Industrial Products: Top Glove Corporation Bhd

Introduction
Malaysia is the world leader (Boleh la!!) in rubber gloves, with a market share of ~60%, followed by Thailand (~25%), Indonesia (~10%), China and Sri Lanka. Following consolidation of the many players in 1980s & 1990s, they are now just a few of them and enjoying an oligopolistic (very dominant) position, this will make it harder for new entrants to achieve economies of scale (make more & sell them cheaper through bulk selling).

Here comes Top Glove Group which was established in 1991, an ambitious and nimble company that has grown to become the world's largest glove manufacturer under founder Tan Sri Dato Sri Lim, Wee-Chai and is still the Chairman. It has 19 factories across Malaysia, Thailand & China (as of August 2009) with 355 production lines making 33 billion pieces per annum. Top Glove alone supplies 23% of the global market, exporting to more than 180 countries especially to USA, Europe and Far East (Japan, HK and Taiwan).

The demand for rubber gloves is expected to grow around 10% pa, owing to better health awareness and standards. Demand for growth is quite recession-proof because a large % of them are being used in healthcare sector. With the increase in fast food consumption (good correlation with health problems), growing aging population, health threats like SARS/H1N1 & emerging developing countries like BIRC (Brazil, India, Russia and China), I find that the 10% pa figure by economists to be optimistic. Good news for Top Glove and other rubber glove companies in Malaysia (which are competitors):

• Supermax Corp Bhd (14 bil pieces per annum)
• Kossan Rubber Industries Bhd (11 bil pieces per annum)
• Hartalega Holdings Bhd (6 bil pieces per annum)
• Latexx Partners Bhd (6 bil pieces per annum). A good friend of mine made this research already here at The Fool Investor

Fundamental

1. Does the company have an identifiable durable competitive advantage?

Being the largest rubber glove company in the world, it can produce high quality gloves with efficient low cost. Economies of scale & its dominant position are Top Glove's competitive advantages.

2. Do you understand how the product/service works?

Rubber gloves are not only used in healthcare but also in the food and services industries for hygiene purposes. As such, it is anticipated that the demand to stay resilient (stable) even with the global economy being sluggish.

3. What is the chance that it will become obsolete (KO) in the next twenty years?

Definitely NO. Ask yourself, is there any substitute for rubber? Is like asking what other material apart from rubber can be used to make condoms :)

4. Does the company allocate capital exclusively in the realm of its expertise?

Yes, they are moving forward in a two-prong growth strategy. Vertical strategy on the downstream via overseas marketing offices, upstream via take overs of smaller companies involved in the rubber sector. Horizontal strategy by increasing sales in new flavours via R&D and value added products.

5. What is the company's financial history and status?

• Net Profit Margin is in the 10-15% range. Nothing special as the other competitors have these kind of figures as well, though Top Glove enjoys better average margins most probably due to its economies of scale.
• Return of Equity which means how much shareholders get in return of investment is in the 20-30% range over the last 10 years.
• Revenue Growth Rate saw a tumble since 2007. This is due to the drastic increase in the cost of raw materials of latex and fuel. Also affected slightly by the strengthening of the ringgit vs the greenback (USD). Soon after that, the world was hit with the 2009 financial crisis and further weaken the growth rate.

• Earnings Per Share & Dividend Per Share is on the rising trend over the past 10 years. If one compares this with the stock price, you can clearly see that the stock price is affected by human emotions (panic & greed) even though the company is growing steadily well. Once again I would like to stress that you should value a company from it's financial ratio/numbers, not just purely from stock price.

6. Is the company conservatively financed?
Yes, with RM185mil in cash and bank balances enabling the company to deal with rising commodity prices like latex and to fund potential expansion plans. They did have do have the occasional short term borrowings but has been paying back effortlessly thanks to a good balance sheet. D/E ratio is at 0.02 (which is negligible) while in the last 5 years has never exceeded my trigger limit of 0.5.

7. Is the company actively buying back its shares?
Amount of treasure shares (buy backs) stands at 6.6 million units. There has also been a 1:2 share split in Year 2005 and also many bonuses. All of these add value to shareholders in terms of equity.

• Year 2002: 3/10 Bonus
• Year 2003: 2/5 Bonus
• Year 2007: 2/5 Bonus

8. Is the company free to raise prices with inflation?
According to Dynaquest, they did pass on the cost increase to its customers in the year 2009. With the increasing thrust & volatility of latex and oil prices, passing cost to the customers is inevitable not just Top Glove but to the rest as well.

9. Are large capital expenditures required to update plant and equipment?

Because it is a manufacturing company, capex are always required to boost production capacity via upgrades or expansion. Top Glove is no different and is investing about RM100mil to increase production of its five plants in Malaysia. This will up the capacity to 41.25 billion from 33 billion by 2011 (looks like company is anticipating at most a 10% growth in demand).

Discounted Cash Flow Analysis

DCF treats a company as a business rather than just a ticker symbol and a stock price which most blind people think that price only matters. It requires you to think through all the factors that will affect the company's performance and gives you an appreciation for what drives stock values. Go to Investopedia.com and learn.

I have estimated that TOPGLOV's revenue growth rate is at 10% averagely following demand %, with 85% operating cost margin, 25% corporate tax, 2% re-investment (~RM30mil a year) but a growing working capital in tandem with revenue growth at 10% for the next 5 years. Having computed all these in my opinion it is fair to buy..

TOPGLOV at RM6.90 to RM8.40 for ~15-13% discount rate.

From its listing in 2001 to 2010 the stock would have appreciated by 1200% not accounting dividend reinvestment which would give you more. Is the stock overvalued? I would say Yes based on FCF (free cash flow) & some technical indicators, a value of ~RM12.00 is only appropriate if I did assume the revenue growth rate at 15% but as an optimist and the company's expansion plan, 10% is more sensible. Having bought them during the start of the bull run and sold at ~RM11 this is merely short term profit riding for me on bad times > good times. One would only do this sort of profiting if I find that the underlying fundamentals of the company is good and NOT solely because of stock price as have been explained earlier.

What Do I Think? 

The time to buy is too late, over the last three months has seen the price hovering at RM12.00 level (saturated). Also with this industry being quite competitive and at most times volatile (revenue margins dependent on latex and oil prices), there is a lot of risks at stake and it is in my honesty to say that it only makes it harder to value such company. I do like the fact that Top Glove has consistently being rewarding their shareholders with dividends & bonuses.

TOPGLOV is a good stock if one follows the trend in commodity prices & also to follow the demand of rubber gloves of different categories such as powder-free latex gloves & the increasing demand of nitrile gloves. Plus be on the lookout for the next global pandemic (if you watched Discovery Channel like me) you will know that viruses keep mutating so it is not a matter of will it but when.


Because the rubber glove and plantation sector in Malaysia is one of world-class, their stocks tends to be on the limelight thanks to hot news & bullish analysts. The result? Simply panic & greed. The prices of these stocks will fall hard during bad times and go up high when it is in Disneyland especially the blue chips. 

My strategy is simple, if I need short term funding, buy during bad times and sell at good times. If I look forward for long term then I will need to monitor closely perhaps by quarterly. This stock is not as easy as buy, hold, sleep and wait as they are just too many uncertainties for me to relax.

**I would one day like to compile a grandmother story with a side-by-side comparison of all the major rubber gloves companies as well as plantation companies for they are world-class Malaysian companies. It is wise to know in depth how these companies compare to each other and why they are important to Malaysia. There are many other financial ratios I look at as well but to put them into my usual blog writing will make most people blur blur & zzzz...until I get that long writeup done I feel that a short sharing will interest some people to pick up investing as a life skill & dump the gambling mindset that most people have away as a start.