Top Glove Corporation - DBS Research 2019-03-13: Adjusted Valuations

SGinvestors.io

TOP GLOVE CORPORATION BHD (SGX:BVA)

Top Glove Corporation - Adjusted Valuations

• Top Glove's share price correction leads to normalised valuations. 
• Solid position with advantage on latex and emerging markets.
• Cut earnings by 6%-8% for FY19F-21F. 
• Upgrade to HOLD with lower Target Price of RM4.25. 

More reasonable valuations

• We upgrade our call to HOLD from FULLY VALUED following TOP GLOVE CORPORATION BHD (SGX:BVA)'s 20% YTD share price correction stemming from industry oversupply concerns.
• While we cut FY19-21F earnings by 6-8% for higher operating costs and lower ASPs, we believe valuations are now more reasonable.
• Top Glove should be in a better position as the margin compression from the nitrile segment will be cushioned by its latex segment. It will also benefit from the growing demand in emerging markets which are predominantly latex gloves users.

Where We Differ: Below consensus profit.

• Our earnings forecasts are below consensus as we have factored in lower ASPs in view of the near term pressure from oversupply.

Potential catalyst: Stronger growth from emerging markets

• Top Glove could benefit from the growth from emerging markets given that emerging markets are predominantly latex users.

Valuation:

HOLD with Target Price RM4.25.

• Our Target Price is based on 23x CY19 EPS which is its 5-year mean PE.
• (Using FX rate of RM1 to SGD0.3312 as of 14-Mar-2018, we derive target price of 1.41 in SGD term)

Key Risks to Our View:

Rising competition could erode margins.

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

WHAT’S NEW - Volume driven

Solid footing:

• With Top Glove's share price correction of 20% YTD, valuations are more reasonable given Top Glove is forecasted to enjoy an earnings CAGR of 9.7%, backed by its continuous expansion and steady demand. This will backed up by
  1. its advantages in the latex segment vs the increasingly crowded nitrile space,
  2. its ability to leverage on emerging markets, and
  3. Aspion’s turnaround.
• With this, we have upgraded our Fully Valued call to HOLD.

Latex play:

• Top Glove is the market leader for latex in terms of volume. With the industry focusing in expanding in nitrile, the group has a cushion from its less competitive latex business. The combination of latex powdered and latex powder-free gloves makes up about 46% of total volume sold as of 1QFY19.
• Latex has been offering better margins in the past quarter at 17% vs nitrile’s 15% as latex raw material prices are more stable compared to nitrile latex. The natural rubber price has been ranging from RM3.70/kg to RM4.40/kg since June 2018 whereas nitrile has been trading at RM5.90/kg to RM9.00/kg. Nitrile latex moves in tandem with the crude oil price as part of it comes from butadiene. As for the natural rubber price, it moves more in tandem with the auto industry in China whereby the bulk of consumption goes to making tyres. Back in CY17 when China had a boost in auto sales from the cut in tariff, natural rubber prices went up to as high as RM8.20/kg.
• In terms of demand, the emerging markets are a key market for latex gloves. This comes as latex gloves are cheaper compared to nitrile gloves and there is no regulation to restrict the use of latex gloves. The emerging markets hold immense potential as their current glove consumption is low at c.0.8 (India) to 18.1 (Brazil) glove consumption by capita vs developed markets’ glove consumption by capita of 47.9 (Korea) to 146.2 (US).
• For 1QFY19, the highest volume growth came from Africa with 45.2% growth y-o-y and Western Europe with 37.7% growth y-o-y.

Aspion:

• Aspion is still chugging along with management focusing on bringing up efficiency with engineering teams working on the plants. Given Top Glove already has the technology in their existing plants, it is capable of turning Aspion around. 1QFY19 saw losses for the plant but this should swing back to the black in the coming quarter. The target to achieve a initial contribution of RM80m p.a. will require 4-7 years. However, no impairment is needed for the acquisition of Aspion.

Glove landscape:

• With most players crowding the nitrile space and coupled with the higher nitrile latex prices, the nitrile segment faced some margin compression. Both Kossan Rubber Industries and Hartalega registered lower EBIT/k gloves in their recent results partly due to higher costs despite the strengthening of the ringgit. We have yet to monitor if ASPs are fully adjusted to the higher costs as ASP takes 1-2 months to adjust.
• As for the demand, China’s supply of vinyl gloves are back online as factories are able to operate as long as they switch part of the operations to natural gas from coal. This applies to the Top Glove factory in China as well, as it operates with a mix of coal and natural gas. With this, the lead time is lower and we expect demand to normalise.
• All in all, we believe FY19 will be a year of consolidation. Glove players will need to time their expansion concurrently with demand to ensure smooth pass through of costs and maintenance of margins. The glove sector has enjoyed superb growth in the past year and we think growth should normalise as it has a larger base now. Demand is expected to be at 8%-10% vs supply of 11% for FY19F. We think that this will be adjusted by glove players if they feel supply exceeds demand.

Cut earnings

• We cut earnings by 6%-8% for FY19F-21F to include higher operating costs as well as adjustments to ASPs. This results in a lower EBIT/k gloves of RM11.48-RM11.54 vs RM11.75-RM11.91 previously.

Upgrade to HOLD

• Top Glove's share price has corrected by 23% since our last report and we think that the current share price (trading at 23x FY19 PE) is more reflective of earnings growth. Our Target Price is reduced to RM4.25 post earnings cut, based on 23x CY19F EPS.
• We believe the positives have already been priced in and remain cautious about the supply and demand dynamics.
• A re-rating catalyst for Top Glove would be faster-than-expected upgrade of Aspion vs management’s guidance of 4-7 years.

Siti Ruzanna Mohd Faruk DBS Group Research | https://www.dbsvickers.com/ 2019-03-13

SGX Stock Analyst Report HOLD UPGRADE FULLY VALUED 1.41 DOWN 1.770