Top Glove - CGS-CIMB Research 2019-03-20: Time Will Prove It All

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TOP GLOVE CORPORATION BHD (SGX:BVA)

Top Glove - Time Will Prove It All

• Top Glove Corporation (SGX:BVA)’s risk-reward profile is attractive at 20.6x CY20 P/E (below +1 s.d. of its 3-year and 5-year historical mean), post the recent Top Glove’s share price correction.
• We estimate effective capacity to increase by only 5.3% y-o-y in 2019, and believe any heightened pricing competition will be short-lived.
• Maintain ADD with a lower Target Price of RM5.08 (24x CY20 P/E).

Value emerging at current valuation

• YTD, Top Glove’s share price is down 18.7%. We attribute this mainly to concerns over:
  1. heightened competition;
  2. headwinds from current operating environment, such as strengthening of ringgit vs. US$; and
  3. potential extended losses from the acquisition of Aspion.
• Post the recent Top Glove’s share price correction, we believe that value is emerging as the stock is now trading at 20.6x CY20F P/E (below +1 s.d. of both its 5-year historical mean and 3-year historical mean).
• In our view, current valuations have yet to take into account Top Glove’s positive track record and strong long-term outlook in terms of:
  1. consistent EPS growth across the years (5-year EPS CAGR of 17.3% in FY13-FY18);
  2. defensive nature of its business; and
  3. its position as the world’s largest producer of gloves which allows it to benefit from the inelastic demand for rubber gloves (annual average demand growth of 7-8% over past 5 years).

Expects capacity growth to be well absorbed

• In 2019, we estimate that Top Glove’s production capacity will increase by 15.9% to 70.1bn pieces p.a. This will mainly be in the nitrile glove segment (~90%).
• Based on our channel checks, commercial production on its new lines will begin on a gradual basis, depending on supply-demand dynamics. This will help in alleviating any pricing pressure, in the event of heightened pricing competition in the industry, in our view.
• Note that our forecast has yet to account for any potential delays in construction and/or commissioning works. Given that not all this new capacity will come onstream at one go, our calculation indicates that the effective capacity increase in 2019 will only stand at 5.3%.

Aspion – temporary drag to be resolved in time

• In 1QFY8/19, we gather that Aspion reported a loss (estimated net loss of RM3m-4m), mainly due to less efficient production lines as well as a weaker-than-expected operations team. Top Glove has highlighted that it is taking efforts to improve Aspion’s performance by upgrading its production lines as well rebuilding the latter’s operations team.
• With Aspion’s key strengths intact, such as its marketing team and superior surgical product range, Top Glove remains confident that its acquisition of Aspion will pay off in the long run.
• We understand that Top Glove expects Aspion’s performance to improve on a gradual basis, from 2QFY8/19 onwards (expected to turn profitable), with the right initiatives in place. In our estimates, we expect Aspion to record a net profit of RM15m/30m/40m in FY19/20/21F (vs. our previous estimates of RM50m/75m in FY19/20F).

Expect flattish 2QFY8/19 net profit

• For Top Glove’s upcoming 2QFY8/19 results that will be announced on 22 Mar 2019, we expect the group to record flattish q-o-q (1QFY19: RM110m) and y-o-y (2QFY18: RM108m) net profit.
• Despite our forecast of positive earnings contribution from Aspion in 2QFY19, we expect this to be mitigated by an increase in tax rates and interest costs. On a q-o-q basis, we also expect the lower nitrile butadiene cost (NBR) to be mitigated by the strengthening of ringgit vs. US$.
• Also, we expect sales volume in 2QFY19 to be flattish q-o-q (higher by 10-15% y-o-y) given it has not added any new capacity since 1QFY19.

Lower FY19-21F EPS by 18.7-19.8%

• We lower our FY19-21F EPS by 18.7-19.8%. This is mainly to account for:
  1. lower profits from its Aspion operations;
  2. a higher tax rate of 19% (from 17% previously); and
  3. a slowdown in its expansion plans.
• Nevertheless, we still expect Top Glove to record a 3-year EPS CAGR of 10.4% (FY19-21F).

Maintain ADD; Target Price lowered to RM5.08

• We retain our ADD call on Top Glove with a lower Target Price of RM5.08. Our Target Price is now based on 24x CY20F P/E (+1 s.d. of its 5-year historical mean) vs. 22x previously (20% discount to Hartalega’s previous target P/E of 28x).
• At current 20.6x CY20F P/E, we believe that Top Glove is undervalued given its:
  1. dominant position in the glove industry as the world’s largest glove maker;
  2. strong position to benefit from the inelastic global demand for gloves; and
  3. 3-year EPS CAGR of 10.4% (FY19-21F).
• Key risks to our view: stronger-than-expected pricing competition and/or sharp strengthening of ringgit vs. US$.

Walter AW CGS-CIMB Research | https://research.itradecimb.com/ 2019-03-20

SGX Stock Analyst Report ADD MAINTAIN ADD 5.08 DOWN 5.40