Top Glove (TOPG MK) - UOB Kay Hian 2018-06-20: 3QFY18 Beats Estimates But Risk/reward Remains Unfavourable

TOP GLOVE CORPORATION BHD SGX: BVA

Top Glove (TOPG MK) - 3QFY18 Beats Estimates But Risk/reward Remains Unfavourable

The 21% q-o-q core profit growth in 3QFY18 trumped expectations on lower-than-anticipated raw material costs and the acquisition of Aspion being completed a month earlier than expected.
Nevertheless, we stay bearish on the stock as valuations are rich and risk-reward profile is unfavourable. Within our coverage, Top Glove is the second-priciest proxy to the sector. Also, it is trading at more than +2SD its 5-year forward PE.
Maintain SELL but at a higher target price of RM8.40.

Top Glove’s 3QFY18 core earnings growth of 21% q-o-q (+58% y-o-y) brought 9MFY18 bottom-line to RM332m (+44% y-o-y). This came in above expectations, accounting for 80% of our full-year forecast but in line with consensus (at 73%).

The variance was due to soft raw material costs and the acquisition of Aspion being completed ahead of time.
An interim DPS of RM0.07 (+17% y-o-y) was declared.

Revenue rose 15% q-o-q with 5% attributed to organic growth and the remaining 10% coming from the consolidation of Aspion. The pick-up in volume (+4% q-o-q given better demand from emerging nations) along with positive ASP revision (+3% q-o-q due to cost pass-through) continued to buoy sales performance on a standalone basis.
Again, forex headwinds (-2% q-o-q as the US dollar weakened against the ringgit) acted as a negative factor in 3QFY18.
Trickling from the top, core earnings (ex-forex gains/losses) increased 21% q-o-q. Collectively,
1. robust capacity utilisation (flat at 90%),
2. tight cost control,
3. soft raw material prices (inched up at a slower pace of 3% q-o-q, matching the quantum of ASP revision), and
4. higher-margin products from Aspion helped to retain operating profitability in 3QFY18.
However, the five-fold jump in interest expense capped bottom-line from growing at an even faster clip (PBT margin narrowed 1ppt q-o-q to 12%).

With the acquisition of Aspion being completed in early-April, Top Glove is now capable of producing up to 57.5b gloves p.a.
The expansion timeline for Factory 32 (early-19) is unchanged, but that for Factory 31 has been pushed back to Jul-18. When fully operational, Top Glove’s enlarged manufacturing capacity will balloon to 64.9b gloves p.a. (+13%). The new lines are for nitrile gloves, which should raise capacity mix in this space to about 40% from 30% currently.
Management intends to achieve a 50:50 nitrile-to-latex glove production split by 2020.

Going forward, there is a rising threat of slower demand as we observe tapering forward orders.
Top Glove shared that it has 40-45 days of sales backlog, implying they are sold out until Jul-Aug 18; this is shorter than 1QFY18's level of 60 days (but similar to 2QFY18’s). Two possible reasons are:
1. supply recovery in China as capacities restart after 2017's environmental clampdown, prompting price-sensitive F&B customers to switch back to using vinyl gloves (more economical); and
2. customers adopting a wait-and-see attitude since more nitrile glove supply capacity will be coming on stream in the near term.

Considering the stronger-than-expected 3QFY18 results, we revise up our FY18-20 net profit estimates by 3-13% on the back of lower raw material costs and factoring in an additional month of contribution from Aspion as the acquisition was completed in early-April (we had previously assumed late-April).

Maintain SELL but with a higher target price of RM8.40 (from RM8.00) as we raise our earnings forecasts.
For the valuation methodology, we are still employing the same price multiple, pegging Top Glove to 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 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 0.8x vs peers’ average of 0.1x). Likewise, our PE-ROE regression analysis suggests pegging the stock to 18-20x forward PE.
Post-bonus issue, our target price would be adjusted to RM4.20, excluding the potential dilution from full guaranteed exchangeable bonds conversion into new Top Glove shares pending more details of the exercise.

Chan Jit Hoong CFA UOB Kay Hian | https://research.uobkayhian.com/ 2018-06-20

SGX Stock Analyst Report SELL Maintain SELL 8.40 Up 8.000