Top Glove (TOPG MK) - UOB Kay Hian 2018-10-12: 4QFY18 Weaker-Than-Expected Earnings; Priced To Perfection

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TOP GLOVE CORPORATION BHD (SGX:BVA)

Top Glove (TOPG MK) - 4QFY18: Weaker-Than-Expected Earnings; Priced To Perfection

• Top Glove’s 4QFY18 core earnings decelerated 9% q-o-q, mainly due to higher raw material, interest and tax costs. Also, forward orders remained softer than 10 months ago.
• 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 five-year forward PE.
• Maintain SELL and target price of RM8.20.

RESULTS

Weaker than expected.

• Top Glove’s 4QFY18 core earnings fell 9% q-o-q (but up 26% y-o-y) vs our earlier expectation of a q-o-q improvement. This brought FY18 bottom-line to RM448m (+39% y-o-y), which was at the lower end of our expectations, making up 96% and 100% of our and the street’s full-year forecasts respectively.
• A final DPS of RM0.10 (+18% y-o-y) was declared, lifting total payout in FY18 to RM0.17 (+17% y-o-y).

Good increase in sales.

• The company registered a good quarterly revenue growth of 11% q-o-q in 4QFY18. This was lifted by better volumes (+6% q-o-q on encouraging demand from emerging countries), positive ASP revision (+1% q-o-q due to cost pass-through to customers) and forex tailwinds (+3% q-o-q as the US dollar strengthened against the ringgit).

Dragged by higher raw material, interest and tax costs.

• Despite the positive top-line growth, 4QFY18 core earnings (ex net forex losses) fell 9% q-o-q. This was due to:
  1. higher raw material prices (inched up at a quicker 3% q-o-q vs the 1% q-o-q rise in ASP);
  2. 45% q-o-q jump in interest expense; and
  3. elevated effective tax rate of 28% vs 11% in 3QFY18.
• That said, robust capacity utilisation (~90%) and tight cost control helped prevent bottom line from declining at a faster clip.

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STOCK IMPACT

Unveiling new expansion plans.

• With the acquisition of Aspion completed in early-April along with the completion of Factory 31 in July, Top Glove is now capable of producing up to 60.5b gloves per year.
• Also, management unveiled its new expansion plans (Factory 33, 5A and 8A) on top of the outstanding expansion timeline for Factory 32 (by end-19). When all are fully operational by 2020, Top Glove’s manufacturing capacity will balloon to 70.3b gloves annually (+16%). The new lines are for nitrile gloves, which should raise capacity mix in this space to about 40% from 35% currently.
• Management intends to achieve a 50:50 nitrile-to-latex glove production split over the longer term.

Rising threat of demand tapering?

• Management shared it is still seeing only 40-45 days of forward orders, shorter than Dec 17's level of 50-60 days. Generally, we remain concerned about:
  1. rising competition where more nitrile glove supply capacity will be coming on- stream in the medium term; and
  2. the vinyl glove undersupply in China is easing with capacities restarting after 2017's environmental clampdown, prompting price-sensitive F&B customers to switch back to more economical glove offerings.

EARNINGS REVISION/RISK

• We introduce FY21 earnings estimates but make no changes to our FY19-20 forecasts.
• Key upside risks include:
  1. recovering the RM640m 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 and target price of RM8.20, based on 18x 2019F PE, or +0.5SD above its 5-year forward mean PE of 16x but below the sector's 27x. The premium is fair as:
  1. Top Glove has been making steady headway into the generally faster-growing nitrile glove space; and
  2. 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 0.9x vs peers' average of 0.1x).
• Post-bonus issue, our target price is RM4.10, excluding the potential dilution from full guaranteed exchangeable bonds conversion into new Top Glove shares pending more details of the exercise.

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/ 2018-10-12

SGX Stock Analyst Report SELL MAINTAIN SELL 8.200 SAME 8.200