• Top Glove's 1QFY21 earnings beat consensus expectations. The surge in raw material cost was well absorbed by still-rising ASPs.
• Management expects full production to resume in a matter of weeks, following the untoward COVID-19 outbreak among its foreign workers. Similarly, US CBP’s withhold order is expected to be resolved soon as well.
• ASP outlook remains robust and we should reasonably see a step change in earnings.
• Maintain BUY on Top Glove with target price of RM12.30.

Top Glove's 1QFY21 Earnings

• Top Glove (SGX:BVA)’s 1QFY21 core net profit of RM2,560m (+98% q-o-q, +2,198% y-o-y) was within our expectations but surpassed consensus’, accounting for 23% and 30% of full-year estimates respectively. Heading into the quarters ahead, we expect still-robust ASP revisions to increase earnings significantly q-o-q. Overall demand visibility remains highly robust.
• An interim dividend of 16.5 sen was declared, representing a dividend payout of 56% or 6% above Top Glove's dividend payout policy of 50% (1QFY20: 1.3 sen).

Blockbuster revenue growth sustained.

• Top Glove's revenue grew 53% q-o-q (+294% y-o-y) to RM4,759m in 1QFY21. This was attributed to:
  1. blended ASP rising by 57% q-o-q;
  2. US$/RM rate sliding by 2.3% q-o-q; and
  3. flattish volume growth arising from the enhanced movement control order (EMCO) implemented on Top Glove’s operations arising from the COVID-19 outbreak.
• Despite the steep ASP hike in the quarter, we continue to expect further ASP hikes to be sustained into 2QFY21.

Spike in nitrile cost well absorbed by steep ASP hikes.

• EBITDA margin expanded to 66.1% against significantly higher ASPs. Margins were slightly tempered with raw material costs seeing step changes in cost.
• Latex and nitrile costs came off a low base and grew 13% and 39% y-o-y respectively against unfavourable forex (-2.3%). Net margin was further tempered to 49.9% by a higher effective tax of 22.3% (4QFY20: 18.3%).

Visibility for Near-term Earnings Windfall for Top Glove Remains Intact

• We gather December-February nitrile ASPs would be raised by 15%, 10% and 5% m-o-m respectively. Meanwhile, latex glove ASPs would be revised by 5% m-o-m throughout 2QFY21.
• On a quarterly basis, 2QFY21 blended ASPs are expected to be up 30% q-o-q. The still-uptrending ASPs should result in step changes in earnings over the coming two quarters.
• Similarly, spot 2QFY21 ASPs are expected to be priced in the region of US$140-150/’000 pieces (1QFY21: US$120/’000 pieces). Despite our expectations for quarterly earnings to peak in 3QFY21, the likes of its peers such as Supermax pricing its spot ASPs at ~US$200/’000 pieces represents upside to our expectations.

Light at the End of the COVID-19 Outbreak Tunnel

• Recall that 20 of Top Glove's glove manufacturing factories have been placed under EMCO since mid-November. This accounts for 50% of production. Overall, on a group level, we gather that current utilisation rate is close to 60%. Thus far, ~5,000 of 8,868 workers have tested positive for COVID-19. However, 90% have been cleared fit to work. As such, management expects a gradual resumption of production over the following 2-3 weeks, before achieving optimised utilisation rates in early-21.

Could Sentiment See An Additional Boost From the Lifting of the WRO?

• In relation to Top Glove’s Withhold Release Order (WRO) or a detention order on gloves manufactured by Top Glove, issued by the US Customs and Border Protection (CBP), management believes it is at the tail end of resolving the issue. This would allow Top Glove to fully resume sales to the US that previously saw restriction on two subsidiaries. As a result of the WRO, 1QFY21 US volume sales declined by 2% y-o-y.
• While the earnings impact is negligible, we think that the lifting of the WRO would improve sentiment as it positively affirms Top Glove’s labour practices.

Lucrative Special Dividend From Top Glove in FY21?

• While Top Glove has not declared a special dividend, we do not rule out a special dividend in FY21, given its anticipated windfall earnings.
• Based on the Top Glove’s dividend policy payout of 50% alone, the implied dividend yield for FY21 is 9.8%.
• For every 10% additional payout, the dividend yield increases by 2.0%. That said, dividend yield would moderate to 2.7% and 1.5% in FY22-23 respectively.

Top Glove - Earnings Forecast

• We leave our Top Glove's earnings forecasts unchanged for now until we gain further visibility over ASPs.
• Key downside risks include:
  • swift containment of COVID-19 outbreak; and
  • disruption to its production or supply chain caused by the COVID-19 outbreak.
• Every -1% deviation from our RM4.10/US$ assumption translates into 1.2% and 1.8% declines to our FY21-22 earnings respectively.

Top Glove - Valuation & Recommendation

• Maintain BUY on Top Glove with target price of RM12.30, based on 13.0x 2021F PE, or close to -3SD of its 5-year forward PE mean. It is at a significant discount as we believe valuations are being pegged to windfall peak earnings, upside to earnings is increasingly being factored in, and the risk-to-reward at this juncture is increasingly pronounced given the surge in share price.
• That said, our PE peg is reasonable as Top Glove is an established FBMKLCI component with sublime earnings growth.

Source: UOB Kay Hian Research - 10 Dec 2020