INVESTMENT HIGHLIGHTS

• Targeting three M&As in FY18

• Potential capacity expansion in Vietnam as demand for gloves remain robust

• Growing the specialty gloves segment

• Acquisition of Aspion earnings accretive with double-digit FY19 EPS growth expected

• Maintain NEUTRAL with a revised TP of RM8.55 per share

Targeting three M&As in FY18. Top Glove in its analyst briefing held last Friday indicated that it is targeting to achieve at least a double-digit growth of 10% annually in terms of revenue and earnings – this will be achieved via both organic and inorganic growth. As organic growth will only lead to approximately 3% growth in earnings, inorganic growth will help to propel its earnings to double-digit growth. Hence, it targets to undergo three merger and acquisition activities in FY18, one of which is currently underway with Aspion Sdn Bhd (Aspion).

Potential capacity expansions in Vietnam as demand for gloves remain robust. We also understand from the management that demand for gloves remains robust with factories currently in an overbooked position with a lead time of two months. Demand remains strong at 8-10% growth annually and predominantly comes from examination gloves. That said, other glove division such as the TPE/CPE gloves are still gaining traction with +83% sales growth volume yearover-year and +14%qoq respectively. New capacity expansions in Vietnam remain a viable option for Top Glove due to this overbooked position. Top Glove noted that Vietnam has: (i) good infrastructure; (ii) friendly government as well as; (iii) tax benefit of 7% that is supportive of the glove industry.

Growing the specialty gloves segment. Management also revealed during the briefing that it plans to grow its specialty gloves segment by venturing into glove segments which are high in margin and less competitors such as the: (i) industrial gloves; (ii) safety gloves as well as; (iii) surgical gloves. The acquisition of Aspion which is currently underway is expected to drive its surgical gloves segment with sales volume and revenue expected to increase by >50% for the segment.

Acquisition of Aspion earnings accretive with double-digit growth in FY19 EPS expected. To recall, on 24th

November 2017, Top Glove announced that it has entered into a term sheet agreement with Adventa Capital Pte Ltd to negotiate on the potential acquisition of the entire equity interest in Aspion Sdn Bhd, Adventa’s surgical glove manufacturing division. Subsequently, the parties have announced on 12th of January 2018 that they have signed the sales and purchase (SPA) agreement with a purchase consideration of RM1,370m of which, RM1,233m will be satisfied via cash from borrowings and the remaining RM137m will be through the issuance of 20.5m of new Top Glove shares. As a result, Top Glove’s gearing ratio will increase to about 0.7x which is still below its internal threshold of 0.88x. This values the acquisition at 16.9x PER on FY18F expected profit. Following this acquisition which is expected to be completed in April 2018, we understand that Top Glove and Aspion have entered into an incentive-based agreement where the core profit after tax (PAT) for the first two years (RM80.9m for the first year and RM108.3m for the second year) following the acquisition are guaranteed by Aspion. Therefore, we believe that the acquisition price is fair given that the purchase consideration was arrived at based on a guaranteed profit for a period of two years. According to our forecasts, the core PAT contribution from Aspion will lead to an overall double-digit growth in EPS for FY18-19 of +25% and +18.9% respectively. Additionally, the acquisition of Aspion will make Top Glove the single largest producer of surgical gloves in the world with a combined market share of 29% in the surgical gloves market. Furthermore, following the acquisition, Top Glove’s surgical sales volume will increase to 2% to 4% of its total gloves sales volume while in terms of value, Top Glove’s surgical sales is expected to increase to 13% of its total revenue vs 5% currently. The acquisition will also allow Top Glove to tap on Aspion’s current exposure in various markets worldwide especially the developed markets.

Earnings forecast. Following the recently announced 1QFY18 results and analyst briefing, we are revising our FY17-18F earnings forecasts by +12.8% and +17.4% respectively as we incorporate four months of contribution from Aspion in FY18 and full-year contribution in FY19 into our earnings. Key risks to our earnings would be: (i) higher than expected increase in production costs i.e: raw material prices, labour costs etc; (ii) delays in plant expansions and; (iii) failed acquisition of Aspion.

Maintain NEUTRAL with a revised Target Price (TP) of RM8.55. Post earnings revision and rolling forward our valuation base year to FY19, we revised our TP to RM8.55 (from RM5.53 previously). Our valuation is premised on FY19 EPS of 38.9sen pegged to a higher PER of 22x which is +0.5SD of the company’s 3-year historical average PER to better reflect the earnings accretion coming from the acquisition of Aspion and the current earnings upcycle. However, we maintain our NEUTRAL recommendation as we believe all the positives have been priced in at this juncture and the stock is now fully-valued. Additionally, we opine that despite the current improvement in raw materials price, the cost savings might be offset by: (i) lower ASPs - as a result of the low raw materials price and; (ii) the strengthening of Ringgit, which could limit its earnings potential going forward.

Source: MIDF Research - 15 Jan 2018