Top Glove: do fundamentals back the industry rally or it is the pricing overstretch?

Since I am now back in Malaysia, I have been constantly bombarded by news about the glove makers in Malaysia. Almost a news article about them from each local news-source and it even broke to the Financial Times. So I thought I’d look into the hype and see what it is all about myself.

My narrative of Top Glove

My story for Top Glove is this. Top Glove is the biggest pure-play glove manufacturer in the world. The company operates in Asia and mostly locally, in Malaysia. The company has seen a spurt of growth from the coronavirus pandemic as demand jumps for disposable medical supplies. Due to the commodity nature of its business, most of the growth and profitability will be experienced this year. Supply will meet with demand with high levels of competition in the next few years, causing the company to converge back to the industry.

Medical gloves are a commodity

During the height of the coronavirus panic, hygiene supplies were selling at absurd prices which were contributed by the demand surge, which was exacerbated by the hoarding and supply shock from the lockdown. As factories reopen, pricing for medical gloves has come down. If you don’t trust me, search for medical gloves on Lazada. The industry is also competitive. Sixteen publicly traded companies produce medical gloves primarily, most of them operate out of Asia. Almost half of them alone are Malaysian-based. Despite the fact, Top Glove still has above-average profitability before the pandemic, indicating the efficiency of management.

News article: Glove Demand-Supply Imbalance to Normalise

Data: rubber glove comp

A majority of the company’s sales come from Malaysia and most of, if not all, of it other sales comes from within Asia.

Stories to numbers

I took my narrative for the company and compared it to the management and the (bursa)streets. It turns out that I have the highest expectation among them. Management tends to be conservative, while analyst consensus tends to be upward bias. But it didn’t matter in this valuation, as the market is pricing in an unimaginable amount of growth. I wonder if the momentum has gone out of hand.

July 12, 2020: You could argue that the WACC could be lower or some other drivers could be better. I have included my model, use it, change the assumptions to fit your story. Credits to Aswath again.

Metrics	Management	Consensus	ZacSeng	Market
Revenue growth, average 2020-2024	12.1%	15.2%	22.0%	116.5%
EBIT margins, average 2020-2024	19.4%	18.9%	19.4%	19.4%
Est. share price	2.76	3.05	3.34	21.18

Model adapted from Damodaran: TOPGLOV_dcfmodel_july20

The consensus of analyst estimates for Top Glove. Source: Bloomberg

Why is there a big difference between intrinsic value and market price?

Interest rates around the world are falling; Malaysia is no different. The Malaysian 10-year bond has fallen to 2.63%. This low-interest-rate environment will ultimately nudge investors to redeploy capital into investments with relatively higher returns, namely equities. The problem is that most of the industries in Malaysia have been hit hard by the pandemic, negatively impacting their future cash flows. Because of this, Malaysian investors, especially retail investors, move their capital into “winner” stocks like Top Glove and the momentum starts to snowball.

31% of the shares of Top Gloves are held by retail investors. Source: Capital IQ

Conclusion

I think the company is overhyped and overvalued. Don’t get me wrong, Top Glove is a decent company, it was the fastest to scale up its production and is the more efficiently-run company. But even a great company does not necessarily translate to a good investment if it is not valued attractively. I suspect that a lot of the stocks that were hit in the past months will now be good investments as they are now significantly undervalued as how Top Glove is overvalued.

What am I going to do with this? I would normally short sell the company if I can. But at the moment Bursa Malaysia has conveniently banned short-selling until the end of the year. I will reserve the ban for another rant, but that is my take on the medical glove industry and particularly Top Glove.

What are your thoughts on this? Has the momentum gone out of hand and into bubble territory?