We attended Top Glove’s briefing on its 1QFY18 results and proposed acquisition of Aspion Sdn Bhd (Aspion), hosted by Tan Sri Dr Lim Wee Chai (Executive Chairman), Top Glove’s management team and Low Chin Guan (Aspion’s MD). Top Glove has inked a deal to acquire Aspion, the second-largest surgical gloves maker in the world (with 17% global market share), for a purchase consideration of RM1.37bn. We are positive on this acquisition as Top Glove can immediately widen its surgical gloves portfolio to include specialised surgical gloves, thereby moving up the value chain. Both companies could reap substantial synergies through cross leveraging their respective expertise in examination and surgical gloves. The acquisition is expected to complete in April this year. We adjusted our earnings estimates upward by 2-18% for FY18-20F to account for the potential contribution from Aspion based on the clearer guidance from management, and roll forward our valuation matrix to FY19F. As a result, we revise up our DCF-based TP to RM8.75 (from RM7.86 previously). Share price has surged by 33% since our upgrade on 27th November 2017 and we believe market has already priced-in the positive near term developments. Given a limited upside to our TP, we downgrade Top Glove from Outperform to Neutral.
1QFY18 results. To recap, 1QFY18 revenue and net profit grew by 19.4% and 43.8% YoY respectively, mainly fuelled by growth in sales volume on the back of strong demand growth in both developed and emerging markets (particularly for nitrile glove) as well as the disruption in vinyl glove supply. Net profit margin showed significant improvement of 1.9 ppts on the back of continuous improvement initiatives in terms of automation, better production lines and cost savings as well as lower effective tax rate due to tax incentives.
Details on the proposed acquisition of Aspion. Top Glove has signed a deal to acquire Aspion, the surgical glove producing unit of Singapore’s Adventa Capital Pte Ltd (ACPL), for RM1.37bn. Of the total RM1.37bn purchase consideration, RM1.233bn (90%) will be satisfied in cash while the balance of RM137.0m (10%) is intended to be satisfied via the issuance of 20.5m new Top Glove shares (c.1.6% of the current share base) at an issue price of about RM6.6813 each (refer to Figure 3). Post-acquisition, the net gearing will jump to 0.88x (from 0.19x) but is still below its comfortable level of <1 .0x.="" br="">
Implied valuation. The acquisition comes with a core net profit guarantee of RM80.9m and RM108.3m for Aspion’s FY18 and FY19 (FYE 31 October). ACPL will reimburse Top Glove for any shortfall in the core net profit for FY18 and FY19, up to an aggregate maximum limit of RM100.0m. The acquisition is pricing Aspion at 16.9x forward P/E multiple (based on its FY18 profit guarantee of RM80.9m) and 10.5x forward EV/EBITDA multiple, which is relatively attractive, considering the (i) average sector P/E of 21.6x (Range: 14.1x - 36.7x), and (ii) average sector EV/EBITDA of 14.2x (Range: 8.9x - 25.2x).
Aspion’s capacity expansion. Aspion’s manufacturing facilities are located at Kulim (surgical and examination gloves), Kota Bahru (surgical gloves) and Kluang (examination gloves). It has a current total capacity of 4.6bn pcs p.a. (examination: 3.1bn pcs p.a., surgical: 1.5bn pcs p.a.) with an ongoing plans to increase to 6.0bn pcs p.a. by 2019 by doubling the production of surgical gloves (examination: 2.9bn pcs p.a., surgical: 3.1bn pcs p.a.). Post-acquisition, Top Glove plans to focus on expanding Aspion’s surgical gloves production at Kulim plant in Kedah. Meanwhile for examination glove operations, Top Glove will transfer its technical know-how and technology to assist in upgrading Aspion’s efficiency and cost optimisation in examination glove operations. Both companies could reap substantial synergies through cross-leveraging their respective expertise in examination and surgical gloves.
Finessis surgical gloves, Aspion’s latest innovation, are synthetic surgical gloves manufactured using Flexylon polymer, which is a high performance synthetic polymer developed using in-house proprietary technology. Finessis surgical glove range include Finessis Aegis, Finessis Corium and Finessis Zero. Finessis Aegis glove is designed to contain a disinfecting liquid, which aims to provide added protection against potential virus transmissions. It is capable of reducing as much as 96% of the number of HIV viruses transmitted in the event of puncture when compared to double gloves, and 98% when compared to a puncture with no glove protection. Finessis gloves have been launched in selective markets in 2016 and has received regulatory approvals from the FDA, the EU and the TGA. Finessis gloves has the highest Acceptable Quality Level (AQL) of <0 .1="" 0.65="" a="" access="" acquire="" although="" and="" aql:="" be="" believe="" br="" business="" catalyst="" could="" cutting="" earnings="" edge="" eers="" finessis="" from="" future.="" glove="" in="" innovative="" is="" know-how="" manufacturing="" materials.="" new="" now="" post-acquisition="" potential="" processes="" proprietary="" relatively="" s="" small="" surgical="" technologies="" technology="" the="" this="" to="" top="" we="" will=""> Finessis Incentive. In addition to the purchase consideration of RM1.37bn, Top Glove has agreed to provide Finessis Incentive based on the actual net profit derived from the sale of Finessis range of surgical gloves over a period of 3 years (FY18 to FY20) (refer to Figure 2). This incentive will be paid every year by cash and capitalised as purchase costs (in addition to the purchase consideration of RM1.37bn) as the net profit from Finessis will also be in addition to the above-mentioned profit guarantee. As the Finessis Gloves are a new product range of Aspion, the gradual ramp-up in the percentage of Finessis net profit will be subject to the Finessis Incentive over a period of 3 years (where the larger proportion is deferred to a later stage, i.e. FY18: 20%, FY19: 30% and FY20: 50%). We are positive on this arrangement as it allows Top Glove to expand its portfolio to include Finessis Gloves without requiring substantial upfront initial investment. Besides, the Finessis Incentive will also encourage rolling out of new products with higher margins.
Moving up the value chain. We are positive on this acquisition as Top Glove can immediately widen its surgical gloves portfolio to include specialised surgical gloves, thereby moving up the value chain. This is expected to allow Top Glove to grow further in developed regions such as North America, Europe and Japan, which constitute a major segment of the global surgical glove market. Upon successful acquisition of Aspion, Top Glove’s surgical glove sales quantity is projected to expand from the existing 2% to 4%. While in term of revenue, the contribution of surgical gloves is projected to increase from the current 5% to 13%. Surgical gloves typically command higher ASP as they have more specialised usage. As such, surgical gloves generally fetch higher gross profit margin compared to the other types of gloves, including examination gloves. This in turn is expected to contribute positively to Top Glove’s profitability. Post-acquisition, Top Glove will be the single largest surgical glove producer globally with an estimated 29% glove market share (Top Glove: 12% + Aspion: 17%). Top Glove aims to grow its surgical glove market share (by volume) to 34% in 2018 (refer to Figure 5). This will increase its profitability and further accelerates its plan to attain 30% market share in the global rubber glove market by 2020.
Overcome entry barriers. By riding on Aspion's resources and experience with an estimated 7 years of research ahead of competitors, Top Glove is set to overcome manufacturing, regulatory and customer barriers to entry into the surgical glove market. Unlike examination glove, surgical glove market has higher barriers to entry in manufacturing (i.e. stricter AQL, 100% sterile) and distribution, which provides >5 year entry gap for new entrants.
Earnings impact. Aspion’s contributions to Top Glove’s FY18 and FY19 net profit is expected to be c.5% and c.17% respectively, taking into consideration of the (i) FY18 and FY19 core net profit guarantee of RM80.9m (only 4 months’ contribution) and RM108.3m respectively, as well as (ii) the post-tax interest costs associated with the financing of the acquisition. We have yet to incorporate the potential earnings accretion from Finessis gloves into our forecasts until we see earnings visibility from the new products. Hence the total contributions from Aspion could be higher.
Other expansion plans. In term of inorganic growth, Top Glove will continue to explore M&As with businesses that synergise with the Group’s current business. Last year it had acquired 2 companies, while the plan is to acquire 3 companies this year (Aspion and another 2 more companies) and 4 companies next year. Preference is for glove, condom, chemical plant and glove-related companies. In term of organic growth, Top Glove will continue to construct 1-2 factories every year. Besides, Top Glove plans to expand its manufacturing facilities into Vietnam in the next two years to capitalise on the country’s competitive edge (i.e. infrastructure, workforce, skills and investment-friendly government).
Cost pressure and forex impact to be offset by increase in ASP. The impact of natural gas price hike and policy of levy absorbed by employer is an increase of about 1.1% and 0.3% on total manufacturing cost respectively. The impact of foreign levy is spread over 12 months upon renewal of work permit. Given the strong current global demand and the disruption in vinyl glove supply, Top Glove should be able to raise its ASP to pass on the higher cost to customers to offset the negative impact of recent strengthen of ringgit, natural gas hike and foreign levy. We understand that the disruption in vinyl glove supply is still persistence due to the shortage of natural gas (due to the cold weather), which would delay the process of switching coal to natural gas and hence the re-start of production. As such, this condition is expected to continue in 1H2018 and may normalise in 2H2018.
Source: PublicInvest Research - 15 Jan 2018
