It is hard to predict Covid-19 before it happened and equally as hard to pre-determine the winners prior to the pandemic.
For one, the glove maker stocks have performed crazily since Covid-19 has struck. Even Bloomberg has to make a comparison to Tesla, and said that the high tech company’s stock returns were of no match to the low tech glove makers.
I quote Bloomberg’s article, A 1000% Rally Has Glove Maker Stock Mania Outpacing Even Tesla
“Top Glove Corp. is up 428% this year in Kuala Lumpur, the most on the MSCI Asia Pacific Index, while Supermax Corp. has leaped more than 1,200%, compared with Tesla’s 259%”
Investors often prefer to put their money in glamorous stocks and to shun the mundane. But once these mundane stocks warm the cockles of the hearts, investors would relentlessly pursue their shares and send the prices to the moon. And that’s what has happened to glove stocks.
Top Glove (SGX:BVA) has gained 455% year-to-date (23 Jul 2020).
Riverstone (SGX:AP4) has gained 257% year-to-date.
UG Healthcare (SGX:41A) was the most impressive with a 1,129% return year-to-date.
Such mouth watering returns are unimaginable and unexpected. Investors’ interest can only be intensified after such crazy runs. Forget about buying low and selling high. Humans are herd animals and following the hottest stocks is a trait that remained in us despite after 100,000 years of evolution.
I would like to inject some rationality and look at 3 glove maker stocks listed on the SGX – Top Gloves (SGX:BVA), Riverstone (SGX:AP4), and UG Healthcare (SGX:41A). Let’s evaluate if there’s a basis for their meteoric rise.
Are glove stocks expensive now?
There are two key challenges in valuing glove stocks at this point int time.
First, price multiples based on historical data are no longer applicable. Take a look at the following metrics based on figures from their latest annual reports:
| Top Gloves | Riverstone | UG Healthcare | |
| Price | $8.55 | $3.26 | $1.72 |
| PE | 105 | 56 | 164 |
| PB | 26 | 9 | 8 |
| Div Yield | 0.3% | 0.7% | 0.2% |
| EV/EBIT | 86 | 46 | 114 |
| PEG | 5 | 118 | 15 |
All these metrics suggested that the glove stocks are overvalued. But Covid-19 has caused a burst in the demand for their products that rendered last year’s performance irrelevant for current valuation. The change has been too huge.
Second, we cannot use historical growth rates to project their future value. This is because the growth is no longer continuous as a large dislocation (Covid-19) in their growth trend has occured. For example, Top Glove’s compounded annual growth rate of its EPS was 19% from 2015 to 2019. But the EPS jumped 373% in the third quarter (ending 31 May 2020) as compared to the same period last year. Historical growth rate has been made irrelevant too.
This means that the best way to value them is to figure out the forward earnings of these glove stocks. Unfortunately, it is a very difficult task because the forward earnings are dependent on many factors such as sales, production, average selling prices, cost of raw materials (subject to fluctuations), forex (exports and sold in foreign currencies) and capital expenditures (to expand capacity).
One can get some indication from the management commentaries. For example, Top Glove mentioned the following in their 3Q2020 report (emphasis mine),
The Group’s extraordinary performance was attributed to unparalleled growth in Sales Volume, on the back of the global COVID-19 pandemic. Monthly sales orders went up by some 180%, resulting in long lead times, which went up from 40 days to around 400 days, whereby orders placed now would only be delivered over a year later. However, Top Glove has endeavoured to allocate capacity to as many countries as possible, to ensure its life-saving gloves reach those most in need, while also prioritising its existing customers. It also accommodated requests from various governments of hard-hit countries who approached the Group directly to procure gloves.
Following the marked increase in glove demand from virtually every country in the world, the Group’s utilisation rate rose from a pre-COVID level of 85% to above 95% in 3QFY2020, resulting in greater efficiency and economies of scale. Additional capacity which came onstream in 3QFY2020 also enabled the Group to meet demand growth, while upward revisions in average selling prices in line with prevailing market prices were also effected.
We can tell that the average selling prices should increase since there’s a supply squeeze – there’s backlog of about a year and the capacity is already running at 95%. Top Glove has earmarked RM3 billion for CAPEX to build 450 new lines, creating new capacity of 60 billion pieces of gloves from 2020 to 2026. That should cater to some growth rates if the demand remains. But we still won’t know the changes to the cost of raw materials and forex fluctuations are difficult to determine too.
It is tedious to build up the model especially if security analysis is not your full time job. This is where we can rely on analyst reports but be mindful that each analyst has his assumptions. And a little difference can be amplified in any projection.
For example, Maybank Kim Eng covered Top Glove (dated 22 Jul 2020 by Lee Yen Ling) and below is a table showing the analyst’s assumptions for average selling price, sales volume, production capacity, forex rates and cost of raw materials in the next two years.
Thereafter, the analyst will model the financial projections and ratios,
Based on these assumptions, the analyst has set a target price of RM28.60 (because Top Glove is listed in Bursa Malaysia too) or an equivalent of S$9.30. CGSCIMB has covered UG Healthcare and Riverstone with target prices of $1.36 and $3.12 respectively.
I am not sure if I can agree with their assumptions and their target prices because I don’t have a trustworthy crystal ball. There can be a million possibilities in the future and it is hard to determine a path with a reasonable degree of confidence. This shows how challenging it can be when valuing such sudden explosive growth stocks. One’s guess is as good as anybody’s and hence this led to a large variance of valuations that introduced volatility in the stock prices. This is too hard for me.
Insiders have raised their stakes
We should also see the behaviours of the insiders and management as their wealth has skyrocketed. It would be a bad sign if they have been selling their holdings to cash in their profits.
The good news is that Tan Sri Dr Lim Wei Chai has been exercising his options and acquiring more shares in Top Glove. Lee Keck Keong, the CEO of UG Healthcare, and Wong Teek Son, the CEO of Riverstone, have also increased their stakes in the last few months.
These are good signs and provide some insiders’ optimism in the future of their businesses.
Conclusion
The glove stocks enjoyed the sudden windfall from Covid-19. The share prices have gained multiple folds and investors are wondering if there’s more room to grow. It seems to be the case as supply shortfall remained and order backlog lasted over a year. This could mean higher selling prices and more margin for the glove makers.
Historical financial ratios and growth rates are irrelevant in figuring out the fair prices for these glove stocks. This is because the abrupt jump in sales and history can’t tell us much about their future. The world for glove makers has changed overnight. The only way is to build models and make assumptions about the new business metrics for these glove stocks. But it is tedious and we can refer to analysts’ reports to save us the trouble. The only concern is that their target prices are only as good as their assumptions, which is hard to know if they got them right.
Warren Buffett has a box named “TOO HARD” on his office desk. He would place stuffs that he found difficult to comprehend in this box. I would do the same. Glove stocks happened to be in this TOO HARD box for me.