Top Glove - UOB Kay Hian 2020-10-07: Creating Value Beyond Earnings


Top Glove - Creating Value Beyond Earnings

  • Prospects for Top Glove (SGX:BVA) remain highly attractive. An increased dividend payout frequency would allow for better rationalisation of distributed super-cycle earnings, with the possibility of a special payout in 2HFY21.
  • Meanwhile, plans to venture upstream would help Top Glove secure precious NBR supply over the longer run. In the meantime, the lifting of the WRO by the US CBP remains uncertain. That said, the impact to overall sales is negligible.
  • Maintain BUY on Top Glove. Target price: RM12.30.

Key takeaways from our recent conference call with Top Glove's management:

  • We gathered that contracted nitrile glove ASPs are expected to be raised by 5% m-o-m for November to US$100/’000 pieces. Meanwhile, spot orders are being priced between US$140-150/’000 pieces heading into 2021. Latex glove ASPs are raised by 10% m-o-m for November to about US$50/’000 pieces.
  • The current shortage of nitrile rubber (NBR) has switched demand to latex gloves. Our channel checks suggest there is a possibility of larger latex ASP revisions going forward. This represents further upside to Top Glove’s latex ASPs.

Better dividend frequency with possibility of special payout.

  • Heading into FY21, Top Glove will be paying out a quarterly dividend. This represents a deviation from its usual semi-annual payout. Should Top Glove declare any special dividends, it would be in 3QFY21 at the earliest.
  • Based on the company’s dividend policy payout of 50% on our projected earnings, the implied dividend yield for FY21 is 7.7%. For every 10% additional payout, the dividend yield increases by 1.6%. That said, dividend yields would moderate to 2.1% and 1.2% in FY22-23 respectively. See Top Glove Dividend History.

Timeline on CBP agency lifting WRO remains uncertain but overall sales unaffected.

  • Top Glove announced a revision to its foreign worker remediation amount to RM136m. This is almost 3x higher than management’s initial expectation of RM53m. The deviation arises from official foreign government recruitment fees vs agency imposed fees, discovered only through an audit interview with its foreign workers. The lifting of the Withhold Release Order (WRO) on two of Top Glove’s subsidiaries now lies with the US Customs and Border Protection (CBP) with no indicative timeline.
  • That said, utilisation rates remain maxed out as demand remains robust with sales to North America contributing a healthy 20% to overall sales mix. The WRO issue has been alleviated with sales diverted through other subsidiaries unaffected by the WRO. Terefore, we believe the CBP agency lifting the WRO is a non-factor for now.

NBR shortage sees spike in costs…

  • Notably nitrile butadiene costs have been skyrocketing, rising by 15-20% m-o-m. Meanwhile, spot prices are close to 2-3x the usual ASPs. This is in line with our channel checks with China glove producer, Blue Sail.
  • Nitrile butadiene accounts for 30% of COGS for nitrile gloves. In return, nitrile gloves accounts for ~50% of overall revenue. For every 10% deviation from our nitrile butadiene assumption, our FY21 earnings will be affected by -1.2%.

...but building its own NBR processing facility; due in 2022.

  • In view of the tight NBR supply, Top Glove is looking to expand upstream into establishing its own NBR processing plant in Banting, Selangor. The plant is due for completion over two phases (Phase 1: 1Q22 and Phase 2: 3Q22). Upon completion, it is due to fulfil 50% of internal NBR requirements.
  • The capex outlay is estimated to be in the region of RM600m.

New entrants to glove manufacturing industry

  • Companies from other sectors have entered the glove manufacturing industry. Based on some preliminary information on public listed companies that have disclosed their capacity expansion, we should reasonably expect at least 14.9b pieces p.a. from these new entrants. This further excludes the likes of Kanger International, Titijaya Land, HLT Global and Inix Technologies that have declared the same intention but have not disclosed their capacity expansion plans.
  • However, we think the new entrants will likely struggle to secure already tight NBR supply – an issue already plaguing existing glove producers. Furthermore, it may take up to 1.5 years to complete the glove manufacturing facilities.
  • Lastly, by 2022, supply arising from new entrants which is estimated at 14.9b pieces p.a. represents 3.1% of global glove demand (485b pieces). Given the aforementioned factors, we think that the additional supply from these new entrants is not a concern for now.

Top Glove - Valuation & Recommendation

  • We leave our earnings forecasts for Top Glove unchanged until we gain visibility over ASPs after a vaccine discovery. Key downside risks include:
    1. swift containment of the COVID-19 outbreak;
    2. disruption to its production or supply chain caused by the COVID-19 outbreak; and
    3. COVID-19 vaccine discovery.
  • Every -1% deviation from our RM4.30/US$ assumption translates into a 1.2% and 1.8% reduction to our FY21-22 EPS respectively.
  • Maintain BUY on Top Glove and target price of RM12.30, based on 13.0x 2021F PE, or close to -3SD of its 5-year forward PE mean. Our PE peg is well below the normalised mean PE peg of 24.5x as we believe it is tied to windfall peak earnings.
  • See Top Glove Share Price; Top Glove Target Price; Top Glove Analyst Reports; Top Glove Dividend History; Top Glove Announcements; Top Glove Latest News.
  • Upside to Top Glove's earnings has been increasingly factored in, and the risk-to-reward at this juncture is increasingly pronounced given the surge in share price. That said, our PE peg is reasonable as Top Glove is an established FBMKLCI component index constituent with a sublime earnings CAGR of 450% (FY19-21F).
  • Furthermore, its explosive q-o-q earnings growth over the next 2-3 quarters should catalyse valuations going forward. That said, sustained spot sales mix and narrowing latex glove prices to nitrile’s may represent further upside surprise to our earnings forecasts.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-10-07
SGX Stock Analyst Report BUY MAINTAIN BUY 4.040 SAME 4.040