Review

• Top Glove’s 1HFY17 core earnings of RM150.4mn (-35.3% YoY) was within ours but slightly below consensus estimates at 46.9% and 42.9% respectively.

• YoY, revenue grew by 9.6% to RM1,637.1mn mainly on sales volume growth of 8%. Core earnings, however, declined by 35.3% YoY to RM150.4mn due to the more competitive operating environment, steep ascend in natural latex prices as well as higher natural gas prices and minimum wages. On average, prices of natural rubber latex and nitrile latex respectively increased by 40.5% YoY and 3.5% YoY. Meanwhile, in terms of product mix, the group’s latex:nitrile mix continues to balance out with the latex:nitrile mix at 60:40 in 1HFY17 versus 65:35 in 1HFY16.

• QoQ, core net earnings improved by 17.1% to RM81.1mn on the back of the strengthening of the USD against the Ringgit by 6.0% and upward revisions to average selling prices (ASPs) by 3% in USD terms to pass through the increase in raw material prices - natural rubber latex +33.4% QoQ and nitrile latex +10.2% QoQ. Suggesting improving supply and demand dynamics, management guided for further upward revisions to ASPs made during the quarter that will only be reflected in 3QFY17 due to the time lag factor. Coupled with improvements made across the manufacturing process, EBITDA margins improved by 0.9%-points to 14.6%. Meanwhile, sales volume declined by 1% QoQ owing to the quarter’s shorter working period.

• On the group’s financial standing, while remaining healthy, its net cash position declined by RM220.7mn QoQ to RM39.0mn. This was attributed to capital expenditure for expansion of RM160.3mn, dividend payments of RM106.5mn and the increase in working capital requirements caused by the increase in raw material prices.

• Separately, as per previous years, dividends are only expected to be declared in the second half of the financial year.

Impact

• Our FY17/FY18/FY19 earnings estimates are revised by +3.9%/+0.9%/+2.6% after effecting the following changes: 1) increasing ASP assumptions on the back of the group’s improved ability to pass through cost increases, 2) increasing FY17 and FY18 CAPEX assumptions, and 3) factoring in variations to near term expansion plans.

Briefing Highlights & Outlook

• Looking ahead, concerns lie with the direction of raw material prices, particularly natural latex which positively, of late, have retreated from its YTD2017 peak of RM8.18/kg at end-January 2017 to RM7.27/kg at its last close, representing a 11.1% decline. Barring growth in sales volume, management expects sustained sequential performance at the very least if prices do not deviate far from current levels.

• On the expansion front, management alluded that it will continue to progressively expand its glove manufacturing capacity to capitalize on the sustained growth in global demand for gloves of 6-8% per annum. We note however of some variations to imminent nitrile glove focused expansion with delays to F30 (4.4bn gloves p.a) and F31 (2.8bn gloves p.a.) due to hiccups related to the supply of natural gas. Additionally, the group introduced a new plant, F32 (4.8bn gloves p.a.), which is also intended to house nitrile gloves. With increased requirements for expansion plans, management guided that CAPEX for FY17 and FY18 would respectively be around RM250-300mn and RM200-250mn, higher than its previous guidance of RM200mn across both years.

• Meanwhile, as for efforts to propel the group towards its target of growing its global market share from 25% currently to 30% by 2020 via the inorganic route, management highlighted that the lack of value accretive opportunities has been a obstacle to its yearly KPI of making 1 to 2 acquisitions a year. Nevertheless, we understand that the group remains on the lookout for mergers and acquisitions as well as joint ventures. To recap, targets are not just limited to glove manufacturers but also supporting industries (i.e. chemicals and other raw materials).

Valuation & Recommendation

• Our TP for Top Glove is revised upwards to RM5.05/share (RM4.90/share previously) based on an unchanged PER of 18.0x. At this juncture, the stock is trading at a PER of 18.5x, close to 1 S.D. above its historical 5-year average PER of 15.9x and hence, we reiterate our Sell recommendation.

Source: TA Research - 17 Mar 2017