Top Glove - Capacity expansion paying off BUY

- We reiterate our BUY recommendation on Top Glove Corp (Top Glove), with an unchanged fair value of RM6.50/share, based on a target PE of 19x FY13F earnings.

- Top Glove reported another strong set of results, with 1QFY13 net profit surging 83% YoY to RM57.5mil (1QFY12: RM31.4mil). Annualised, this made up 27% and 26% of our full-year forecast and consensus estimates, respectively. We deem the results to be in-line with expectations.

- However, we note that on a sequential basis, net profit fell by 9.5%. This was mainly due to the much lower tax expense in 4QFY12 from the recognition of deferred tax assets  and overprovision in prior periods. The effective tax rate has since rebounded to 16% for 1QFY13. (4QFY12: 3% and 1QFY12: 22%) 

- In tandem with the continued decline in raw material prices (QoQ: -14%; YoY: -30%), average selling prices (ASP) for rubber gloves have been falling, too. Nonetheless, we believe the impact will be cushioned by the rise in glove sales volume from sustained re-stocking activities. To be sure, our checks with management reveal that QoQ volumes rose 5.6%.

- Management’s move to expand capacity in the higher margin nitrile segment has paid off. Together with its improved operating efficiency and favourable business environment, Top Glove’s EBITDA margin expanded a further 1.3ppts to 15.3% in 1QFY13. YoY, the increase was larger, at 1.9ppts.

- Moving forward, we expect EBITDA margin to be at ~13.8% as we believe:- (1) latex prices will remain between RM6.00/kg- RM6.50/kg as a result of disequilibrium in the global supply and demand, and no further government interventions, and (2) the strengthening of the greenback against the RM (USD1:RM3.10) 

- With regard to its upstream venture, management said that land preparation will commence soon and it expects planting to begin in mid-2013. We have not included any earnings contribution from this undertaking in our forecasts as gestation for rubber trees take about 6 years.

- Key industry players have hinted that further sector consolidation would be likely in the near future. With its strong balance sheet (net cash: RM346mil), Top Glove is in a prime position to partake in M&A activities. 

- As expected, no dividend was declared for this quarter. We are keeping our gross DPS estimates of 17 sen and 18 sen for FY13F and FY14F, in-line with management’s 50% payout ratio. 

- We continue to like Top Glove as its position as the largest and “purest” natural rubber glove manufacturer makes it the prime beneficiary of easing latex prices.  

Source: AmeSecurities