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Yesterday an article published by The Edge mentioned a report by JP Morgan with a very grim expectation expressed on the glove sector. To be more precise, The Edge's article was based on a "research note" by JP Morgan dated January 11. I managed to view the original report, through a membership I have, and it is actually dated January 6.

As with AmInvest's report (you can read my notes on it here), I will not comment on the assumptions made, no matter how inconsistent with real world data and trends they are. I will solely focus on the numerical values from which the target prices are derived. To reiterate, JP Morgan's target prices are RM3.50 for Top Glove, RM8.50 for Hartalega, and RM3.80 for Kossan. These target prices are substantially lower than the consensus target prices, and even substantially lower than the target prices of the next most bearish analyst. For instance, for Top Glove, the nearest most bearish analysts are Macquarie at TP RM5.80, and the infamous AmInvest at TP RM6.50. Coincidentally, Macquarie have outstanding structured warrants that would be in the money if the market price of Top Glove goes above RM6.627, expiring on January 29 (see here).

We will once again focus our attention on the figures for Top Glove, because that is the company that has released the largest amount of data about its current and expected financial position publicly and therefore the company for which revenue and earnings are most predictable. A few days ago I sent an email with questions to Top Glove to fill some of the gaps of data that was not available publicly yet. They replied to me yesterday, and I am currently seeking their approval to share this additional data publicly. I will do so as soon as I get the approval.

Referring to my notes on AmInvest's analysis, the part that made the least sense was the calculated net profit for FY21. The case with JP Morgan is not the same. In fact, the estimated revenue and earnings in their report are above the consensus level of RM20.5 billion and RM10.5 billion respectively. JP Morgan's analysts expect FY21 revenue to come at RM22.956 billion, and net profit to come at RM11.674 billion. This translates into a net profit margin of 50.9%, which is perfectly in line with the consensus (see my AmInvest report notes for reference). Let's assume that JP Morgan's estimated EPS of RM1.46 for FY21 is accurate. As Top Glove recently released news on increasing the dividend payout to 70% for the financial year, and having in mind that the payout for 1QFY21 was 56%, dividend per share (DPS) for FY21 will come to RM0.97 according to JP Morgan's own estimate. At target price of RM3.50, this is a dividend yield for the year equal to a whooping 27.7%!!! Warren Buffett, arguably the greatest investor in the modern history of the world, has only been able to achieve 17.1% CAGR since 1985 (reference), so such a dividend yield would beat him by an enormous margin. Additionally, the report (again, it is dated January 6, 2021) provides outdated information to the clients of JP Morgan, because the dividend payout is estimated at 50% whereas the 70% payout announcement was made on December 4 (reference).

Did JP Morgan make a very significant miscalculation somewhere?

While JP Morgan did not deviate from the consensus at all with their estimate from the consensus estimate for FY21, the deviation is drastic for FY22. Their estimated revenue is RM11.971 billion, in line with the consensus RM13.4 billion. However, their estimated net profit is RM1.686 billion, way off from the consensus RM4 billion. In other words, the consensus profit margin for FY22 is 30%, while JP Morgan's is 14.1%, or more than twice lower. Even more drastically, for FY23, their estimated net profit margin is 6%, compared to consensus average 20%, or more than three times lower. There is no explanation on why the profit margin of the company is so much below the consensus average. The last time Top Glove has reported profit margin below 6% was in November 2011 - 9 years ago (reference). This is important, because JP Morgan peg their valuation to FY22 earnings, ignoring FY21 and any consequences this financial year might have on the financial position of the company.

Is JP Morgan saying that the largest glove manufacturer in the world will operate at entry level profit margins?

Note that JP Morgan believe that Top Glove will report RM11.674 billion in net profit for FY21. Additionally, they believe that the cash pile of the company by FY22 will be RM4.107. If we take these two figures, and we apply one of the most basic and most conservative valuation methods - discounted cash flow, we get that at RM3.50, 55% of that target price's value is contained in what the company is expected to earn this year alone.

One of the answers I received from Top Glove was on a question I had about the percentage deposit they collect from customers for both spot orders and non-spot orders. As I mentioned I will publish their response as soon as I get the permission to do that, but the percentage is materially different from JP Morgan's estimate. In their report they mention (quote from The Edge): "the deposit paid is merely 4.7% of projected revenue for the financial year ending Aug 31, 2021 (FY21)." I am sure that this information would have been given to JP Morgan if they had asked for it since they are a substantial shareholder of Top Glove (20th largest shareholder in the company).

Have JP Morgan not contacted Top Glove to ask for information before publishing their report?

Ironically, yesterday Stephane Bancel, the CEO of Moderna, talking about COVID-19 at JPMorgan Healthcare Conference, said that "we are going to live with this virus, we think, forever." (reference)

Important disclaimer: Any views expressed are for informational and discussion purposes only. None of this information is intended as, and must not be understood as, a source of advice. It is imperative that you always do your own research and that you make any decisions based on your personal situation and your own personal understanding.


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