Top Glove (TOPG MK) - UOB Kay Hian 2017-11-27: Aspiring To Lead In Surgical Glove Space

TOP GLOVE CORPORATION BHD BVA.SI

Top Glove (TOPG MK) - Aspiring To Lead In Surgical Glove Space

Top Glove has entered into exclusive negotiations to acquire Aspion for RM1.3b- 1.4b.
Despite the deal having its pros and cons, it will be value-accretive, as Top Glove’s current forward PE of 23x is higher than Aspion’s 16-18x.
Maintain HOLD but lift our target price to RM6.38 as we roll valuation to 2019. Entry price: RM6.10.

Top Glove has finally unveiled its acquisition target – Aspion Sdn Bhd – a second-ranked player in the surgical glove space. The proposed price tag is RM1.3b-1.4b with a net profit guarantee of RM80m, translating into 16-18x PE.
At a glance, the price seems inexpensive, considering that the glove sector in Malaysia is trading at a forward mean PE of 25x. However, Aspion has a relatively stretched balance sheet with a net gearing ratio of 0.9x (peers’ average: 0.1x). Thus, we believe the offer price is fair; further supported when evaluating the deal on a P/B basis (4-5x vs sector’s 4.4x).
The transaction will be financed via debt and new shares ( < 10% in value of the purchase price).

We see the move in line to what was earlier conveyed to the investment community, ie to grow its surgical glove business (touted to generate higher margins). Currently, this product line makes up only 2% and 5% of total sales volume and value, and we estimate these could rise to 4% and 13% post-inclusion of Aspion.
Besides, we expect meaningful transfer of knowledge (from Aspion to Top Glove) as the technology in manufacturing surgical gloves is more sophisticated than that for other generics.
Also, there are cross-sell opportunities and the marketability of Top Glove’s niche product offerings may strengthen further in the future. Although unquantifiable at this juncture, as in all other M&As, there should be some cost-savings synergies.

Upon completion, Top Glove’s margins and ROE remain relatively unchanged but ROA is likely to deteriorate in the immediate term, given the RM1.0b-1.2b goodwill from the deal. That said, we reckon management would be able to eke out some improvement over the medium to longer term, given its prudent track record in running existing operations.
In fact, during the last analyst briefing, Top Glove shared that the surgical glove business typically generates higher margins vs other glove products (by 2-7ppt at gross profit level).

For credit profile, we believe Top Glove would see a jump in its net gearing to 0.6x (from net cash position). This is due to Aspion’s high borrowings and Top Glove taking on a huge debt to finance the acquisition. Hence, we predict competing need for operating cash flow (OCF).
On a standalone basis, OCF is already fully taken up by capex and dividend requirements. Consequently, we think it is difficult to keep the same capex level as % of sales (5-10%) and this may in turn affect Top Glove’s ability to chalk a comparable historical revenue growth (5-year CAGR of 10%).
Further, there is rising risk of higher cost of borrowings especially as the Fed is in the mood to raise interest rates.

Although this deal has its pros and cons, it is going to be value accretive, considering Top Glove’s current forward PE of 23x is higher than Aspion’s 16- 18x. Assuming a full year of contribution from Aspion, Top Glove’s FY18 EPS could rise by 10%.
Generally, a premium valuation is required for a takeover to materialise and thus, opportunity like this does not come by often.

Maintain HOLD but with a higher target price of RM6.38 (from RM5.65) as we roll valuation to 2019 (from 2018) and based on an unchanged 18x to 2019F EPS. This implies +0.5SD above its 5-year forward mean PE of 16x but below peers’ average of 25x.
Our PE multiple is fair, noting that:
1. the industry is in an upcycle,
2. Top Glove has been making steady headway into the faster-growing nitrile glove space, and
3. the acquisition of Aspion is value-accretive.
However, we are wary of the current rich sector valuation as it appears to have already priced in most of the positive near-term developments.
Note our new target price has not factored in Aspion. Entry level is RM6.10.

Chan Jit Hoong CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-11-27

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