• 2H20 results were above our expectations. PATMI rose 9x YoY in 2H20 to S$12.5mn.
• Gross margins in 2H20 jumped 16% points to 36%. Margins were higher in 4Q20 at 48% as glove prices only started to rise significantly Apr20 onwards.
• Capacity will jump 59% to 4.6bn gloves over the next 2 years.
• Maintain BUY with a higher target price of S$4.15. We are raising our PATMI estimates for FY21e by 55% to S$54.5mn. Our valuations are benchmarked at 15x PE FY21e, around 40% discount to larger peers. We expect another stellar year of earnings growth from volume increase and selling prices which have been rising monthly. Longer-term, UGHC is further entrenching its distribution network and brand name into emerging markets such as China, Brazil and Nigeria. As an OBM (or brand owner) that sells directly to end consumer, UG can capture both manufacturing and distribution margins.

Positives

+ Spike in revenue. Revenue jumped 81% YoY in 2H20. We believe the bulk of the growth came from higher selling and more distribution volume. Production capacity was flat on a YoY basis at 2.9bn gloves. By country, the fastest-growing major market was Brazil +191% YoY, USA +26% YoY and Europe +22% YoY. Europe remains the largest market at 36% of sales, followed by Brazil at 33%.

+ Record gross margins. Gross margins were at a record 36% in 2H20. Most of the price increases of around 10% mom were pure profit as production cost were relatively flat. The 4Q20 margins stood at 48% as ASPs only significantly increase from April onwards.

+ Positive operating leverage. Past three years, UG net profit was dragged down by administrative expenses as it was expanding its distribution network. Admin expenses, which are relatively fixed in nature, was around 13% of sales. 2H20 admin expenses dropped to 8% of sales and only rose 5% YoY.

Negatives

– Foreign exchange loss of S$5mn. Under operating expenses, UG was hit by a foreign exchange loss of S$5mn. This is due to weak Brazilian Real faced by its subsidiary. UG production in Malaysia invoices the Brazil subsidiary in US dollar, which in turn sells into the local market in Brazilian Real terms.  

Outlook

The outlook for UGHC in FY21e appears stellar. We believe the bulk of 2H20 S$12.5mn PATMI came from just 4Q20, judging by the huge 48% GP profit. We think the incremental appr.30% point uplift gross margins in 4Q20 (vs 3Q20) lead to an additional S$15mn of gross profits*. But the bulk of this gain was offset by the S$5mn foreign exchange loss. PATMI in 4Q20 could be at least S$10mn. If we then annualise the S$10mn, FY21e PATMI would be S$40mn.  But this excludes prices that have been rising for the industry every month even in July and August.

Longer-term, the earnings in FY22e will be hazier. But as per our initiation report, we think the demand-supply mismatch can persist into 2022. For UG, we think it can grow faster than the industry because:

• UG is raising production capacity by 59% to 4.6bn gloves by FY22e in two stages – FY21e add 500mn pieces and FY22e add 1.2bn pieces. Apart from the current surge in demand, UGHC has typically outsourced 20% of its internal glove requirements to external manufacturers. Capital expenditure for the expansion is RM70mn to RM80mn.
• The priority for the new capacity is for UGHC OBM (or branded) business namely in China, Brazil and Nigeria. UGHC primary focus is on these emerging markets where competition from other distributors and brands are less entrenched. And the penetration of gloves usage for these countries is low and provides an extra lever of growth compared to other developed countries. Worth noting that in FY20, the strongest growth in sales was in Brazil, up 191% YoY.

*we assume the split in 3Q20/4Q20 revenue was S$40mn/S$91mn, and GP margin split 20%/48%.

Maintain BUY with higher TP of S$4.15 (previously S$2.70)

Our valuation is based on a 15x PE FY21e, a 40% discount to larger peers. We raised our FY21e PATMI by 55%. Our gross margins assumptions have increased modestly by 80 bps to 43%. Revenue estimates increased by 35% on account of the higher than expected increase in capacity and selling prices. Operating expenses were raised a marginal S$2mn. There is an upside to our estimates if margins in 4Q20 can sustain longer than we expected.