Top Glove (TOPG MK) - UOB Kay Hian 2017-03-01: Reaping The Benefits Of Firmer Glove ASPs

Top Glove (TOPG MK) - UOB Kay Hian 2017-03-01: Reaping The Benefits Of Firmer Glove ASPs TOP GLOVE CORPORATION BHD BVA.SI

Top Glove (TOPG MK) - Reaping The Benefits Of Firmer Glove ASPs

  • The industry has seen glove ASPS rising over the last two months. This reaffirms our view that the oversupply situation over the last three quarters is approaching its tail-end and we expect the supply-demand dynamics to be normalised by mid-17.
  • Being the prime beneficiary of the sustained US dollar strength, we expect Top Glove to deliver a stronger set of numbers in 2QFY17, and this should give rise to some near-term trading opportunity. 
  • Maintain BUY. Target price: RM5.89.



WHAT’S NEW


Rising glove ASPs... 

  • Management had recently carried out several upward adjustments to glove selling prices in order to pass on the rising latex and nitrile raw material input costs. 
  • We note that the selling price adjustments had been more apparent for latex gloves (+8-9% over the last two months) as compared with nitrile gloves (+3% over the last two months) due to heightened competition within the latter’s segment. Nevertheless, this had understandably kept gross margins for both its powder and powder-free latex gloves stable qoq at 20%, while nitrile glove gross margins had also held stable qoq at 15-16%, in spite of the rising raw material prices. 
  • While we believe that nitrile glove margins have bottomed out, any recovery in nitrile glove margins would likely be more gradual due to upcoming capacity arising from the industry’s nitrile glove-skewed expansion pipeline.
  • That said, the industry has seen a marked improvement from a year ago, where heightened price competition had prevented industry players from passing on rising input costs to customers.

…point to end of industry oversupply situation. 

  • The rise in glove ASPs were not confined only to Top Glove, as other glove companies under our coverage had reportedly carried out selling prices revisions. 
  • Our channel checks revealed that both Kossan and Hartalega had raised its glove ASPs by approximately 2-3% and 4-6% respectively over the last 2 months. This reaffirms our view that the oversupply situation that had plagued the industry over the last three quarters is approaching its tail-end and we expect the supply-demand dynamics to be normalised by mid-17.

Anticipates a stronger set of earnings in 2QFY17. 

  • Top Glove, with its sizeable proportion of natural rubber glove production, could emerge a winner as it stands to benefit from a reasonable scope of margin expansion (following some upward adjustment in glove selling prices carried out at end-Nov 16). This could give rise to trading opportunities in the coming quarter. This, coupled with the progressive production rampup at its newly completed F27 plant and firmer glove ASPs (arising from the recent price revisions), should see Top Glove deliver wider margins and firmer earnings in 2QFY17.
  • Our back-of-the-envelope calculation suggests a sequentially firmer 2QFY17 bottom-line of RM82m-86m (+12-18% qoq) premised on: a) 5-7% sequential top-line growth, and b) 0.5-1.0ppt qoq margin expansion.


STOCK IMPACT


Committed towards a sustainable expansion plan. 

  • Top Glove remains committed to achieving a sustainable capacity growth of 8-12% p.a. in order to achieve a 30% market share over the next five years (from 25% currently) and to further entrench itself as the world’s largest rubber glove manufacturer. To achieve its goal, management had lined up two new factories (F30 and F31) in its pipeline that would collectively lift its annual production capacity by 8.8b pieces to 56.8b pieces p.a. (from 48.0b pieces currently) by 2H18. 
  • Both factories are also focused on the production of nitrile gloves and would lift Top Glove’s nitrile glove capacity mix to about 40% (from about 31% currently).

Minimal impact from recent US ban on powdered latex gloves. 

  • The US FDA had enforced a ban on the use of powdered surgeon and examination gloves in the medical sector with effect from 19 Jan 17 onwards. Nevertheless, management alluded that sales were not impacted as the group had over the last two quarters ramped up production of substitute powder-free latex and nitrile gloves to cater to the shift in customers’ orders.
  • Evidently, this was reflected in the yoy increase in Top Glove’s 1QFY17 powder-free latex (+9% yoy) and nitrile glove (+16% yoy) sales volume that helped mitigate the steep 15% yoy decline in its powdered latex gloves sales volume.

Automation to improve productivity over the long run. 

  • Management indicated that it has allocated approximately 25% of its projected annual capex requirement of RM200m- 250m to further automate its production lines (with the remaining channelled towards capacity expansion). While the immediate impact to bottom-line cannot be quantified at this juncture, we expect the automation drive to help mitigate the rising production cost associated with the recent rebound in nitrile (+19% qoq) and latex (+45% qoq) raw material prices and the new ruling on foreign worker’s levy (which stipulates that employers will be fully responsible for their foreign worker’s levy).
  • Latex prices had recently rebounded to approximately RM7.75/kg currently (from RM5.09/kg in early-Nov 16) due to: 
    1. an output curb as wet weather in Southern Thailand hampered harvesting efforts, and 
    2. speculative buying spurred by expectations of robust demand from China automakers. 
  • While we believe that latex prices would likely sustain above the RM6.00/kg mark over the next two quarters due to the approaching winter period, management noted that it does not foresee any significant difficulties in passing on the higher latex costs given the improving operating landscape and dearth of oncoming production capacity arising from within the natural rubber glove segment.
  • However, the typical 2-month time lag in passing on the recent steep 45% qoq appreciation of the latex prices in 2QFY17 could temporarily crimp margins in 3QFY17.

R&D initiatives bearing fruits. 

  • Considerable progress was achieved through the group’s the R&D initiatives in the last two years as the group is now able to produce lighter-weight nitrile gloves of comparable quality to Hartalega and Kossan. 
  • We note that the group is now capable of producing lightweight nitrile gloves weighing as little as 2.7g (from 3-3.2g in end-15). We believe this considerable achievement will allow the group to increase its range of product offering and help bridge the gap with Hartalega (which still produces the industry’s lightest nitrile gloves, 2.5g).

Firmer US dollar a boost to bottom-line. 

  • Sustained greenback strength was seen postFed rate hike. The US dollar sustained its strength against the ringgit, having appreciated further to RM4.44/US$ currently (1QFY17: RM4.21/US$), well above our FY17-19 assumption of RM4.15-4.25/US$. This could give rise to some margin expansion and positive earnings surprises over the next two quarters, with our sensitivity analysis suggesting that every 1% appreciation in US$/RM would lift Top Glove’s FY17-18 earnings by 6-7%.


EARNINGS REVISION/RISK

  • No change.


VALUATION/RECOMMENDATION

  • Maintain BUY with target price of RM5.89, based on an unchanged 18x 2018F PE. 
  • Our target benchmark of 18x 2018F PE represents a 1x premium above its historical mean, which in our view, fairly reflects the potential earnings upside in the coming quarter and the group’s position as the prime beneficiary of the strengthening US dollar trend within the sector. 
  • At 16x 2018F PE, Top Glove’s valuations is also attractive as compared to Kossan and Hartalega (18x and 24x respectively). 




Lester Chin Kent Lake UOB Kay Hian | http://research.uobkayhian.com/ 2017-03-01
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 5.89 Same 5.89





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