Top Glove Corporation - DBS Research 2019-10-07: Lower Utilisation Rate Expected


Top Glove Corporation - Lower Utilisation Rate Expected

  • Lower utilisation rate expected due to gradual optimisation of new capacity.
  • Cut Top Glove's net profit estimates by 10% and 9% for FY20-21.
  • Trading at rich valuation of above +2.0 SD of 5-year mean.
  • Maintain HOLD with reduced Target Price of RM4.00.

Optimal utilisation to take time.

  • TOP GLOVE CORPORATION BHD (SGX:BVA) plans to add 18.2bn gloves p.a. of capacity in CY20, raising its annual capacity to 84.1bn. However, the new capacity will be added in phases. Optimal utilisation will likely take time, reducing its effective capacity.
  • Overall, we are now more conservative and cut Top Glove’s utilisation rate from 85% to 83%. We reduced our target price (TP) from RM4.50 to RM4.00 to reflect the earnings adjustment. (Using the latest FX rate of RM1 to SGD0.3292, we derive the target price of 1.32 in SGD term)
  • Valuations remain at the high end of its historical range. Maintain HOLD.

Where we differ:

  • We cut our FY20 and FY21 net profit estimates by 10% and 9% respectively mainly to impute the lower utilisation rate and higher interest expenses (due to higher capex assumptions funded by borrowings). Our assumptions on average selling prices (ASPs) are also more conservative contributing to our earnings forecast being below consensus.

Factoring in lower utilisation rate

Capacity expansion on track...

  • There are no changes to Top Glove’s plans for capacity expansion since its last update in September 2019. To recap, the Group’s total installed capacity is 63.9bn pieces of gloves. Factory F32 Phase 2 is expected to commence operations in 4QCY19, while F2B’s refurbishment has been scheduled for 1QCY20. Expansion plans for CY20 include F2B refurbishment, Factory F5A, Factory F40, Factory F42 (Phase1), Factory F41 (Vietnam), and Factory F8A (Thailand).
  • These expansions will add 18.2bn gloves p.a. capacity in CY20, raising Top Glove’s annual capacity to 84.1bn pieces at the end of CY20, up 32% from its current installed capacity of 63.9bn pieces. We have incorporated Top Glove management’s capacity expansion guidance into our earnings forecasts.

…but we are more conservative on utilisation rates.

  • However, the new capacity will come in phases, with about 62% commercialising only in 2HFY20. As such, the company’s effective capacity will be lower and optimal utilisation will likely take time. Overall, we cut estimates for Top Glove’s utilisation rate from 85% to 83%. Our expected sales volume growth for FY20 is 11%, compared to management guidance of 10-15%.

Raw material prices trending downward.

  • Raw material prices have been trending downward. According to Bloomberg, nitrile raw material prices dropped to RM6.72/kg (-4.4%) from its high of RM7.04/kg in September 2019. Natural rubber latex prices also fell to RM4.23/kg from its high of RM5.13/kg (-17.5%) in April 2019.

ASP expectations.

  • ASP for natural rubber latex gloves increased 0.5% to USD19.0/k gloves in September-October 2019 compared to June-August 2019, reflecting pass through of higher raw material prices. ASP for nitrile rubber gloves also increased 1.3% to USD22.7/k gloves in the same period. As such, ASP in 1QFY20 should be higher than 4QFY19.
  • However, with natural rubber latex raw material prices trending downward since October 2019, we expect ASP to adjust lower in 2-3 months with the cost pass through mechanism.

Minimum impact of US-China trade war.

  • China’s export of rubber and nitrile gloves to the US is not significant and any order switch from the US is not likely to be material. Overall, the US-China trade war should have minimal impact on Top Glove’s earnings.

No impairment for Aspion.

  • In 4QFY19, Aspion contributed positively to Top Glove with implementation of transformation processes. Management has guided that there is no impairment required for Aspion in the near term. Aspion will need to register higher sales volume to overcome high fixed costs.

Revised capex forecast to RM600m.

  • Top Glove’s FY19 capital expenditure (capex) of RM632m (vs RM461m in FY18), was used for new factories (50%), upgrading existing factories (42%) and the balance for maintenance. Management expects to maintain capex at RM600m in upcoming years which will be utilised mainly for new factories in Malaysia, Thailand and Vietnam.
  • We adjusted our capex forecasts upward from RM400m to RM600m for FY20-21 in line with management’s guidance.

Digitalisation and automation to save costs.

  • In the middle to longer term, Top Glove’s management intends to embark on digitalisation and automation via the Industry 4.0 framework involving the application of Internet of Things (IoT), robotics and automated real-time manufacturing systems. This is to reduce its reliance on foreign labour and improve manufacturing efficiency.
  • The number of workers/million pieces of gloves has decreased to 2.54 in FY19 (vs 3.43 in FY13) due to Top Glove’s ongoing automation.

Cut net profit forecasts.

  • We cut our FY20 and FY21 net profit forecasts by 10% and 9% respectively, mainly to impute Top Glove’s lower utilisation rate and higher interest expenses (from higher capex assumption funded by borrowings).
  • We are taking this opportunity to introduce FY22 net profit estimates of RM500m (+2% y-o-y) on the back of 5% sales volume growth.

Siti Ruzanna Mohd Faruk DBS Group Research | Malaysian Research Team DBS Research | https://www.dbsvickers.com/ 2019-10-07
SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.32 SAME 1.483