Top Glove Corporation - Raising ASP to offset minimum wage policy

The key takeaways from Top Glove’s Corporation 1QFY13 results briefing include: (i) 1QFY13 key statistics explained, (ii) ASPs hike of 3%-5% to mitigate the effect of the minimum wage policy, (iii) the allocation of an average RM200m capex p.a. and (iv) the start of production automation.  While we believe the declining trend in raw material prices could improve the glove makers’ margins, including that of Top Glove, there are also headwinds ahead, which include the strengthening trend in Ringgit vs. USD, higher natural gas prices and the minimum wage policy. Furthermore, feedstock latex price is expected to move upwards in 1Q CY2013 due to the low output period. We maintain our MARKET PERFORM rating on the stock with a target price of RM6.00 based on 15x its FY14E EPS.

1QFY13 results explained. Top Glove 1QFY13 results briefing shed light that provide further explanation to revenue and EBITDA growth. Recall, 1QFY13 revenue rose by 5.4% Y-O-Y to RM584m was driven by  higher sales volume (+23%), which more than offset the lower ASPs (-14%). Volume grew across the board on the back of a utilisation rate of 75% compared to 70% previously. Nitrile registered the highest sales volume growth  at 40% with the rest being latex powdered (+18%), surgical (+23%) and latex powdered-free (+13%). In terms of product mix, latex gloves accounted for 75% (1QFY12: 79%; 4QF12: 76%) and nitrile accounted for 16% (1QFY12: 14%; 4QF12: 15%). The remaining balance was made up by vinyl and surgical. The EBITDA rose faster than revenue to RM89m (+54% Y-O-Y) due to a sharp drop in the raw material prices. Latex prices declined by 30% (from an average of RM8.34/kg in 1QFY2012 to RM5.83/kg in 1QFY2013) while nitrile prices fell by 31% (from an average of USD2.06/kg in 1QFY2012 to USD1.42/kg in  1QFY2013. The higher effective tax rate (ETR) in 1QFY13 compared to 4QFY12 was largely due to the absence of a RM8.7m recognition of deferred tax assets and lower deferred tax liabilities in 4QFY12. We had highlighted in our previous quarter results report that the normalized ETR would be around 20% going forward. 

ASPs hike of 3-5% to mitigate the effect of the minimum wage policy. Top Glove has raised its rubber glove average selling prices (ASPs) by USD1.00/1000 pieces to USD1.50/1000 pieces or by 3%-5% to between USD29/1000 pieces and USD32/1000 pieces with effect from 1 Jan 2013 to mitigate the effect of the minimum wage policy. We have already factored these revised ASPs into our earnings model. We understand that 50% of its workforce or total of 3,850 workers fall below the new minimum wage of RM900/month and expect their salaries to increase by 50%. Ceteris Paribus, assuming ‘a no cost pass-through’ scenario, the minimum wage policy is expected to hit Top Glove’s bottom line by 9% based on our back-of-the-envelope calculation. Labour accounts for 9% of the overall production cost. 

Embarking on production automation.  Over the last 12 months, Top Glove has invested in automation and computerisation of its manufacturing processes and has gradually reduced its reliance on manual workers to minimise the adverse effect of the minimum wage policy. Some of  the automations put in place include the (i) automated mechanical stripping system (removing gloves off hand moulds) and (iii) glove puller and stacker system. In addition, Top Glove has signed an agreement with SAP Malaysia to implement an enterprise resource planning system that integrates its various divisions, including procurement, marketing and finance at a cost of around RM10m-12m. 

Earmarked an average RM200m capex p.a. Management has earmarked for an estimated capex of RM200m in FY13 for: (i) automation including packaging and computerisation on some processes to reduce the full impact of the minimum wage policy; (ii) the planting of rubber trees in Indonesia; (iii) building of new factory and production lines; and (iv) the acquisition of GMP Medicare Sdn Bhd. Over the longer term, Top Glove plans to build 40 new factories or 2-3 factories p.a. (1-2 billion pieces of gloves per factory p.a.) including investing in new machineries, technologies as well as research and development, and to gradually reduce its dependency on foreign workers. We have factored this capex guidance into our earnings model.

Source: Kenanga