We attended Top Glove’s 1QFY17 results briefing. Key highlights include: 1) improved QoQ profitability on higher sales volume, ASP adjustments and the stronger USD against the Ringgit, 2) plants remain operating healthily with utilisation rates of above 80% with growing contributions from nitrile gloves, 3) commitment to expansion plans are intact to capture growing demand and entrench market leadership, and 4) efforts such as ASP adjustments and efficiency improvement initiatives to weather challenges (i.e. foreign worker levy). Maintain Sell with a TP of RM4.75/share pegged to an unchanged PER of 18.0x on lofty valuations.

1QFY17: QoQ Improvements on Higher Sales Volume, ASPs & USD/Ringgit

To recap, following consecutive quarters of declining profitability since 2QFY16 (see Figure 1) attributed to diminishing tailwinds coupled with competitive and cost pressures, Top Glove displayed improvements in 1QFY17 with its core net earnings and margins respectively having increased by 19.9% to RM69.3mn and 0.8%-points to 8.8%. The recovery was on the back of higher sales volume (+5% QoQ), the strengthening of the USD against the Ringgit (+4% QoQ) and average selling prices (ASP) adjustments (+1% QoQ to pass through the 11.1% minimum wage hike and 6.0% natural gas hike in July 2016), albeit partly offset by higher prices of natural latex (+2% QoQ) and nitrile latex (+2% QoQ).

Demand Intact with Growing Contributions from Nitrile Gloves

In 1QFY17, plant utilisation rates remained healthy above 80%. YoY, except for latex powdered gloves, sales volume of all glove types grew. The decline in sales volume of latex powdered gloves reflects the group’s active efforts to promote demand towards powder free gloves following the Food and Drug Administration’s proposal in March 2016 to ban the sales and distribution of powdered medical gloves to USA’s medical sector. The ban will be legally enforced soon on 19 January 2017 and the group does not expect a significant impact from it as it is currently selling powder free medical gloves to USA’s medical sector.

In terms of glove type, the group’s nitrile focused capacity expansion over the years continues to pay off with increasing contributions from nitrile gloves observed. YoY, the group’s latex:nitrile mix has shifted from 65:35 in 1QFY16 to 59:41 in 1QFY17. Meanwhile, by geography, Europe, North America and Asia remained the group’s key markets. They collectively contributed circa 79% of 1QFY17’s sales volume, a 2%-point increase from 77% in 1QFY16. The remaining proportion of 21% were contributed by Latin America, Middle East and Africa.

Seeking to Continuously Expand

On the expansion front, the group remains committed to continuously expand to ride on the sustained growth in demand for rubber gloves primarily from the defensive healthcare sector and alongside this, entrench its position as the world’s largest rubber glove producer. The current nitrile focused capacity expansion in Klang, Malaysia is expected to expand the group’s capacity to 56.8bn gloves per annum by 2018, an 18.3% increase from its latest capacity of 48.0bn gloves per annum. As for the medium to longer term, ambitions are to grow its current 25% market share to 30% by 2020.

Sustained Emphasis on Efficiency to Weather Recent Challenges

The recent enforcements by the government and regulatory bodies have dealt challenges to local glove manufacturers. Among others, this includes the requirement for employers to be fully accountable for their foreign workers levy, the gradual increase in natural gas tariffs from 1HCY17, as well as Bank Negara Malaysia’s (BNM) requirement for exporters to convert 75% of their export proceeds into Ringgit. With regards to the foreign levy, management alluded that the impact will be a 3.5% increase on labour cost and based on this quantum we deduce that a manageable change in ASPs of circa +0.3% is required for it to be offset. As for BNM’s requirement, we note that while the impact of reconverting is almost negligible, it introduces unproductive administrative work. Above all, management alluded that efforts will continue to be made to alleviate operating cost increases via ASP adjustments and sustained emphasis on operating efficiency (i.e. further automating production lines to reduce reliance on labour).

Impact

We make no changes to our earnings estimates.

Valuation & Recommendation

Our TP for Top Glove is maintained at RM4.75/share based on an unchanged PER of 18.0x. At this juncture, valuations appear lofty with the stock currently trading at a PER of 20.7x which is close to 1 S.D. above its historical 5-year average PER of 16.1x and hence, we reiterate our Sell recommendation on the stock.

Source: TA Research - 6 Jan 2017