• Accelerating capacity expansion in view of robust demand.
• Gloves shortage to sustain ASP; order backlog extended.
• FY20-22 net profit forecast raised.
• Reiterate BUY on Top Glove (SGX:BVA) with higher Target Price of RM27.80.

Capacity Expansion to Capture Strong Demand

Infection rates remain high.

• Global COVID-19 infection rates have been increasing with 160,000-210,000 new cases daily in the past five days. Countries such as the US and Brazil account for 30% and 13% of new cases, respectively, as of 7 July. Countries with high populations such as India have also contributed significantly to the increase of daily new cases, with 14% of new daily cases on 7 July. Daily new cases in Asia (excluding China) are also increasing, contributing 32% of new cases on 7 July. COVID-19 currently has 11.6m confirmed cases, about 24 times that of H1N1. Many countries are slowly reopening their economies after being hit by COVID-19. However, there are increasing concerns that asymptomatic patients may trigger a second wave of infection.

Upwards revision of capacity expansion to capture the strong demand.

• In its update in Jun 2020, Top Glove’s total installed capacity stands at 78.7bn pieces of gloves, +5.3bn pieces of gloves compared to 73.4bn pieces of gloves in Mar 2020. Management has revised its capacity expansion upwards for CY20 and CY21 in order to capture the robust demand arising from COVID-19 pandemic.
• Management targets capacity of 86.4bn pieces in Dec 20 and 100.4bn pieces in Dec 21 compared to earlier expectation of 81.6bn pieces and 91.1bn pieces respectively. We are assuming utilisation rate of 90% for FY20-FY21.

ASP continues to trend upwards.

• ASP improved 9% y-o-y and 5% q-o-q in 3QFY20. We gather that pricing increased by 15%, 15% and 30% on a m-o-m basis in June/July/August 20 on the back of robust demand. Spot orders, which account for approximately 20% of total capacity, fetch higher ASPs.
• Coupled with the increase in capacity, our Top Glove's FY20-21 net profit forecast is higher by 18% and 87% respectively.

Longer order lead time.

• The lead time for nitrile gloves has increased to 420 days in early June 20 and 470 days in end June 20, while the lead time for natural rubber gloves increased to 410 days. In Apr 2020, the order book lead time for latex and nitriles gloves was 300 days. Pre-COVID 19, the lead time for order book was about 30-40 days. The significant increase in sales order took place after Jan 2020 when Wuhan, China announced its COVID-19 outbreak.

M&A a Longer-term Strategy

• Inorganic growth is one of Top Glove’s long-term strategy. Management is actively looking for acquisitions to further increase its capacity. However, we understand that acquisition activity is more difficult in the near term as other glove players are unlikely to sell their assets in view of the strong demand of gloves.
• Management expects capital expenditure of RM700-800m for FY20-22 to be mainly funded using internally generated funds.

Convertible Bond Conversion

• Top Glove issued guaranteed exchangeable bonds amounting to US$200m on March 2019. The exchange price was determined at RM6.10/share. To-date, we understand about 113m shares (or 85% of total shares from bond issue) have been issued arising from the conversion of the exchangeable bonds. We have assumed all bonds are converted by end-FY20. This increases the share base by 5.7% and dilutes FY20-22F EPS by 5.3%.

More Automation in the Pipeline

• With foreign worker intake being frozen by the government, Top Glove has taken in local workers to fill the gap. We understand that the salary of local workers’ could be slightly higher than foreign workers. However, local workers account for only about 10% of the workforce. Thus, the impact to net profit is minimal.
• Meanwhile, management’s efforts of embarking on digitalisation and automation via the application of robotics and automated real-time manufacturing systems will reduce its foreign labour reliance and improve the efficiency of its manufacturing process.

Valuation

Reiterate BUY on Top Glove with higher Target Price of RM27.80.

• We raise our Top Glove's target price to RM27.80 post earnings adjustment (Using the latest FX rate of RM1 to SGD0.326, we derive target price of 9.06 in SGD term). Our Target Price is based on 39x CY21F PE. . This is based on +2 SD of its 5-year mean.
• We reiterate BUY in view of Top Glove's strong earnings outlook.

Potential Catalysts

• Stronger-than-expected ASP and sales volume will further drive the company’s earnings and share price. Every 1% improvement in net margin could boost Top Glove's net profit by 6.3%. A second wave of COVID-19 infections after the gradual easing of lockdowns could see glove demand sustained at high levels.
• In the long term, even as infection rates ease, we expect COVID-19 to drive increased usage of gloves globally, sustaining a “new normal” of demand.

Source: DBS Research - 9 Jul 2020