increase in costs. During the quarter, Top Glove registered a PBT margin of 12.1% vs 11.4% in 1QFY17 - the highest in four consecutive quarters post period of strong USD appreciation in late 2015.

Capacity expansion timeline extended. We understand from the management that Top Glove’s factory 30 (F30), factory 31 (F31) and factory 32 (F32) will have some changes in its commissioning timeline. F30 which is expected to be commissioned this coming April has been pushed back to May while F31 and F32’s commissioning have been pushed to November 2017 and December 2018 from August 2017 and May 2018 respectively. We understand that this is due to the delay in supply of natural gas to Plant 31.

Earnings forecasts. We are revising down our earnings forecasts for FY17-18F by -8.8% and -3.7% respectively as we input higher production costs as well as the changes in its capacity expansion timeline. Key risks to our earnings would be: (i) higher than expected increase in production costs i.e: raw material prices, labour costs etc and; (ii) further delays in plant expansions.

Maintain NEUTRAL with a revised Target Price (TP) of RM5.11. Following our earnings revision, we reiterate our NEUTRAL call on Top Glove with a revised TP of RM5.11 (from RM5.31 previously). Our valuation is premised on FY18 EPS of 28.4sen pegged to an unchanged PER of 18x which is the company’s 5-year historical average PER. We think this is fair given that we continue to foresee the raw materials price to continue trading at the current level of above RM7/kg at least for the rest of 1H17. In addition, we also wary on the delay in its capacity expansion as this could potentially disrupt its revenue and earnings growth going forward.

Source: MIDF Research - 17 Mar 2017