Top Glove (TOPG MK) - UOB Kay Hian 2018-07-10: Value Has Not Fully Emerged

SGinvestors.io

TOP GLOVE CORPORATION BHD SGX:BVA

Top Glove (TOPG MK) - Value Has Not Fully Emerged

• Management shared more details on what and where went wrong with the Aspion deal.
• It is perceived to be overvalued and the profit guaranteed by Adventa Capital is unlikely to be met.
• After cutting our FY19-20 net profit forecasts by 6-8%, Top Glove is trading at +1SD to its five-year forward PE.
• For now, we reckon value has not fully emerged. Maintain SELL but at a lower target price of RM7.80.

WHAT’S NEW

More backstory.

• Yesterday, Top Glove hosted an analyst briefing to allay investors’ concerns (Top Glove's share price plunged 25%) and provided more details on the lawsuit against Adventa Capital.
• Management is seeking damages amounting to RM715m for fraudulent misrepresentations, which in turn, led to Aspion being acquired at a price tag of RM1.4b. This analyst research report is shared at SGinvestors.io

STOCK IMPACT

How it went wrong?

• Management explained the due diligence exercise was conducted through a Virtual Data Room (VDR). Here, Top Glove along with other bidders were able to search up for the operational, financial, tax and legal information of Aspion. This was the preferred method due to the fear of over sharing data with competitors who end up not acquiring the target company. 
• Hence, the unintended consequence was being too reliant on the materials furnished by Adventa Capital.

Where went wrong?

• It was only later that the vendors gradually slipped hints of a potential deceitful act, prompting Top Glove to investigate further. 
• After more thorough checks, management found that:
  1. Aspion may not be able to achieve the RM100m FY18-19 (Oct) profit guaranteed by Adventa Capital due to inaccurate historical information,
  2. non-existing or obsolete inventories, and
  3. some fixed assets being unable to operate, de-commissioned or missing.
• Collectively, these led to a claim of RM715m where RM640m was attributed to overvaluation, RM58m to inventories, and RM17m to plants and machineries.

What now?

• Management calmed nerves by sharing that Aspion’s surgical glove technology is real and other physical assets are in place. Thus, Top Glove did not acquire an empty shell and Aspion is said to be capable of remaining in the black but not at the level of profits as initially promised by the vendors.
• Preliminarily, management is looking at only RM40m over the next one year but RM80m is a more realistic target over a 2-3 years’ horizon. Also, Top Glove stressed that existing standalone operation is running business as usual.

Good track record in turning around loss-making acquisitions.

• We understand Mr Low Chin Guan (one of the vendors) has been relieved from his duties and Top Glove has effectively taken over the role of supervising the day-to-day operations of Aspion.
• With more assertion of power and control, management remains optimistic on the deal. It is worth highlighting Top Glove's good track record in integrating and turning around past loss-making acquisitions like Medi-Flex, A1 Glove and Titi Glove within a short timeframe of 1-3 years. If the RM715m is successfully claimed, it would be a huge plus, in management's eyes.

Impairment charge undeterminable for now.

• We believe a potential one-off impairment charge relating to this unfortunate incident is in the cards. However, management was not able to paint more colour on this matter. We gathered the segregation of goodwill and intangibles exercise is still on-going, therefore the financial impact cannot be reliably determined at this juncture.
• Assuming the impairment charge is RM640m (overvaluation figure), we estimate Top Glove's book value per share of RM1.77 as at 3QFY18 may decline by 28%. Nevertheless, management suggests strong evidence against the vendors and the likelihood of winning the case is high. This analyst research report is shared at SGinvestors.io

EARNINGS REVISION/RISK

Cut FY19-20 bottom-line estimates by 6-8%.

• Considering this negative development, we tone down our FY19-20 net profit forecasts by 6-8% on the back of lower sales (-6%) and net margin (-5ppt) assumptions at Aspion.
• Management guided low double-digit sales growth (we forecasted high-teens earlier) and implied thinner profitability for the recently acquired company (we forecasted low-teens earlier).

Key upside risks include:

1. recovering the RM715m from Adventa Capital,
2. market share gains,
3. more bona fide sizeable value-accretive M&As, and
4. US dollar appreciating markedly vs the ringgit.

VALUATION/ RECOMMENDATION

• Maintain SELL but with a lower target price of RM7.80 (from RM8.40) as we lower our earnings forecasts. For 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 24x. The premium is fair as:
  • Top Glove has been making steady headway into the generally faster-growing nitrile glove space, and
  • despite the negative development at Aspion, the group is still touted as 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 at 18-20x forward PE.
• Post-bonus issue, our target price would be RM3.90, excluding the potential dilution from full guaranteed exchangeable bonds conversion into new Top Glove shares pending more details of the exercise. This analyst research report is shared at SGinvestors.io

SHARE PRICE CATALYST

• Supply-demand imbalance structurally driving up ASP.
• More meaningful bona fide M&As contributing to higher inorganic growth.
• Innovative product offerings to disrupt the marketplace.

Chan Jit Hoong CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-07-10

SGX Stock Analyst Report SELL Maintain SELL 7.80 Down 8.400