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This article first appeared in The Edge Financial Daily on June 20, 2018

Glove sector
Upgrade to neutral:
The sector has further rerated in 2018 year to date (YTD) and at a weighted average 12-months (12M) forward price earnings  (PER) of 33 times, it is a new high. That said, we think current valuation could stay in the second half of 2018 (2H18) supported by the sector’s above-market earnings growth prospects. We now benchmark glove stocks against the sector’s 12M forward PER on our unchanged 2019 earnings per share (EPS )forecasts.

 

We upgrade Top Glove Corp Bhd to “buy” (from “hold”) as we believe its strong earnings growth, rising earnings before interest taxes, depreciation and amortisation (Ebitda) margin and return on equity (ROE), and bonus issue would propel further rerating

Despite the ringgit’s strength against the USD in January-April 2018 (+3.4%) and flattish quarter on quarter (q-o-q) aggregate core earnings in 1Q18 (+2.2% q-o-q, +23.3% y-o-y),the sector’s weighted average 12M forward PER has expanded to 33 times (from 30 times in end-December 2017). We attribute the multiple expansion to fund flows, liquidity-enhancing corporate exercises (that is bonus issues, share split) and EPS-accretive acquisition (that is acquisition of Aspion Sdn Bhd by TopGlove).

We think the presently high valuation could stay in the second half of 2018 (2H18) on our expectations for capacity expansion-led earnings growth. We expect aggregate core net profit of the three glove stocks under our coverage to expand +19.1% in 2018, triple our research universe’s +6.8% core earnings growth forecast. Additionally, we believe the consolidation of Aspion’s earnings from 3QFY8/18 (March-May 2018) would see Top Glove’searnings base surpass that of Hartalega Holdings Bhd in 4QFY8/18 (June-August 2018) and propel further rerating.

We now benchmark glove stocks against the sector’s 12M forward PER on our unchanged 2019 EPS forecasts. After taking into account the keymetrics (that is margin, ROE), we ascribe the following PER targets: (i)Hartalega — 33 times PER (from 31 times) deriving a new TP of RM5.20 (+6%).Maintain “Sell”;

(ii) Top Glove - 30 times PER (from 24 times) deriving a new TP of MY12.90 (+30%). Upgrade to “buy” (from “hold”);

(iii) Kossan Rubber Industries Bhd — 26 times PER (from 24 times) deriving a new TP of RM9.20 (+8%). We are maintaining a “buy” call. — Maybank IB Research, June 19

 

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