This article first appeared in The Edge Financial Daily on March 11, 2019
Top Glove Corp Bhd
(March 8, RM4.59)
Maintain buy with a lower target price (TP) of RM5.93: We met with members of the management to discuss the latest developments at Top Glove Corp Bhd (Top Glove). Our discussions focused on convertible bonds, capacity expansion and market dynamics, as well as its wholly-owned subsidiary Aspion Sdn Bhd.
We can expect a muted quarter on given seasonality in the second quarter and timing differences between average selling price (ASP) revision and costs on the back of the strengthening ringgit, higher minimum wage beginning January and as well as about 4-6% higher cost of natural rubber quarter-on-quarter (q-o-q). In terms of Ebitda margins we can expect a slight contraction of about 1 percentage point to 15% from 16% q-o-q. Nonetheless we can still expect earnings growth on a year-on-year (y-o-y) basis.
Overall management is still positive on the global demand growth for rubber gloves in financial year 2019 (FY19), thus the growth story remains intact. We understand that lead times are at about 30 days (normal level: 30-45 days). In terms of volume growth we can expect Top Glove to see about +15% y-o-y which is in line with the global demand growth (five-year CAGR:+15.1% by Frost and Sullivan). Due to delays in construction, F33 (1.2 billion pieces) and F32 first phase (2.2 billion pieces) will be delayed to mid second quarter of financial year 2019 (2QFY19) from the original target of 1QFY19. Whilst Factory 41 (Vietnam — two billion pieces) will be pushed beyond the scheduled 1QFY20 due to delay in getting the appropriate government approvals for the investment. We view this in a positive light as slight delays may ease the pressure on ASP in 2019.
Top Glove has issued US$200 million in convertible bonds as part of its debt restructuring and should result in cash savings of about RM16 million per annum, while the profit and loss (P&L) impact is more muted as the yield to maturity (YTM) of 3.75% is amortised as part of the finance cost on the P&L. The P&L impact is expected to be about RM2 million per annum savings. The debt restructuring will enable Top Glove to tap on a lower fixed yield for the duration of the bond vis-a-vis the syndicated loan which is based on the position of Libor (about 4% subject to Libor fluctuations). Upon full conversion to shares, Top Glove is expected to save about RM32 million a year — no dilution will occur as the additional new shares of around 4.9% of existing share base will be offset with the interest savings of RM32 million.
We understand that Aspion is expected to turn profitable in 2QFY19 (from a loss of RM4 million in 1QFY19). Management remains confident that there will be no impairment in the near term as they expect the second half of financial year 2019 (2HFY19) to be better and will form the basis of their impairment test calculations. We understand that the Kulim plant is running well but much work needs to be done at the Kota Baru and Kluang plants. In terms of capacity utilisation, Aspion is hovering at about 50-60% and product mix is 70:30 of examination to surgical.
Prospects for the surgical glove segment remain positive and Aspion will benefit from the recent unrest at WRP Asia Pacific Sdn Bhd (foreign worker and shareholder issues). WRP is Aspion’s competitor for the poly isoprene surgical glove segment, and management expects some switching to Aspion. Recall that poly isoprene surgical gloves are premium products (about 60-70 cents per piece versus natural rubber surgical gloves 12-20 US cents per piece). Aspion also manufactures X-ray gloves in small volumes but is achieving about RM1 million profit after tax per annum (ASP: US$20 per pair). Despite Aspion’s woes, the segment remains a lucrative addition to Top Glove’s stable of offerings.
Of the RM400 million designated for capital expenditure in 2019, about RM160 million is assigned for new capacity while the remainder will be for existing facilities. We understand that Top Glove is in the process of testing vision inspection machines at some of their newer factories to help expedite the quality control process. We understand that the group will ultimately roll out a vision inspection machine at each of their 600-plus production lines. This is expected to reduce about 600 foreign workers per shift. Top Glove has a total workforce of about 17,000 people, of which 13,000 are foreign workers.
Top Glove has undertaken a tax planning exercise and will continue to enjoy sub-statutory effective tax rates. The bulk of the unutilised tax allowance (about RM99 million) is available at newer subsidiaries with a lower profit base, while the group has exhausted tax incentives for subsidiaries with higher profit base in 1QFY19, thus resulting in a higher effective tax rate (21.3% versus 13.1% in 1QFY18). Future earnings growth will come from these new entities that still enjoy the reinvestment allowance and tax allowance. Moving forward the effective tax rate should remain below the 20% level.
The condom factory (capacity: 100 million pieces per annum) has commenced production, but is awaiting ISO certification. It will be a few quarters before production meets the standards and quality to be marketable. Top Glove will not participate in the tender market as they do not yet meet the three-year pre-qualification by tender market players. The initial batches will be sold only under the original equipment manufacturer (OEM) market segment.
We are adjusting our FY19-21 forecast downward by -6.3%,-5.3% and -4.6% respectively as we calibrate our finance cost assumptions as we had earlier assumed a higher level of interest savings (about RM24 million per annum versus RM2 million per annum) resulting from the bond issuance.
Post forecast realignment, our TP decreases to RM5.93 (from RM6.26). Our TP is based on FY20 earnings pegged at a PE (price-earnings) multiple of 28 times, a slight discount to the glove sector’s one standard deviation above three-year mean PE (29 times). — Hong Leong Investment Bank Research, March 8