YTD, Top Glove Corporation (TOPGLOV) has fallen by 19% triggered by oversupply concerns, intense competition and lower ASPs. However, we believe this is just a temporary rough patch and all the negatives have been priced in. Due to the recent price weakness, we have a BUY on TOPGLOV with TP at RM5.10 based on 25.5x FY20 EPS. We like TOPGLOV because (i) its “highly automated production processes” model is constantly improving, and (ii) Aspion is showing positive signs of improvement.

In the last two years, the sector has become a victim of its own success. The frantic pace of capacity expansion has resulted in a mild excess supply for rubber gloves leading to ASPs compression and flattish or lower profits over the past two quarters. As a result, rubber gloves players had since; (i) slowed new capacity expansion, (ii) more measures to maintain margins, including automation and other cost reduction initiatives, and (iii) intensifying sales efforts to penetrate emerging economies.

We believe signs of a prolonged oversupply appear overplayed judging by past oversupply experiences where players’ new capacity expansions are expected to be delayed and staggered. Case in point is Top Glove’s effective new capacity in CY19 is now only estimated at 2.6b to 3.0 pieces compared to 4-5b previously due to a more coordinated expansion. Interestingly, ASPs pressure is well contained ranging between USD21-23/1,000 pieces as compared to the previous down-cycle in 2016 ranging between USD19-USD21/1,000 pieces.

In an effort to mitigate rising cost and reduce reliance on labour, TOPGLOV is embarking on more automation in the production processes including: (i) an artificial intelligence system to detect and remove defective gloves; (ii) automated warehouse management system (expected to commence in mid-2019), and (iii) automated glove packing system (expected to commence by mid-2019) with total savings estimated at 5% of our FY20E earnings forecast.

Looking ahead, Top Glove’s capacity expansion includes namely: Factory 32 (Phases 1 & 2 to commence production by 2Q and 3Q 2019, respectively; 3.4bn pieces), Factory 33 (operational by 2Q 2019; 1.2bn pieces), Factory 2B (operational by 4Q19; 0.8bn pieces), Factory 5A (operational by 4Q 2019; 2bn pieces), Factory F40 (operational by 1Q 2020 and 4Q 2019; 3bn pieces), Factory F41 (operational 2Q 2020; 2bn pieces) Factory F42 (operational by 4Q 2020 delayed from 3Q 2020; 4.8bn pieces), and Factory 8A (operational by 3Q 2020 delayed from early 2020; 3.2bn pieces) which will boost the group’s total production capacity by 20.4bn gloves per annum to 80.9b (+33%).

Source: Rakuten Research - 23 Apr 2019