Top Glove Corporation - CGS-CIMB Research 2020-07-16: A Speed Bump On The Road Ahead

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TOP GLOVE CORPORATION BHD (SGX:BVA)

Top Glove Corporation - A Speed Bump On The Road Ahead

• US customs authorities (CBP) imposed a detention order on gloves produced by Top Glove (SGX:BVA) units Top Glove Sdn Bhd and TG Medical Sdn Bhd effective 15 Jul. See Top Glove Announcements.
• Top Glove said this detention order is in relation to foreign labour issues. It expects a resolution to this issue within the next 2-4 weeks.
• We expect a 0.4% decline to our FY20F EPS forecast for every week the detention order is in effect on both subsidiaries by the CBP.

US CBP imposes detention order on two of Top Glove’s subsidiaries

• On 15 Jul 20, US Customs and Border Protection (CBP) placed a withhold release order (detention order) on disposable gloves produced by two of Top Glove’s subsidiaries, Top Glove Sdn Bhd and TG Medical Sdn Bhd. This is mainly due to allegations of forced labour; exact details of the allegation were not specified by the CBP.
• Under this detention order, products made by both companies are not allowed entry into the US. We gather sales to the US from both companies made up c.12.5% of Top Glove’s 9MFY20 revenue (US sales made up 24% of Top Glove’s total 9MFY20 revenue).
• Currently, Top Glove is of the view this detention order applies to just these two units.

Likely due to labour issues, particularly agents fees prior to Jan 19

• While Top Glove has yet to get direct confirmation from the CBP as to the exact reason for the detention order, it believes this was due to foreign labour issues, particularly on the outstanding matter of retrospective payments of recruitment fees by Top Glove’s workers to agents prior to Jan 19 (Top Glove implemented a zero recruitment fee policy in Jan 19 in which it will bear all of its workers’ recruitment fees).
• Top Glove said it reached this conclusion post meeting a consultant who previously aided non-listed glove maker WRP Asia Pacific Sdn Bhd in resolving a similar issue (WRP received a detention order by CBP on 30 Sep 19 but this was revoked on 24 Mar 20).

Top Glove expects this issue to be swiftly concluded in 2-4 weeks

• As part of the solution, Top Glove is looking to conduct extensive tracing activities to identify and reimburse its workers their agents’ fees. It estimates that this will require a sum of RM20m-50m (2.4-5.9% of our current FY20F net profit forecast). In our view, this will be one-off payment to resolve a non-recurring issue.
• As Top Glove plans to work together with consultants, its customers and CBP to resolve this issue amicably, it believes the detention order can be lifted in 2-4 weeks.

0.4% drop in FY8/20 EPS every week the detention order is in place

• Until CBP’s detention order is lifted, we gather that both of Top Glove’s affected subsidiaries will not be allowed to sell disposable gloves to the US. Based on our back-of-envelope estimates, Top Glove’s FY8/20 EPS will be negatively impacted by 0.4% for every week the detention order is in effect. Assuming that the detention order lasts 2-4 weeks, this will lower our FY20F EPS by 0.8-1.6%.
• This is on the basis that:
  1. only the aforementioned subsidiaries are affected by this detention order, and
  2. gloves exported to the US by both subsidiaries are not rerouted and sold to other countries in this period.
• In our view, given the current acute shortage of rubber gloves globally, the products originally destined for the US could easily find a market elsewhere.

No changes to our EPS forecasts for now; maintain ADD

• We make no changes to our EPS forecasts pending further updates on this matter. Our ADD call and Target Price of RM25.00 (22x CY21 P/E, +0.5 s.d. above its 5-year mean) also remain intact.
• While this news could lead to some near-term Top Glove share price weakness, we advise investors to buy on dips given that Top Glove is still set to post record-breaking profits in the next few quarters, while trading at 17.6x CY21 P/E, a 36.3% discount to the sector (weighted average of 27.7x CY21 P/E).
• See Top Glove Share Price; Top Glove Target Price; Top Glove Analyst Reports; Top Glove Dividend History; Top Glove Announcements; Top Glove Latest News.
• Re-rating catalyst: Further rise in average selling prices.
• Downside risks are stiff pricing competition and/or faster-than-expected success in finding Covid-19 vaccine.

Walter AW CGS-CIMB Research | https://www.cgs-cimb.com 2020-07-16

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