Top Glove Corp Bhd
(Sept 28, RM5.25)
Downgrade to underperform at RM5.25 with lower fair value of RM5.30 (from RM6.90): Top Glove is expected to announce its full-year results on Oct 6. While we expect weaker numbers quarter-on-quarter (q-o-q), for the full-year, we see year-on-year (y-o-y) growth of approximately 40% to 45% largely due to: (i) higher sales volume on the back of the new lines in F19 and F20; and (ii) y-o-y margin expansion resulting from better economies of scale.
We expect earnings to be weaker by 30% to 40% q-o-q on the back of: (i) weaker revenue largely due to lower sales volume as customers opt to run down their inventory levels due to the high latex price; and (ii) margin contraction largely due to the time lag in passing on the weakening US dollar against ringgit (-1.7% q-o-q).
According to management there are no plans for now to delay expansion plans. However, management will be monitoring the situation closely. Should demand remain weak for the next one or two quarters, the planned expansion at F23 could be pushed back. Currently, Top Glove’s average utilisation rate stands at approximately 70% to 75%, which the group believes is at a comfortable level to take advantage of any potential surge in demand for its gloves.
The risks include: (i) sharp surge in raw material (latex) and/or energy (natural gas) prices, which may result in margin squeeze; (ii) an appreciating ringgit against the US dollar; (iii) execution risk from capacity expansion; and (iv) weaker than expected results from overseas operations.
We have kept our FY2010 earnings forecast unchanged for now. However, we have lowered our FY2011 and FY2012 earnings forecasts by 10.4% and 9.7% respectively after lowering our FY2011 and FY2012 capacity utilisation rate assumptions to 77.5% and 82.5% (from 85% and 90%) respectively.
Given the weaker earnings outlook, we have cut our target PER to 12.5 times from 15 times. Our revised target PER is based on one standard deviation below the stock’s five-year average PER. Together with the earnings revision above, we have lowered our fair value to RM5.30 from RM6.90. In our view, Top Glove’s near-term outlook appears challenging on the back of the high latex cost, strengthening ringgit (against the US dollar) as well as slowing orders, which, we believe, makes it harder for Top Glove to adjust prices for the higher costs. We therefore downgrade our call on the stock to “underperform” from “market perform”. — RHB Research Institute, Sept 28
This article appeared in The Edge Financial Daily, September 29, 2010.
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