Impact of slow adoption of Top Glove’s nitrile gloves catches up

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Top Glove Corporation Bhd
(Oct 2, RM4.94)
Maintain “hold” with target price of RM4.80.
We expect Top Glove’s financial year 2014 (FY14) to FY16 earnings growth to be subdued as demand for its products remains lacklustre and as margin pressure weighs. Top Glove’s sales volume is likely to rise at a lower rate (vis-a-vis the global demand growth of 8% to 10% per annum) in the near term, dragged down by its unfavourable product mix.

Latex gloves presently make up 68% of the group’s total product mix while nitrile gloves — the growing segment — constitute 24%.

With its previously proven volume strategy no longer effective following the industry’s structural shift and its late entrance into the nitrile segment, we opine that the group had been compelled to compete on price to gain market share.

The management, however, believes that the low average selling price is due to overcapacity in the segment. In light of its cautious outlook, the company is holding back its expansion plans. It is targeting to add only 2.6 billion pieces by end-FY15 to its current installed capacity of 42 billion pieces. The year-on-year (y-o-y) growth in capacity of 1% to 5% is lower than its previous years’ average of 10%.

We note that Top Glove’s earnings before interest, taxes, depreciation and amortisation (Ebitda) margin has remained relatively flat at approximately 14% despite its ongoing expansion up the value chain into the nitrile segment (contribution up seven percentage points y-o-y to 24% for nine months of financial year 2014, [9MFY14]).

The management attributes this to cost pressure such as electricity and natural gas tariff hikes, and stiff competition which limits its ability to pass on the cost increases.

In response to recent reports of a 30% cap on foreign ownership of Indonesian plantation land which includes rubber estates, the management said it is open to joint ventures to pare down its 95% stake in PT Agro Pratama Sejahtera.

We are keeping our FY14 to FY16 earnings estimates for now, pending the release of its full year results on Oct 14. While net profit for FY14 is likely to be below FY13’s (down 10% y-o-y), we expect a minimal 5% growth for FY15, given that its China operations are expected to return to the black in first quarter (1Q) and a forex impact (9MFY14: RM14 million loss) is anticipated to diminish with shortened forward contract periods.

Since retracing to a low in June, Top Glove’s share price has advanced 12% on the back of the Ebola outbreak despite the absence of a significant pickup in glove demand. Valuation-wise, the stock is trading at FY14 to FY16 price-to-earnings ratio of 15 times to 18 times. — AmResearch, Oct 2

This article first appeared in The Edge Financial Daily, on October 3, 2014.