Top Glove - UOB Kay Hian 2020-12-11: Down But Not Out; Takeaways From Conference Call With Management


Top Glove - Down But Not Out; Takeaways From Conference Call With Management

  • Looking beyond the noise, Top Glove’s prospects remain firmly intact. ASPs continue to uptrend, while 2022’s ASP outlook of a gradual normalisation is encouraging. Rising ASPs should comfortably absorb higher raw material costs too.
  • Meanwhile, the COVID-19-related operational setbacks and detention order by the US CBP that have weighed on sentiment should be resolved soon.
  • Maintain BUY on Top Glove. Target price: RM12.30.

Takeaways from conference call with Top Glove's management

  • We come away encouraged from our conference call with Top Glove (SGX:BVA)’s management. Here are the key takeaways:

Light at the end of the COVID-19 outbreak tunnel.

  • Our note on Top Glove's 1HFY21 results at Top Glove - UOB Kay Hian 2020-12-10: Light At The End Of The Tunnel With Operational Complications.
  • Recall that Top Glove's operations at 28 factories (of which, 20 are glove manufacturing factories) were curtailed due to the COVID-19 outbreak among its workforce. These factories were running at a utilisation rate of 10%. However, we gather that over the next few weeks, operations at these affected production sites will be gradually resumed over four phases to achieve a utilisation rate of 75% in the second half of December, followed by 100% by early-January.
  • Based on our estimates, the full impact on Top Glove's FY21 earnings is close to 3%. However, we leave our earnings forecasts unchanged as the current ASP trajectory suggests upside to our existing forecasts. However, we will factor it in after we gain further visibility on ASPs post-mass vaccination in 1Q21.

Sentiment would see a boost from the lifting of the WRO.

  • In relation to Top Glove’s Withhold Release Order (WRO) or detention order on gloves manufactured by Top Glove issued by the US Customs and Border Protection (CBP), management believes it is at the tail end of resolving the issue. It has been audited and has made all the necessary submissions to the relevant authorities.
  • It could be a matter of weeks before the US CBP lifts its detention order. This would allow Top Glove to fully resume sales to the US that previously saw restrictions on two subsidiaries. As a result of the WRO, Top Glove's 1QFY21 US sales volume declined by 2% y-o-y. While the earnings impact is negligible, we think that the lifting of the WRO would improve sentiment as it positively affirms Top Glove’s labour practices.

Foreign shareholding stands at 34%.

  • This is slightly below its pre-COVID-19 level of 38% and above the multi-year low of 30% back in 2017.

Nitrile latex costs spike but well absorbed by ASP revision.

  • Nitrile raw material cost has further spiked to 2.2x pre-COVID-19 ASPs and is expected to rise up to 4x at its peak. A full cost pass-through for the additional spike in cost will translate into ASP of US$8.5/’000 pieces. Therefore, given the existing trajectory of its ASPs, the spike in raw material cost has been well managed at this juncture.
  • More importantly, nitrile butadiene rubber (NBR) supply for its glove capacity expansion has been fully secured. The shortage experienced in 1QFY21 was due to latex glove production switching to nitrile production.
  • Meanwhile, its own NBR processing facility is due for completion in early-22. This should fulfil close to 15% of its own internal requirements.

Encouraging ASP trajectory and visibility outlook.

  • We gather December-January nitrile ASPs would be raised by 15% and 10% m-o-m respectively. This would price nitrile ASPs at US$120/’000 pieces in January. There is the expectation that these contracted ASPs could be sustained in 2H21, followed by 5-10% q-o-q contractions over 2022. The gradual normalisation in ASPs as opposed to ASPs falling off the cliff, can be attributed to demand which is still expected to outstrip supply up until 2023.
  • Meanwhile, latex gloves are currently being priced between US$46-59/’000 pieces with a revision of 5-7% m-o-m going forward. Based on the trajectory and visibility, there is upside to our existing FY21/22 ASP assumptions of 70.1/33.9 (US$/’000 pieces) respectively. However, we retain our forecasts at this juncture, awaiting further visibility post-commencement of mass vaccinations.

Penalty exposure overblown, but more importantly, underlying labour issue is being addressed.

  • Regarding Top Glove’s possible violations of housing standards for workers under new amendments to the Workers’ Minimum Standards of Housing and Amenities Act 1990 (act 446), reviews by the Human Resource Ministry are still underway. There were misconceptions that the RM50,000 penalty was applicable to each affected worker.
  • However, we gather that the RM50,000 penalty is only applicable to each non-conforming accommodation. Therefore, the possible financial impact is more palatable than initially perceived.
  • More importantly, Top Glove’s plans to invest RM100m in new hotels and houses equipped with necessary facilities and amenities to fully comply within the grace period extended by the Human Resource Ministry.

Maintain BUY on Top Glove

  • We leave our Top Glove's earnings forecasts unchanged for now until we gain further visibility over ASPs.
  • See Top Glove Share PriceTop Glove Target PriceTop Glove Analyst ReportsTop Glove Dividend HistoryTop Glove AnnouncementsTop Glove Latest News
  • Maintain BUY with target price based on 13.0x 2021F PE, or close to -3SD of its 5-year forward PE mean, at a significant discount as we believe valuations are being pegged to windfall peak earnings, upside to earnings is increasingly being 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 sublime earnings growth.
  • Key downside risks to Top Glove's share price include:
    1. swift containment of the COVID-19 outbreak; and
    2. further disruption to its production or supply chain caused by the COVID-19 outbreak.
  • Every -1% deviation from our RM4.10/US$ assumption translates into 1.2% and 1.8% declines to our FY21-22 EPS respectively.

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-12-11
SGX Stock Analyst Report BUY MAINTAIN BUY 4.040 SAME 4.040