With expectation for a structural shift in demand toward rubber gloves and away from vinyl gloves, Macquarie Equities Research (MQ Research) is of the view that Top Glove will continue to have strong sales volume and robust earnings in the fourth quarter of the year (4QFY17), as stated in their research report released last week (7 Nov). MQ Research upgrades to Outperform with an increased target price of RM7.96.
- MQ Research upgrades Top Glove to Outperform from Neutral with an increased target price of RM7.96 from RM5.56. They expect a structural shift in demand toward rubber gloves and away from vinyl gloves will lead to a shortage of nitrile (rubber) gloves in the rest of 2017 and into 1H18. This should lead to a continuation of 4QFY17’s strong sales volume and robust earnings. Analysis shows that Top Glove’s share price tracks quarterly earnings, especially in periods of earnings volatility. Amid strong quarterly earnings, MQ Research expects the stock to re-rate to +2STD at 24x price-earnings ratio (PER) until an expected easing of the supply shortage in 3Q18.
- Sales volume remains supported by ‘new demand’. The expected long-term shift from vinyl to rubber gloves is likely to cause a rubber glove shortage in the remainder of 2017 and 1H18. This should support the strong sales volume (+14% q-q) seen in 4QFY17. Current order lead time is three months (vs. usual 1.5-2 months) suggesting strong demand for nitrile gloves. MQ Research raises their overall utilisation rate to 82% for FY18-19, due to an expected structural change in demand for rubber gloves. As a result, their sales volume assumptions rise 4%/2% in FY18/19E.
- Given an expected shortage of nitrile gloves, MQ Research believes pricing power is now skewed towards suppliers like Top Glove. As such, they lift margin per nitrile glove by 7ppt for FY18E. But this only leads to earnings before interest, taxes, depreciation and amortization (EBITDA) margin rising to 15% in FY18E from 14% in FY17E, as nitrile gloves are c.35% of total product mix.
- Valuation spike due to strong earnings. History
has shown that Top Glove’s share price tracks quarterly earnings. MQ
Research sees earnings remaining strong into 1H18 due to the shortage
and supporting an elevated PE multiple. They raise their target PE for
Top Glove from 18x to 24x, which is +2STD CY18E PE, and this leads to a
higher target price of RM7.96. Positive earnings surprises could see the
shares reach their historical peak at 28x. At 28x CY18E PER, Top Glove
would be worth RM9.28/sh – MQ Research’s blue sky valuation. Their bear
case – if the undersupply situation subsides earlier than MQ Research
expects and margin per glove normalises – Top Glove would de-rate to
+1STD PER of 19x and be valued at RM6.30/sh.
Earnings and Target Price Revision
- MQ Research also expects a lower effective tax rate of 16%-18% for FY18-20 (previously 20%) due to unutilised tax allowance and capital allowances from its upcoming new plants. This is mitigated by a lower USDMYR assumption of 4.50 to 4.30/4.23/4.20 for FY18/19/20E. As a result, MQ Research revises their FY18/19E earnings by +13%/-3% and also introduces FY20 forecasts.
- 12-month price target: RM7.96 based on a PER methodology.
- Catalyst: Fall in raw material prices and further strengthening of USD.
Action and Recommendation
- MQ Research upgrades to Outperform with an increased target price of RM7.96.
Source: Macquarie Research - 15 Nov 2017