This article first appeared in The Edge Financial Daily, on July 27, 2016.

Top Glove Corp Bhd
(July 26, RM4.30)
Maintain buy with a lower target price (TP) of RM5.27: In Top Glove Corp Bhd’s third quarter ended May 31, 2016 (3QFY16), nitrile butadiene rubber (NBR) gloves experienced increased competition with pricing under pressure. Average selling price (ASP) for nitrile gloves fell 17% year-on-year, leading to a low gross profit margin of 16% versus that of natural rubber gloves at 18%.

Nevertheless, with the delay in some capacity expansion in the nitrile segment, ASP for NBR gloves has recently stabilised with an upward revision of 5% since May. With the revision in ASP, we expect earnings before interest, taxes, depreciation and amortisation (Ebitda) margin  to recover from 14% in 3QFY16 to a normalised level of 17% to 18%. Upcoming 4QFY16 results should see quarter-on-quarter earnings improve marginally with notable earnings recovery from 1QFY17 onwards.

Top Glove continues to intensify its efforts to improve efficiency by implementing the automation process and manufacturing its own formers (approximately 40% of own requirement of formers will be fulfilled). In terms of merger and acquisition opportunities, the company has not ruled out future acquisitions of a small condom maker and a surgical glove player.

On its capacity expansion plan, the  F27 Lukut plant will be fully commissioned in November this year with an additional two billion production capacity for NBR gloves. Total capacity is expected to increase by 14% in the financial year ending Aug 31, 2017 (FY17) after inclusion of the partially commissioned F30 factory. A key risk to the expansion plan is the difficulty in securing foreign workers.

Top Glove is trading at an undemanding valuation of 15 times calendar year 2016 (CY16) price-earnings ratio (PER), below five-year average PER of 16 times, compared with peers’ 18 times, as the share price has overshot on the downside after the weak 3QFY16 results. We see the worst is over and earnings should recover with the upward adjustment in ASP and easing of raw material prices.

Among the risks to take note of are: i) further reduction in ASP amid steep competition; ii) surge in nitrile and latex prices; and iii) weaker US dollar against ringgit. In our forecasts, FY16 and FY17 earnings are reduced by 6% and 2% respectively as we factor in slower-than-expected margin recovery. From a valuation perspective, Top Glove is still the most attractive rubber glove stock among our coverage.

We maintain “buy” with TP lowered to RM5.27 based on an unchanged PER multiple of 18 times CY17 earnings per share post earnings adjustment. — HLIB Research, July 26