Top Glove (TOPG MK) - UOB Kay Hian 2018-03-16: 2QFY18 Within Estimates But Risk-reward Unattractive

Top Glove (TOPG MK) - UOB Kay Hian 2018-03-16: 2QFY18: Within Estimates But Risk-reward Unattractive TOP GLOVE CORPORATION BHD BVA.SI

Top Glove (TOPG MK) - 2QFY18: Within Estimates But Risk-reward Unattractive

  • No surprises, with Top Glove’s 2QFY18 core earnings nudging up 6% q-o-q on a lower effective tax rate. However, forward orders have started to taper off. 
  • Echoing the sector’s outlook, we stay bearish on the stock given snowballing downside risks, which we reckon are not being adequately accounted for by the market. Furthermore, we are still concerned about its unfeasible premium valuations. 
  • We maintain our SELL call and target price at RM8.00.



RESULTS


In line. 

  • Top Glove registered decent 2QFY18 core earnings growth of 6% q-o-q (+30% yoy). This brought 1HFY18 bottom-line to RM205m (+36% y-o-y), making up 49%/48% of our and the street’s full-year forecasts. This is largely within expectations. 
  • The contribution from Factory 31 and the inorganic boost from the acquisition of Aspion should kick in from April-May 18 onwards. 
  • No interim dividends were declared, consistent with 2QFY17.

Pedestrian sales increase. 

  • The company chalked in pedestrian quarterly top-line growth of 2% q-o-q in 2QFY18. This was led by better volumes (+3% q-o-q as the vinyl glove supply shortage situation in China persisted) and positive ASP revision (+4% q-o-q due to higher cost pass-through to customers). However, forex headwinds (-5% q-o-q as US dollar softened against the ringgit) threw a spanner in the works and capped overall revenue from rising at a quicker pace.


STOCK IMPACT


Lifted by lower effective tax rate, EBIT margin flat. 

  • Unlike sales performance, core earnings grew at a faster clip of 6% q-o-q due to a lower effective tax rate (-2ppt q-o-q to 12%). That said, EBIT margin was relatively flattish despite:
    1. cost rationalisation efforts, 
    2. robust capacity utilisation (+5ppt q-o-q to 90%), and
    3. decrease in average raw material prices (-6% q-o-q). 
  • The reasons for Top Glove’s muted EBIT margin were the negative drag from the hike in gas prices and new foreign workers levy.

Expansion plans relatively on track. 

  • Top Glove is now capable of producing up to 51.6b gloves p.a. There is no change in completion timeline for Factory 31 but Factory 32 is now expected to commence operations by early-19. 
  • With the inclusion of Aspion and when these factories are fully active, manufacturing capacity will be boosted to 64.0b gloves p.a. (+24%). The new lines will be for the production of nitrile gloves, which should lift its capacity mix in this space to about 40% from 30% currently. 
  • Management aspires to achieve a 50:50 nitrile-to-latex glove production mix by 2020.

Forward orders tapering off. 

  • According to management, the company’s gloves are sold out until Apr-May 18, translating into 50 days of forward orders. Notably, this was a tad lower than 1QFY18’s level of 60 days, suggesting demand for Malaysian nitrile gloves may have begun to normalise. This could be due to the vinyl glove undersupply conditions in China recovering as capacities restart after 2017’s environmental clampdown, prompting price-sensitive F&B customers to switch back to the more economical glove offerings. 
  • Also, it may have been due to rising competition where more nitrile supply capacity is coming on stream. Nevertheless, Top Glove is still running at above-mean capacity utilisation rate of over 80%.


EARNINGS REVISION/RISK

  • No change to our forecasts.
  • Key upside risks include:
    1. market share gains,
    2. more sizeable value-accretive M&As, and
    3. US dollar appreciating markedly against the ringgit.


VALUATION/RECOMMENDATION


Maintain SELL and target price of RM8.00, based on 18x 2019F PE. 

  • This is +0.5SD above its 5-year forward mean PE of 16x but below the sector’s 28x. The premium is fair as:
    1. Top Glove has been making steady headway into the generally faster-growing nitrile glove space, and
    2. the acquisition of Aspion propels the group into becoming 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.

Downside risks snowballing. 

  • We reckon downside risks will continue to snowball and disappointments will not be tolerated by the market. We view that the market is fundamentally underpricing short-term risks such as:
    1. strong currency headwinds that may eat up profits,
    2. potential supply recovery in the Chinese vinyl glove space, and
    3. unprecedented sales volumes which could unwind on possible inventory build-ups.
  • Despite the SELL call, we acknowledge Top Glove still appeals to long-only investors, given its good track-record in sustaining growth over an extended period of time.


SHARE PRICE CATALYST

  • Supply-demand imbalance structurally driving up ASP.
  • More meaningful M&As contributing to higher inorganic growth.
  • Making further inroads into the Asian market.




Chan Jit Hoong CFA UOB Kay Hian | http://research.uobkayhian.com/ 2018-03-16
UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 8.000 Same 8.000



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