Thursday, June 4, 2020

Challenging the Gloves valuation - Top Glove as example

This article is going to be hugely unpopular. But let me put it, I am a supporter of Malaysian gloves business, you can do a search on my write-ups. The recent events on increasing valuation for gloves not just by retail investors but analysts' recommendations really surprised me. Let me take the largest of the gloves maker - Top Glove which is the largest maker by far. I have no doubt that the demand-supply had gone out of whack. However, how is it that the valuation can be this high.

Two analysts put it at around RM20, another put it at RM23. Today, Top Glove's price is around RM15.60. That translates to RM52.6 billion, RM60.5 billion and RM41 billion valuation respectively. Numbers are just numbers. I am taking those numbers and try to present where it is based on that valuation and what are the risks by picking those prices, especially at RM23 and RM20.

Below are the most aggressive numbers based on a RM23 valuation. The analyst presented the numbers for the subsequent 3 years between 2020 to 2023 and went silent on numbers further down the road. It is obvious the next 2 years will be period where numbers are going to be very high - I do not dispute. I am thinking even at 2022/23 (PAT RM836.6 million), if the profits is going to double the numbers for the normal period of 2019/20 - that is a stretch.

However, let us just say I am going to be hugely bullish i.e. after the period 2022/23, it will still grow at 10% per year for the next 6 years. Based on the above situation, I have put up 3 situations i.e. at what average PE would the company be given their price of RM23, RM20 and RM15.60. The average PEs for 10 years would be very high indeed - 64x (at RM23), 55.5x (RM20) and 43.3x (RM15.60)

To go for a more humble situation, I would not challenge the numbers for the next 3 years but let us put the 2023/24 PAT at a more realistic number. Post 2023, the PAT will drop by 20% - even then its number would be 84% higher from its normal year i.e. 2019/20. Subsequently, the profit numbers would grow 5%. That translates to 80.51x PE for price of RM23, 70x PE (RM20) and even a very high 54.61x PE for its current price of RM15.60.

Even, at a price of RM10 (which is not something we can expect given it is now RM15.60, the average PE would have been 35x, given the scenario above. See below's table. That is still high.

Now, let's look at the economics of rubber gloves.

Remember, rubber gloves while at today's situation it is difficult to create enough supply to meet demand, however are we saying that the demand-supply will still be abnormal after COVID-19. In fact, with the creation of extra capacity at large quantities, it is possible that there could be oversupply situation by then i.e. 3 years after this pandemic started in Jan 20.

Rubber gloves business is not a monopolistic business, although there are situations where certain companies such as Top Glove, Kossan and Hartalega are the larger of the manufacturers. Are we saying that with COVID-19 assuming to be still around after this 2 years, there will not be ramp up of supplies by these guys who would act as check and balance of each other in terms of competition? What about the other players?

How long does it take to create new factories and new lines? More than a year?

I cannot see the economics of it as this business is not in a situation where barriers of entry is very high. No player has huge advantage over the other except for some extra efficiencies and economies of scale. Given the huge margins today, many new companies will not even bother with scale. There could even be new entrants - have any of the analysts thought of this given it is so lucrative?

There are just too much unknowns and many of these are not put into considerations. For many businesses, by putting a overly high price, they run into risks of being shun when situation becomes normal. Typically for this business, it is about long term relationships. I understand that some of them had created a new idea by putting a percentage of their supplies on the spot market (meaning let it be done through bids). However, business like this is not done in such manner. It is not our typical commodities.


Anonymous said...

TOP Glove at rm20 plus. Higher PE than amazon? :P

Multi said...

Done in good faithπŸ‘πŸ‘πŸ‘

AnakM said...

Felicity - Bonus or splits do not change the valuation.

Qs - i'm not that well educated on how stock works, but how then can the top4 glove companies pares down valuation when Covid ends?

felicity said...

Had an article long before on this

Md. Yunus said...

Inverting the question of whether to invest in Top Glove or not at, say, RM16 per share: consider that the entire company could be bought at that price.

With 2,634 million shares outstanding, the market cap would be RM42 billion plus change, at a price of RM16 per share. Assuming a Mr. All-In, someone with a fat wallet, a really fat wallet, is walking around with that amount and more, and who also requires a return of just ten per cent on his investment, and he manages to pick up all the shares of Top Glove, say thru a voluntary take over offer.

You might say it wouldn't be possible as the stock is currently trading above that price, but bear with me for a moment.

Top Glove would have to cough up RM4.2 billion or thereabouts in net profit each year in perpetuity to justify his purchase. That would be more than eleven times the FY2019 profit of RM360 million plus change.

Could Top Glove be made to do this act once the bumper Covid profit periods are over? Could it even do it during the next few bumper years? If not how many more years of growth would be required and at what rate, to achieve the required profit in perpetuity.

Surmounting the hurdle rate of ten per cent would not be possible, at least in the forseeable future. Mr. All-in would not be fooled, hopefully.

yauwenchin said...

Rational Thinking (MyTake) is very simple, today, 20 July 2020, Top Glove is RM24.40 or Market Cap of RM66 billion.

1) Past 5 years, PAT is about RM400m p.a.(actually is RM370m p.a.)
2) Next 10 years, average PAT is about RM700m p.a. (assume 10% growth, actually is about RM600m plus)
3) Super profit for FY2020, 21 and 22 is about RM5.0 billion.
4) An estimated total cash flow = Next 10 years + Terminal Value + Super Profit (7b + 18b + 5b = RM30b divided by oustanding shares of 2.56b = RM11.70 per share.
5) Compare with today's market cap of RM66b vs estimate valuation of RM30b, a bit stretch. As usual, due to good sentiment on glove, I will give my estimates a 50% premium, say, RM30b x 1.5 = RM45b (or a share price of RM17.60 per share).
6) Bear in mind, I have not discounted the future cash flow.
7) How the houses can value it at RM37 per share or RM95b market cap (bigger than PBB of RM70b and MBB of RM88b today)
8) Good luck.

yauwenchin said...

Rational Thinking (MyTake Part 2) @ 14 August 2020 Top Glove RM23.80 or Market Cap RM65b

1) Update on Super Profit based on Citi Research about RM15b (previously used RM5b)

2) Using 10 years forecast cashflow + Terminal Value + Super Profit = 7b + 18b + 15b = RM40b divided by 2.7b shares = RM14.80 per share

3) Market sentiment is assumed to be good for next couple of quarters due to increase in ASPs, so, it should be trading at 50% premium = RM22.22 per share (or Market Cap of RM60b)

4) Using rationale thinking in an irrational market (second and third quarter of 2020) wasting the functions of good brain cells, in an irrational market, prices can trade a premium of 100% to 200% to 500% (take a look at GDex).

5) We just have to understand, the current situations, party is held for the traders, long term investors is invited to observe, not to participate.