We met up with TOPGLOV. Indications are pointing to a strong demand recovery moving into FY25 that will exceed our previous assumptions. As a result of higher sales volume assumptions, we upgrade our FY25F/FY26F net profit by 39%/42%, our TP to RM1.02 (previously RM0.97) but reiterate our MARKET PERFORM call.

We are positive on the prospect of TOPGLOV The key takeaways from a luncheon meeting yesterday are as follows:

1. The Group is optimistic that the strong growth momentum will sustain, as customers continue replenishing their depleting glove stockpiles. The group continues to see MoM uptrend in sales volume in Sept 2024 and expects customers’ replenishment activity to pick up in subsequent quarters, underpinned by inventory rebuilding by distributors, indicating that demand recovery had further gained momentum. Presently, its sales volume had strengthened 25%-30% MoM, bringing utilisation rate to 65%-70% vs. our assumption of 55% in FY25 (based on 64b pieces capacity) compared to 45% in 3QFY24. Recall, it has previously highlighted that the bulk of a shipment delay in 3QFY24 estimated at 500m pieces had already been shipped and will be booked in 4QFY24.

2. It is optimistic that ASPs are expected to inch up gradually, potentially by 5%-15% or USD0.80 - USD1.50 per 1,000 pieces due to the uptick in demand and mitigation against the appreciating MYR against USD. However, due to the lag impact, ASP increases will only be felt gradually starting from Nov-Dec CY24. We believe predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competition) have diminished as Chinese players’ utilization hit >90% While TOPGLOV is silent on existing ASP, we estimate every USD1 change impacts earnings by below 2%. We conservatively assumed ASP of USD20/1,000 pieces in our earnings model.

3. The group highlight that its exports to the US is continuing to show improvement which currently accounts for 28%-30% of its geographical sales mix. As an indication, TOPGLOV has seen its volume sales from the US market raising 20% YoY to account for 15% in 9MFY24 compared to pre-pandemic average of 20%-30%.

The group believe this were due to inventory replenishment by its customers coupled with more China suppliers being listed under US FDA’s import alert list and Chinese players capacity hitting 90%. The group expect to benefit from the recently announced further US upward tariffs revision, with a brought-forward timeline. Recall, the United States Trade Representative (USTR) has recently unveiled tariff increases on Chinese imports which includes a higher tariff of 50% instead of the previously announced (in May CY24) imposition of 25% effective CY26 and 100% on China’s rubber medical and surgical gloves’ exports into the US beginning CY25 and CY26, respectively. For illustration purposes, a 50% tariff hike is expected to raise Chinese glove producers’ ASP to USD25-USD26/1,000 pieces (we assume base case ASP at USD19/1,000 pieces) compared to Malaysian players’ ASPs at USD16-21/1,000 pieces.

4. We are not perturbed by the present appreciation of MYR against the USD as we expect the rising momentum of sales volume will more than offset the impact from the stronger MYR. YTD CY24, the USD had weakened 10% against the MYR (USD1 = MYR4.12). Since sales are USD-denominated, theoretically, an appreciating MYR against the USD will lead to less revenue receipts for glove makers.

Ceteris paribus, (i) a 1% strengthening of MYR against USD will lead to an average 1.5% decrease in the net profit of rubber glove players, and (ii) a 1% rise in sales volume is expected to add 1%-2% to net profit. Note that since nitrile raw material (30%-40% of total cost) prices are quoted in USD, this gives manufacturers a slight natural hedge as ASPs are also quoted in USD.

Valuations. We raise our FY25F and FY26F net profit by 39% and 42%, respectively, as a result of raising sales volume assumptions. Consequently, we raise our TP from RM0.97 to RM1.02 based on unchanged 1.7x FY26F BVPS, which is at a discount to sector’s recovery cycle of between 1.8x to 2.5x, i.e. the levels seen emerging from an oversupply downturn in 2008, and a discount that we believe is valid due to the emergence of Chinese glove makers. We roll forward our valuation base from FY25F to FY26F due to the improved outlook. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 3). Reiterate MARKET PERFORM.

Outlook. With market expectations of losses and falling ASPs increasingly being priced in, we see sector value emerging being derived on a medium-term horizon. Amplifying the optimism are: (i) indications pointing towards a strong demand recovery moving into 2HCY24 and CY25 that will be stronger than what we had previously assumed, underpinned by inventory rebuilding from distributors and faster-than-expected industry consolidation,( ii) tell-tale signs that predatory pricing by certain overseas players (i.e. selling below cost over an extended period to eliminate competitors) have diminished as Chinese players’ utilization hit >90%, and (iii) US imposition of tariff ratchets up to 50% and 100% in CY25 and CY26, respectively, (revised up as announced on 13 Sept) making Malaysian glove makers the prime beneficiary. We expect glove stock prices to re-rate in anticipation of near-term earnings upsurge which clearly is a positive for the sector. We now expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants and exit of new entrants. Based on our estimates, the demand-supply situation will only start to head towards equilibrium in CY26 when there is no more net new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum underpinned by rising hygiene awareness.

Key risks to our recommendation include: (i) certain Chinese glove giants end predatory pricing practices (i.e. selling below cost over an extended period of time to eliminate competitors), leading to a strong earnings rebound for the sector, (ii) stronger-than-expected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (iii) further changes in tariffs which have happened before; recall that post the implementation of the initial 15% tariff on Chinese glove imports, this figure was lowered to 7.5% during phase first US-China trade agreement back in 2019, and (iv) epidemic and pandemic occurrences.

Source: Kenanga Research - 26 Sep 2024