Top Glove - UOB Kay Hian 2018-01-15: Staying On Top Of The Game

TOP GLOVE CORPORATION BHD BVA.SI

Top Glove (TOPG MK) - Staying On Top Of The Game

Post-briefing last Friday, we turn more optimistic on the Aspion deal, given:
1. the attractive price tag even after taking into account its high debt and control premium;
2. the outlook for Finessis - Aspion’s new line of surgical gloves - appears to be promising; and
3. the good funding structure is not as straining to cash flow as first anticipated.

Maintain HOLD but raise target price to RM8.00, in line with our upward earnings revision. Entry price: RM7.20.

Last Friday, Top Glove entered into a conditional share purchase agreement with Adventa Capital to acquire full control of Aspion for RM1.4b. There is a profit guarantee of RM81m and RM108m for FY18-19, translating into 17x and 13x PE (sector mean: 25x) respectively.
Besides, incentive payments are available to Adventa Capital based on the profit generated from selling Finessis, Aspion’s new line of surgical gloves. This arrangement will only last three years from FY18 to FY20. The expected timeline for the deal to complete is Apr 18.
Management hosted a briefing to shed more light on this M&A transaction and provided some business updates.

Post-briefing, we turn more optimistic on the deal, given:
1. the attractive price tag on an EV/EBITDA basis, Top Glove is only paying 11x for Aspion vs peers’ average of 16x; and
2. the bright outlook for Finessis.
Prior to this, we believed that the discounted PE valuation was due to Aspion’s high debt level (net gearing of 0.9x vs peers’ average of 0.1x) but even after considering this, it seems inexpensive despite including a control premium.
Also, we are impressed by the sophistication of Finessis that is FDA approved (no chemical accelerators and its acceptable quality level is < 0.1 vs industry standard of 0.65).

The acquisition will be funded by 90% debt and 10% equity (at RM6.68 per Top Glove share).
The borrowings will be in US$ and is separated to two tranches:
1. US$155m Murabahah 5-year term financing at LIBOR+1.25%; and
2. US$155m conventional 2-year term loan at LIBOR+0.825% for the first 12 months and then revised upwards to LIBOR+1.325%.
We understand the principal of the first tranche will be amortised and paid from 18 months onward while the second tranche will be refinanced after 24 months. Besides, 50% of the new shares issuance are subjected to a moratorium of 3 months.

To encourage a more enthusiastic rollout of Finessis, Top Glove has devised a 3-year incentive plan for Adventa Capital (44% owned by Mr Low Chin Guan, Managing Director of Aspion) to lift sales and profit of this new product line. Note that the RM81m-108m bottom-line guarantee excludes contribution from Finessis.
The incentive payment will be based on a 20-50% sharing from FY18-20 profit after tax together with a PE multiplier of 17x. We gather this will be settled by cash and the amount will be capitalised as investments.

Over the past 10 months, Aspion has sold more than 3m pairs of Finessis gloves and is capable of producing up to 12m pairs per year. We understand the price range is 3-17x higher than the average for surgical gloves sold by Top Glove and Aspion.
The potential gross margin Finessis is able to fetch is 10-20ppt above both its average run-rate of 20-30%. Based on 25% capacity utilisation, we estimate Finessis chalked up sales and earnings of about RM19m and RM3m respectively in Mar-Dec 17. Nevertheless, the contribution is still minuscule vs Aspion’s corresponding FY17 total revenue and core profit of about RM600m and RM60m.

At present, Top Glove and Aspion are running at capacity utilisation rates of 85% and 70% respectively.
For Top Glove, besides organic expansion via Factories 31 and 32, it plans to penetrate into Vietnam in the next 1-2 years. The intention is to build a factory over there to house the production of 1b vinyl gloves. Besides, it is targeting to acquire another two small companies in 2018.
For Aspion, the aim is to increase its current 4.6b gloves capacity to 6b (new surgical gloves’ production lines) with capex of RM40m-50m by 2019. Overall, we laud Top Glove’s clear plans for the future but we think it needs to be watchful with the ballooning debt level (net gearing estimated to rise to 0.6x from net cash position post-acquisition of Aspion).

Management expects the global vinyl glove shortage caused by China’s anti-pollution drive to persist in 1H18 but the undersupply conditions should improve heading into 2H18.
Recall the noble initiative by the Chinese government forced vinyl glove companies in the country to temporarily shut down their operations. Hence, Top Glove looks set to continue benefitting from this situation. We gather it has 60 days of forward orders on hand until Mar 18 (vs 50 days in 4QFY17).

We raise our FY18-20 net profit estimates by 5-20% as we incorporate the financial contributions from Aspion and Finessis but slightly capped by interest expense from new borrowings. That said, EPS was lifted by a smaller 4-18% due to the dilution effect from new share issuance.
Key downside risks include:
1. market share losses,
2. value-destructive M&A, and
3. US$ severely weakening against the ringgit.

Maintain HOLD but lift our target price to RM8.00 (from RM6.75), based on an unchanged 18x 2019F PE. This is +0.5SD above its 5-year forward mean PE of 16x but below the sector’s 29x.
The premium is fair as:
1. Top Glove has been making steady headway into the faster-growing nitrile glove space; and
2. the acquisition of Aspion propels the group to be the no.1 surgical glove player globally.
That said, the discount to the glove sector is warranted, considering its relatively stretched balance sheet (net gearing of 0.6x vs peers’ average of 0.1x). Likewise, our PE-ROE regression analysis suggests pegging the stock to 18-20x forward PE.
Despite the recent run-up of Top Glove's share price, we believe the risk-reward remains balanced, given the strong inorganic growth contributions from Aspion and Finessis.
Entry price is RM7.20.

Chan Jit Hoong CFA UOB Kay Hian | http://research.uobkayhian.com/ 2018-01-15

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