Top Glove - DBS Research 2018-10-18: Focus On Growth

TOP GLOVE CORPORATION BHD (SGX:BVA)

Top Glove - Focus On Growth

Volume growth of 26% y-o-y supported by demand in developing markets.
Aspion to undergo enhancement and improvement which will contribute positively to earnings.
Impairment on goodwill not needed based on impairment test.
Maintain FULLY VALUED with higher Target Price of RM9.28.

We are maintaining our FULLY VALUED call with a higher Target Price of RM9.28. We make changes to our PE multiple from 16x CY19 EPS to 23x CY19 EPS which is equivalent to +1SD of its 5-year mean PE.
Top Glove is poised to deliver strong earnings, backed by its continuous expansion as well as improving efficiency. We believe that using its mean PE is no longer justified as no impairment is needed for the acquisition of Aspion.
Moving forward, the group will leverage on its expertise to turn around Aspion which will result in better earnings contribution.

Our valuation of 23x CY19 EPS is conservative, given our more cautious stance on rising nitrile prices as well as incoming capacity by the industry as a whole, which may see some consolidation in the sector in the medium term.

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Top Glove is ramping up its nitrile glove business by increasing its capacity in this segment. The expansion plans put in motion, such as Factory 32 in Klang (to commence in early 2019), Factory 33 (early 2019), Factory 5A (end 2019) and Factory 8A (early 2020), will raise its total production capacity to 70.3bn gloves p.a. (+16% from current capacity).

Following the 4QFY18 results briefing, Top Glove gave more clarity on the volume growth, contribution from Aspion as well as the goodwill impairment test of Aspion.

Top Glove recorded solid volume growth in 4QFY18 (+27% y-o-y; +6% q-o-q).
As for FY18, volume growth came in at 26% y-o-y. This was backed by growing demand in the developing countries such as Eastern Europe (+39.6%), Asia ex Japan (+58.0%), Latin America (21.8%), Africa (+35.3%) as well as the Middle East (38.7%).
In terms of product mix, nitrile tops the chart with 36% of total sales volume followed by latex glove at 51%. Others are made up of vinyl and surgical gloves.
As Aspion’s volume contribution is still small, the surgical gloves segment continued to see a lower mix of 2% of total sales volume. In view of its ongoing rollout of capacity expansion, we expect the group to record sales volume growth of 12%/10%/9% for FY19F/20F/21F.

Following the lawsuit by Top Glove against Adventa, we have factored in lower contribution from Aspion as management has guided for the potential for Aspion’s earnings to fall short. Excluding Aspion’s contribution and funding costs, FY18 net profit could have improved by 37% instead of 33%.
Moving forward, management is positive that it can revamp and improve Aspion’s earnings by leveraging on management’s expertise and readily available technology. Past acquisitions such as the Factory 27 and Factory 33 are success stories by the group, whereby it managed to turn around the factories to profit-making. For Aspion, guidance on the expected earnings of RM80m p.a. may require 4-7 years to achieve.

It has performed a goodwill impairment test on Aspion using discounted cash flow method. It has factored in further enhancement, modification and improvement of the glove production process to its 5-year discounted cash flow projection.
Based on the analysis under four different scenarios which include different WACC figures of 6.4% to 8.5%, no impairment is needed for the goodwill.

We maintain our FULLY VALUED call with a higher Target Price of RM9.28. We make no changes to our earnings, but we are bumping up our PE multiple to 23x CY19 EPS (16x previously) which is equivalent to +1SD of its 5-year mean PE.
We believe earnings will continue to be supported by capacity expansion and also feel the negatives of Aspion have been overly priced in as no impairment is needed.
We still feel that its current valuations of 29.8x CY19 EPS is expensive as there are still headwinds from the rising nitrile prices as well as incoming capacity by the entire industry in the medium term.

Competition is heating up in the glove sector with several glove makers expanding aggressively. This could result in higher pressure on margins.

Siti Ruzanna Mohd Faruk DBS Group Research | https://www.dbsvickers.com/ 2018-10-18

SGX Stock Analyst Report FULLY VALUED MAINTAIN FULLY VALUED 9.28 UP 6.460