Project Top Glove Completed

AFW364 FINANCIAL STATEMENT ANALYSIS Semester I Academic Session 2012/2013 Group Assignment:-

Analysis of Lecturer:

Datin Dr. Joriah Muhammad

Chuah Ting Chia Ng Kin Yung Ng Yi Ning Ng Zhei Ying Nor Hashimah Binti Yahaya

Acknowledgement First and foremost, we would like to thank Datin Dr. Joriah Muhammad for leading and guiding us in completing our project. Datin Dr. Joriah Muhammad dedicated so much of her precious time to help all of us. Also, we are thankful that Datin Dr. Joriah Muhammad readily helps us with supplying useful hints and solutions to our questions. Otherwise, we would have used up more time than needed to complete our project. Furthermore, we have learnt much in completing this project. In order to sharpen Universiti Sains Malaysia undergraduates’ ability, Datin Dr. Joriah Muhammad has set the requirements of the group project accordingly. Nevertheless, it dawns on us to work more diligently to be up to scratch. Therefore, we would like to thank Datin Dr. Joriah Muhammad again. Finally, thanks to Datin Dr. Joriah Muhammad for urging us to know more about financial statements analysis. Moreover, we thank our entire group members for their precious time and for making every endeavor and contribution to get the group project completed.

2 AFW364 Financial Statement Analysis | Top Glove

AFW364 FINANCIAL STATEMENT ANALYSIS - Top Glove Project Outline 1.0

Executive Summary

4

2.0

Description of Company’s Background 2.1 Company Background 2.2 Board of Directors `

6 7

3.0

SWOT Analysis

10

4.0

Common-Size Analysis 4.1 Vertical Analysis of Income Statement 4.2 Horizontal Analysis of Income Statement

15 16

5.0

Accounting Issues

17

6.0

Financial Health of Company 6.1 Trend Analysis of Income Statement 6.2 Forecasted Pro-Forma Income Statement 6.3 Trend Analysis of Balance Sheet 6.4 Forecasted Pro-Forma Balance Sheet 6.5 Trend Analysis of Cash Flow Statement 6.6 Forecasted Pro-Forma Cash Flow Statement 6.7 Risks Associated With Forecasting

20 21 22 24 26 29 32

Equity Evaluation 7.1 Dividend Discount Model (DDM) 7.2 Method of Comparables 7.3 Explanation for the Differences in Valuation

33 36 38

8.0

Assumptions/ Limitations/ Obstacles

40

9.0

Conclusion

43

7.0

Reference

3 AFW364 Financial Statement Analysis | Top Glove

1.0

Executive Summary

This study paper focuses on the analysis of Top Glove, a public listed company on the Main Market of the Kuala Lumpur Stock Exchange. Top Glove also the world's largest rubber glove manufacturer exports to approximately 1,000 customers in over 185 countries. In order to analyze Top Glove, many details of the business have to be taken into consideration from the firm’s business model, the management, the firm’s product to its financial statements. This study paper is mainly for the use of outside investor and thus Top Glove’s business model or business strategy serves as the starting point for the analysis. Equipped with the knowledge of the business, an analyst then transform it into a valuation and trading strategy. This paper start off with a description of Top Glove’s background as an analyst must know the business she is analyzing. As the adage goes, one does not buy a stock, one buy a business. When buying a business, know the business. Value depends on the business model, the strategy. Good firm can be bad buys. Price is what you pay, value is what you get. All of these point to the importance of knowing a business before proceeding with the technical or the quantitative part of equity valuation. SWOT analysis is then carried out to further enhance the understanding of Top Glove’s business strategy, the sector it is in and its business environment. This paper then proceeds with the preparation of common-size income statement. Common-size analysis is used for cross-sectional comparison which is the comparison to other firms with the elimination of the effect of size.

4 AFW364 Financial Statement Analysis | Top Glove

Accounting issues were laid out before trend analyses of Top Glove’s financial statements are prepared. Trend analysis enables Top Glove’s financial statements to be compared over time. Trend analyses of financial statements also serve as the foundation for the preparation of Top Glove’s pro-forma financial statements. The analysis of Top Glove is completed with the two valuation models which are the Dividend Discount Model (DDM) and the Method of Comparables. This paper arrived with a value indicating that Top Glove’s share price is overpriced. Hence, potential investors are advised to have a short position in the stock and urged to be on the lookout for share price reversal before proceeding with the purchase of Top Glove’s shares.

5 AFW364 Financial Statement Analysis | Top Glove

2.0

Description of Company

2.1

Company Background

Top Glove was established in 1991 with only one factory and three production lines and has grown by leaps and bounds to become the world’s largest rubber glove manufacturer. At 2th November 2012, this company already has 23 factories and 458 production lines with 40 billion total production capacities per year. Their manufacturing facilities spread across Malaysia, Thailand and China. It was listed in Bursa Malaysia on 27 March 2001. Top Glove Corporation Berhad listing was successfully promoted from the Second Board to the Main Market of the Kuala Lumpur Stock Exchange within a short period of time. Besides that, Top Glove collaboration with government agencies and ministries is to ensure that they follow the latest development in rubber research technology. This company vision is “We Strive To Be the World’s Leading Manufacturer With Excellent Quality Glove Product And Services That Enrich And Protect Human Lives” while their mission is “To Be a World Class Glove Manufacturer Providing Top Quality Products With Excellent Services Through Continuous Improvement And Innovation.”

6 AFW364 Financial Statement Analysis | Top Glove

2.2

Board of Directors

1. Tan Sri Dato Sri Lim Wee-Chai (Chairman) Aged 53, a Malaysian citizen, was appointed as the Chairman of Top Glove Corporation BHD on 4th September 2000. He is also the founder of Top Glove Group of Companies which was established in 1991. He has strongly practiced the business direction of “To Produce Consistently High Quality Gloves at Efficient Low cost” and to remind all staff and workers to ensure continuous improvement in Quality and Efficiency in line with Company tagline of “Top Glove, Top Quality, Top Efficiency, Good Health, Safety First and Be Honest”.

2. Tan Sri Dato’ Seri Arshad Bin Ayub (Independent Non-Executive Director) Aged 83, a Malaysian citizen, was appointed as an Independent Non- Executive Director of Top Glove Corporation Bhd on 4th September 2000. Arshad also sits on the Board of Directors of several public listed companies such as Chairman of Malayan Flours Mills Bhd and Director of Kulim (M) Berhad.

3. Tan Sri Dato’ Dr Lin See Yan (Independent Non-Executive Director) Aged 72, a Malaysian citizen, was appointed as an Independent Non- Executive Director of Top Glove Corporation Bhd on 16th June 2010. He sits on the Board of several public listed companies in Malaysia including Fraser &Neave Holdings Berhad, JobStreet Corporation Berhad and others.

7 AFW364 Financial Statement Analysis | Top Glove

4. Lee Kim Meow (Managing Director) Aged 52, a Malaysian citizen, was appointed as an Executive Director on 15th October 2003 and subsequently, as the Managing Director on 7th April 2009. He joined Top Glove in 1997 as the General Manager in charge of the marketing and promotion of the Company s products to more than 180 countries worldwide.

5. Puan Sri Tong Siew Bee (Executive Director) Aged 53, a Malaysian citizen, was appointed as an Executive Director of Top Glove Corporation Bhd on 4th September 2000. Prior to the listing of the Company, she was the Director and the Co-Founder of Top Glove Sdn Bhd. She is the spouse of Tan Sri Lim Wee Chai.

6. Lim Hooi Sin (Executive Director) Aged 49, a Malaysian citizen, was appointed as an Executive Director of Top Glove Corporation Bhd on 4th September 2000. He is the brother of Tan Sri Lim Wee Chai.

7. Sekarajasekaran A/L Arasaratnam (Independent Non-Executive Director) Aged 83, a Malaysian citizen, was appointed as an Independent Non-Executive Director of Top Glove Corporation Bhd on 4th September 2000.

8. Lim Cheong Guan (Executive Director) Aged 46, a Malaysian citizen and was appointed as an Executive Director of Top Glove Corporation Bhd on 31th August 2006. He joined the Company as Group Financial

8 AFW364 Financial Statement Analysis | Top Glove

Controller in 2005. He is responsible for the accounting, treasury, corporate finance and investor relations of Top Glove Group of Companies.

9. Lim Han Boon (Independent Non-Executive Director) Aged 54, a Malaysian citizen and was appointed to the Board of Directors as an Independent Non-Executive Director of Top Glove Corporation Bhd on 21th February 2011.

9 AFW364 Financial Statement Analysis | Top Glove

3.0

SWOT Analysis

3.1

Strengths

3.1.1 Continuous Capacity Expansion Top Glove has undertaken a rapid and ongoing expansion of its capacity to become the world’s largest rubber glove manufacturer. The company has increased its total production capacity to 40 billion pieces of gloves per year. It is expanding its capacity through creating a total of 23 glove factories across countries with 17 located in Malaysia, 4 in Thailand (2 latex concentrate plant) and 2 in China. Recently, it has completed the acquisition of PT Agro Pratama Sejahtera for some 30.77-ha of green field rubber plantation land in Indonesia. The company continues to work on expanding the business through strategic investments. Having the foresight to expand capacity enables it to capture the growth in the rubber glove industry.

3.1.2 Huge Customer Base Over the years, Top Glove has been building its customer base around the world. To date, it has 1,000 customers in over 185 countries with no single biggest customer constituting more than 4% of the revenue. This has helped cushion any negative effects from the world economic downturn.

3.1.3 Own Rubber Plantation Top Glove is the first rubber glove maker to move upstream by acquiring its own rubber plantation land to ensure a consistent supply of latex which accounts for up to 60% of its production costs. Top Glove has completed its acquisition of PT Agro, which owns a

10 AFW364 Financial Statement Analysis | Top Glove

30.77-ha rubber plantation land in South Sumatera, Indonesia. This move of rubber planting will mitigate some risk. If latex prices are high, Top Glove would benefit from it because it will have in-house supply of rubber to smoothen its earnings. When latex prices are low, it will also continue to benefit, as it can buy from the open market or use its own supply.

3.1.4 High Product Quality To ensure high product quality, the company has implemented a comprehensive quality assurance system. All in-house inspection and testing are conducted in accordance with international product quality standards such as ASTM, EN, ISO and NBR standards. It also conducts quality control of all incoming raw materials, in-process parameters, up till the outgoing finished products. Besides that, the quality control exercise has been extended to include inspection and testing of raw materials at the supplier’s premise. This practice ensures only high and acceptable quality raw materials are delivered to Top Glove. In addition, it has automated many processes to reduce human error and for greater consistency of product quality.

3.1.5 Competitive Pricing Top Glove’s focus on being an OEM (Original Equipment Manufacturer) since the early days has allowed greater economies of scale which translate to more competitive pricing. The consistency of the product quality coupled with competitive pricing has enabled the company to penetrate new markets and steadily gain market share.

11 AFW364 Financial Statement Analysis | Top Glove

3.2

Weaknesses

3.2.1 Rubber Planting Rubber planting is a high capital expenditure game with a long gestation period. With the acquisition of PT Agro Pratama Sejahtera for green field rubber plantation land in Indonesia, the estimated investment cost is around RM450million, over next 13 years including land, planting, maintenance cost up to maturity and facilities. It is time consuming as rubber tree has 6 years gestation period and progressive planting over 8 years. With full development, it will take 13 years.

3.3

Opportunities

3.3.1 Increasing global demand The demand for both natural rubber and nitrile gloves will continue to grow as gloves are deemed basic necessities, especially in the medical industry. The global demand for both natural rubber and nitrile gloves is projected to rise at a rate of 8 to 10% per annum, with still many opportunities in the emerging markets where glove usage is low.

3.3.2 Healthcare surge Top Glove will be the beneficiary of the worldwide trend of increasing expenditure on and demand for healthcare. Governments and individuals spend more on the medical sector, underpinned by factors such as increasing of ageing population, greater healthcare and hygiene awareness and existing of health regulations. Furthermore, its importance as a protective agent is compounded during the global health scares like SARS and H1N1.

12 AFW364 Financial Statement Analysis | Top Glove

3.4

Threats

3.4.1 Volatility in materials costs Latex is the major cost component for rubber glove manufacturers and makes up 60% of Top Glove’s costs. In view of this, latex price volatility will affect the group’s costs and margins. The price of latex price has rebounded due to the intervention by the International Tripartite Rubber Council (ITRC). This upward trend of latex’s price will decrease the profit by increasing the production costs. On a positive note, Top Glove is able to pass on about 70-80% of the cost increase to its customers.

3.4.2 Minimum Wage Concerns The government is going to implement the minimum wage policy by setting the minimum wage at RM900 per month for employees in the peninsula and RM800 for workers in Sarawak, Sabah and the Federal Territory of Labuan. This would decrease net profit of Top glove as the wage costs would increase due to the huge amount of staffs, with about 11,000 employees.

3.4.3 Oversupply There is a 10% to 20% oversupply in year 2011 due to the high demand over the past one to two years and so much capacity being added by Top Glove and its competitors. However, Top Glove expects the current oversupply of rubber gloves in the global market to be absorbed over the next one to three years since the demand for gloves is still growing at 8% to 10% every year.

13 AFW364 Financial Statement Analysis | Top Glove

3.4.4 Currency Exposure Given that most of the Top Glove’s revenue comes from the export market, the strengthening of the ringgit will be the negative market condition. An adverse foreign exchange movement, in particular, the weakening of US dollar will certainly have a negative impact on the group’s sales.

14 AFW364 Financial Statement Analysis | Top Glove

4.0

Common Size Analysis

4.1

Vertical Analysis Top Glove Corporation Berhad Income Statement For the Financial Year Ended August 31 2011

2010

RM’000 Sales revenue

2009

RM’000

RM’000

2,053,916

100%

2,079,432

100%

1,529,077

100%

(1,818,767)

88.55%

(1,640,550)

78.89%

(1,155,975)

75.60%

Gross profit

235,149

11.45%

438,882

21.11%

373,102

24.40%

Other operating income

26,689

1.30%

10,372

0.50%

6,979

0.46%

Distribution and selling costs

(67,121)

3.27%

(66,008)

3.17%

(95,484)

6.24%

Administrative and general expenses

(60,495)

2.95%

(80,987)

3.89%

(53,091)

3.47%

(242)

0.01%

(639)

0.03%

-

0.00%

Operating profit

133,980

6.52%

301,620

14.50%

231,506

15.14%

Interest expense

10,573

0.51%

4,288

0.21%

(8,530)

0.56%

Share of (loss) / profit of associate

917

0.05%

(947)

0.05%

(984)

0.06%

Profit before tax

145,470

7.08%

304,961

14.67%

221,992

14.52%

Income tax expense

(30,338)

1.48%

(54,550)

2.62%

(53,992)

3.53%

Profit for the year

115,132

5.61%

250,411

12.04%

168,070

10.99%

Cost of goods sold

Finance cost

15 AFW364 Financial Statement Analysis | Top Glove

4.2

Horizontal Analysis Top Glove Corporation Berhad Income Statement For the Financial Year Ended August 31 2011

2010

2009

2011

2010

2009

RM’000

RM’000

RM’000

2,053,916

2,079,432

1,529,077

134%

136%

100%

(1,818,767)

(1,640,550)

(1,155,975)

157%

142%

100%

Gross profit

235,149

438,882

373,102

63%

118%

100%

Other operating income

26,689

10,372

6,979

382%

149%

100%

Distribution and selling costs

(67,121)

(66,008)

(95,484)

70%

69%

100%

Administrative and general expenses

(60,495)

(80,987)

(53,091)

114%

153%

100%

(242)

(639)

-

0%

0%

0%

Operating profit

133,980

301,620

231,506

58%

130%

100%

Interest expense

10,573

4,288

(8,530)

124%

50%

100%

Share of (loss) / profit of associate

917

(947)

(984)

93%

96%

100%

Profit before tax

145,470

304,961

221,992

66%

137%

100%

Income tax expense

(30,338)

(54,550)

(53,992)

56%

101%

100%

Profit for the year

115,132

250,411

168,070

69%

149%

100%

Sales revenue Cost of goods sold

Finance cost

16 AFW364 Financial Statement Analysis | Top Glove

5.0

Accounting Issues

5.1

Basis of Preparation

The financial statements of Top Glove Corporation Berhad have been prepared in accordance with Financial Reporting Standards and the Companies Act, 1965 in Malaysia. Nevertheless, at the beginning of the current financial year, the Group and the Company adopted new and revised FRS. Besides, the financial statements have been prepared on the historical cost basis 5.2

Property, Plant and Equipment

All items of property, plant and equipment of Top Glove Corporation Berhad are initially recorded at cost, in which the prices of assets on the balance sheet are based on their nominal or original costs when acquired by the company. Although historical accounting method is less subject to manipulation of figures by managers and is useful for control purposes, it has flaws in times of inflation. The validity of historical accounting rests on the assumption that the currency in which transactions are recorded remains stable, i.e. its purchasing power remains the same over a period of time. Another main point with regards to inflation is rise in prices for an asset. An asset purchased at a point of time may be expensive in the future. The traditional accounting principles record all assets at an original cost and continue to use these historic figures throughout the asset's life, while economists make a more intelligible assumption that money has a time-value attached to it. The economist's approach is broadly embraced in the corporate finance model whose objective is

17 AFW364 Financial Statement Analysis | Top Glove

centered on value creation for the shareholders. Thus, assets of the company may be undervalued over time by using historical accounting method. In addition, effects of inflation may not be the same for all the companies in the market and historical cost accounts become almost unhelpful when comparing corporate performance. 5.3

Depreciation of Property, Plant and Equipment

Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows: 

Buildings: 20 to 50 years



Plant and equipment: 10 years



Other assets: 5 to 10 years

Freehold land has an unlimited useful life and therefore is not depreciated. Assets under construction are not depreciated as these assets are not yet available for use. The straight-line method offers simplicity. Since the same amount is written off each year, profits for future years can be determined easily. In other words, as profits grow, depreciation costs remain the same. This allows us to make financial forecasts for several years. However, this method has several drawbacks. There are some problems with using straight line depreciation to determine the worth of assets since the assets may not depreciate at the same rate every year. Most pieces of office equipment, machinery and other items purchased do not perform exactly the same each year. As assets age they become less efficient. Repair costs usually increase over time. Straightline depreciation does not account for the loss of efficiency or the increase in repair expenses over the years and is, therefore, not as suitable for costly assets such as

18 AFW364 Financial Statement Analysis | Top Glove

plant and equipment. The functional life span of some assets cannot clearly be estimated. Therefore, the straight-line depreciation method is not the best method given that the useful life of an asset is often unpredictable. Besides, assets are often shown with inflated values since the assets may have lost the greatest amount of value in the first year or two. While this may become an issue if the assets are being used to secure credit, in the end a decision will need to be made whether predictability in accounting or creditworthiness is the more important focus.

19 AFW364 Financial Statement Analysis | Top Glove

6.0 Financial Health of Top Glove Corporation Berhad 6.1 Trend Analysis of Income Statement 2009

Revenue

(RM'000) 1,529,077

(-)Cost of goods sold Gross profit

% Change

2010

% Change

2011

Average (%) 17.38

35.99

(RM'000) 2079,432

-1.23

(RM'000) 2,053,916

1155975

41.92

1,640,550

10.86

1818767

26.43

373,102

17.63

438,882

-46.42

235,149

-14.39

(+)Other operating income

6,979

110.05

14,660

154.17

37,262

132.11

(-)Distribution & selling costs

53,091

24.33

66,008

16.86

67,121

20.59

(-)Administrative & general expenses

95,484

-15.18

80,987

-25.3

60,495

-20.24

Operating profit

231,506

32.41

306,547

-52.77

144,795

-10.18

(-)Interest expense

8,530

-92.51

639

-62.13

242

-77.32

(+)Share of results of associate

-984

3.76

-947

196.83

917

100.29

Profit before tax

221,992

37.37

304,961

-52.29

145,470

-7.46

(-)Income tax expense

53,922

-1.16

54,550

-44.38

30,338

-22.77

Net income

168,070

48.99

250,411

-54.02

115,132

-2.52

169,133

44.99

245,231

-53.88

113,091

-4.45

-1,063

587.3

5,180

-60.59

2,041

263.36

168,070

48.99

250,411

-50.02

115,132

-0.52

Profit attributable to: Equity holders of the Company (+)Minority interests

20 AFW364 Financial Statement Analysis | Top Glove

6.2 Forecasted Pro-Forma Income Statement 2011(A)

2012(E)

2013(E)

2014(E)

(RM'000)

(RM'000)

(RM'000)

(RM'000)

Revenue

2,053,916

2,410,887

2,829,899

3,321,735

(-)Cost of goods sold

1,818,767

2,209,576

2,657,557

3,174,193

Gross profit

235,149

201,311

172,342

147,542

Other operating income

37,262

86,489

200,749

465,959

(-)Distribution & selling costs

67,121

80,941

97,607

117,704

(-)Administrative & general expenses

60,495

48,251

38,485

30,696

Operating profit

144,795

158,608

236,999

465,101

(-)Interest expense

242

55

12

3

Share of results of associate

917

1,837

3,679

7,368

Profit before tax

145,470

160,390

240,666

472,466

(-)Income tax expense

30,338

23,430

18,095

13,975

Net income

115,132

136,960

222,571

458,491

113,091

129,544

195,624

360,575

2,041

7,416

26,947

97,916

115,132

136,960

222,571

458,491

Profit attributable to: Equity holders of the Company Minority interests

21 AFW364 Financial Statement Analysis | Top Glove

6.3 Trend Analysis of Balance Sheet

Assets Non-current assets Property, plant and equipment Land use rights Investments in associate Investment securities Goodwill

Current assets Inventories Trade and other receivables Tax recoverable Investment securities Derivative assets Cash and bank balances Total assets Equity and liabilities Non-current liabilities Borrowings Deferred tax liabilities

2009 (RM'000)

% Change

2010 (RM'000)

% Change

2011 (RM'000)

Average (%)

564,380 14,200 9,366 12,853 20,113 620,912

2.92 53.10 -46.02 -98.87 1.13

580,867 21,741 5,056 145 20,113 627,922

13.74 -9.81 39.22 0.69 12.69

660,692 19,608 7,039 146 20,113 707,598

8.33 21.65 -3.40 -49.09 6.91

119,053 206,596 185,848 511,497 1,132,409

40.70 29.54 41.48 45.47 21.16

167,511 267,617 5,473 40,557 262,930 744,088 1,372,010

4.79 -0.44 141.70 167.55 -43.42 -3.85 3.72

175,532 266,445 13,228 108,512 2,954 148,760 715,431 1,423,029

22.75 14.55 70.85 83.78 -0.97 20.81 12.44

8,960 33,413 42,373

-66.24 2.83 -11.77

3,025 34,360 37,385

-5.75 29.20 26.37

2,851 44,393 47,244

-36.00 16.02 7.30

22 AFW364 Financial Statement Analysis | Top Glove

Current liabilities Loans and borrowings Trade payables Other payables Tax payable Dividends payable

Equity attributable to equity holders of the company Share capital Share premium Treasury shares Other reserves Retained earnings Shareholders' equity Minority interests Total equity Total equity and liabilities

11,573 92,430 104,554 14,721 20,781 244,059

-95.33 13.72 7.70 -10.57

541 105,116 112,602 218,259

-70.98 0.80 9.50 5.11

157 105,955 123,300 229,412

-83.16 7.26 8.60 -2.73

151,879 243,677 -38,427 21,964 445,420 824,513 21,464 845,977 1,132,409

103.50 -30.00 -38.76 34.57 32.50 11.18 31.96 21.16

309,081 170,563 13,451 599,407 1,092,502 23,864 1,116,366 1,372,010

0.06 0.71 10.26 4.43 2.68 2.96 2.69 3.72

309,256 171,780 14,831 625,936 1,121,803 24,570 1,146,373 1,423,029

51.78 -14.65 -14.25 19.50 17.59 7.07 17.33 12.44

23 AFW364 Financial Statement Analysis | Top Glove

6.4 Forecasted Pro-Forma Balance Sheet

Assets Non-current assets Property, plant and equipment Land use rights Investments in associate Investment securities Goodwill

Current assets Inventories Trade and other receivables Tax recoverable Investment securities Derivative assets Cash and bank balances Total assets Equity and liabilities Non-current liabilities Borrowings Deferred tax liabilities

2011(A) (RM'000)

2012(E) (RM'000)

2013(E) (RM'000)

2014(E) (RM'000)

660,692 19,608 7,039 146 20,113 707,598

715,728 23,853 6,800 74 20,113 766,568

775,348 29,017 6,772 38 20,113 831,288

839,934 35,300 6,542 19 20,113 901,908

175,532 266,445 13,228 108,512 2,954 148,760 715,431 1,423,029

215,466 305,213 22,600 199,423 105,082 847,784 1,614,352

264,483 349,621 28,612 366,500 205,703 1,214,919 2.046,207

324,654 400,491 65,969 673,554 554,574 2,019,242 2,921,150

2,851 44,393 47,244

1,825 21,646 23,471

1,168 42,244 43,412

747 69,329 70,076

24 AFW364 Financial Statement Analysis | Top Glove

Current liabilities Loans and borrowings Trade payables Other payables Tax payable Dividends payable

Equity attributable to equity holders of the company Share capital Share premium Treasury shares Other reserves Retained earnings Shareholders' equity Minority interests Total equity Total equity and liabilities

157 105,955 123,300 229,412

26 83,788 104,045 217,718

4 104,386 127,908 232,298

0.75 264,045.62 291,223.63 555,270

309,256 171,780 14,831 625,936 1,121,803 24,570 1,146,373 1,423,029

469,389 146,614 12,718 747,994 1,376,715 26,307 1,403,022 1,614,352

712,438 125,135 10,905 893,852 1,742,330 28,167 1,770,497 2.046,207

1,081,339 106,803 9,351 1,068,153 2,265,646 30,158 2,295,804 2,921,150

25 AFW364 Financial Statement Analysis | Top Glove

6.5 Trend Analysis of Cash Flow Statement

Operating activities Profit before tax Adjustments for : Gross dividend Depreciation and amortization Property, plant and equipment Amortization of land use rights Gain on disposal of property, plant and equipment Property, plant and equipment written off Reversal of provision for doubtful debts Share options granted under ESOS Provision for doubtful debts Unrealized foreign exchange loss Impairment on investment in associate Share of results of associate Net fair value gains on derivative Net fair value gains on available-for-sale Negative goodwill written off Reversal of impairment loss Finance costs Interest income Total adjustments Operating cash flows before changes in working capital

2009 (RM'000)

% Change

2010 (RM'000)

% Change

2011 (RM'000)

Average (%)

221,992

37.37

304,961

-52.29

145,470

-7.46

-

-

56,744 218 -366 10,198 -17 13,461 0 -416 0 984 0 0 0 0 8,530 -2,233

36.83 4.13 131.97 -98.84 -100 -26.23

4.26 -1.32 71.14 261.02 0 -100 -100 -36.97 -98.36 -196.83

-92.51 92.03

58,834 227 -849 118 0 9,930 14 13,763 2,800 947 0 0 0 0 639 -4,288

87,103

-5.7

309,095

25.24

276.88 -3.76

26 AFW364 Financial Statement Analysis | Top Glove

-62.13 146.57

61,343 224 -245 426 0 0 0 8,675 46 -917 -1,737 -1,057 -1,767 -397 242 -10,573

20.55 1.41 101.55 81.09 -50 63.12 -50 119.96 -49.18 100.29 0 0 0 0 77.32 119.3

82,135

-33.93

54,263

19.82

387,096

-48.4

199,733

-11.58

Changes in working capital Increase in inventories Increase in receivables Increase/(decrease) in payables Total changes in working capital Cash flows from/(used in) operation Interest paid Income taxes paid Net cash flows from/(used in) operating activities

Cash flows from investing activities Purchase of property, plant and equipment Additional land use rights Purchase of other investments Interest received Dividends income from subsidiaries Proceeds from disposal of property, plant and equipment Additional investment in an associate Issuance of share capital to minority shareholders of a subsidiary Net cash inflow on acquisition of a subsidiary Net cash flows (used in)/from investing activities Cash flows from financing activities Proceeds from issuance of ordinary shares

38,713 22,411 9,000 70,124 379,219 -8,530 -38,851

-225.17 -418.63 130.02 241.41 -24.07 -92.51 89.95

-48,458 -71,409 20,702 -99,165 287,931 -639 -73,797

-87.61 -94.96 -49.73 -100.81 -30.35 -62.13 -61.82

-6,004 -3,597 10,407 806 200,539 -242 -28,176

-156.39 -256.795 40.15 70.03 -27.21 -77.32 14.07

331,838

-35.66

213,495

-19.38

172,121

-27.52

-67,229 -2,773 -12,708 2,233 0

-32.15 -193.54 11.35 92.03

-88,840 -8,140 -27,849 4,288 0

-59.02 -100 47.82 146.57

-141,273 -68,267 10,573 0

-45.59 -146.77 29.59 119.3

2,895

-2.87

2,812 -

-37.69

1,752 -336

-20.28

823 -

-100

0 -

0 624

-0.5

-76,759

-53.37

-117,729

62.27

-196,927

4.45

11,365

175.81

31,346

-96.76

1,015

39.53

27 AFW364 Financial Statement Analysis | Top Glove

Share issue expenses Proceeds from sale of treasury shares Dividend paid on ordinary shares Dividend paid to minority shareholders Repayment of obligations under finance leases Repayment of bank loans Repayment of medium term notes Decrease in short term borrowings Net cash used in financing activities Net increase/(decrease) in cash and cash equivalents Effects of foreign exchange rate changes Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year (Note 20)

0 0 -32,389 0 -1,181 -48,809 -58,500 -56,889 -186,403

-91.55 -100 -38.77

95.51 -93.44 -80.34 -96.12 -92.91

-71 81,575 -109,098 0 -53 -3,204 -11,500 -2,210 -13,215

68,676 -3,298 120,470

20.2 65.83 54.27

185,848

41.48

117.35

28 AFW364 Financial Statement Analysis | Top Glove

62.27 -79.46 -100 -100 562.3

-6 0 -86,575 -1,280 -20 -658 0 0 -87,524

-45.78 -0.5 39.29 78.89 -86.45 -90.17 -98.06 234.69

82,551 -5,469 185,848

-236.07 -66.36 41.48

-112,330 -1,840 262,930

107.94 -0.27 47.88

262,930

-43.42

148,760

-0.97

6.6 Forecasted Pro-forma Cash Flow Statement 2011(A) (RM'000)

2012(E) (RM'000)

2013(E) (RM'000)

2014(E) (RM'000)

145,470

160,390

240,666

472,466

61,343 224 -245 426 0 0 0 8,675 46 -917 -1,737 -1,057 -1,767 -397 242 -10,573

73,949 227 -494 771 0 0 0 19082 23 -1837 0 0 0 0 429 -23,187

89,146 230 -995 1,397 0 0 0 48,951 12 -3679 0 0 0 0 761 -50,848

107,465 233 -2,006 2,529 0 0 0 92,153 6 -7368 0 0 0 0 1,349 -111,510

Total adjustments

54,263

68,963

84,975

82,851

Operating cash flows before changes in working capital

199,733

229,353

325,641

555,317

Operating activities Profit before tax Adjustments for : Gross dividend Depreciation and amortization Property, plant and equipment Amortization of land use rights Gain on disposal of property, plant and equipment Property, plant and equipment written off Reversal of provision for doubtful debts Share options granted under ESOS Provision for doubtful debts Unrealized foreign exchange loss Impairment on investment in associate Share of results of associate Net fair value gains on derivative Net fair value gains on available-for-sale Negative goodwill written off Reversal of impairment loss Finance costs Interest income

29 AFW364 Financial Statement Analysis | Top Glove

-

Changes in working capital Increase in inventories Increase in receivables Increase/(decrease) in payables Total changes in working capital Cash flows from/(used in) operation Interest paid Income taxes paid Net cash flows from/(used in) operating activities

-6,004 -3,597 10,407 806 200,539 -242 -28,176 172,121

3,386 5,639 14,585 20,560 249,913 -55 -32,140 217,718

-1,909 -8,843 20,441 9,689 335,530 -12 36,663 372,181

1,077 13,866 28,647 43590 598907 -3 41,821 640,725

Cash flows from investing activities Purchase of property, plant and equipment Additional land use rights Purchase of other investments Interest received Dividends income from subsidiaries Proceeds from disposal of property, plant and equipment Additional investment in an associate Issuance of share capital to minority shareholders of a subsidiary Net cash inflow on acquisition of a subsidiary Net cash flows (used in)/from investing activities

-141,273 -68,267 10,573 0 1,752 -336 0 624 -196,927

-76,867 0 -88,467 23,186 0 1,397 0 0 0 -140,751

-41,823 0 -114,645 50,848 0 1,113 0 0 0 -104,507

-22,756 0 -148,568 111,510 0 888 0 0 0 -59,814

1,015 -6 0

1,416 -3 0

1,976 -2 0

2,757 -1 0

Cash flows from financing activities Proceeds from issuance of ordinary shares Share issue expenses Proceeds from sale of treasury shares

30 AFW364 Financial Statement Analysis | Top Glove

Dividend paid on ordinary shares Dividend paid to minority shareholders Repayment of obligations under finance leases Repayment of bank loans Repayment of medium term notes Decrease in short term borrowings Net cash used in financing activities

-86,575 -1,280 -20 -658 0 0 -87,524

-120,590 0 -36 -89 0 0 -119,302

-167,970 0 -64 -12 0 0 -166,072

-233,965 0 -114 -2 0 0 -231,325

Net increase/(decrease) in cash and cash equivalents Effects of foreign exchange rate changes Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year (Note 20)

-112,330 -1,840 262,930 148,760

-42,335 -1,343 148,760 105,082

101,602 -981 105,082 205,703

349,586 -715 205,703 554,574

*Note: A- Actual, E-Expected

31 AFW364 Financial Statement Analysis | Top Glove

6.7

Risks Associated with Forecasting

Several assumptions are made in order to best forecast the financial performance of Top Glove for the next three years. Notwithstanding, forecasting the financial performance of a Top Glove is still associated with several risk and constrained by certain limitations. In actuality, Top Glove is subject to different kinds of risks. For instances, inflation, interest rate risk, foreign currency risk, government policy and so forth. In the extreme case, inflation, interest rate or/and foreign currency might fluctuate considerably and unpredictably, which in turn affect Top Glove’s future performance. For example, foreign currency declines would reduce Top Glove importation costs and Top Glove is therefore able to yield more revenue with lower expenses. Subsequently, the forecasted financial statement would be underestimated and turns out to be inaccurate. Moreover, forecasting encounters with accuracy issues. The financial statement of Top Glove is expected to grow constantly in next the three years. Ironically, one of the risks associated with forecasting here is that financial statement might either rise or decline independently with the trends analysis. In other words, it would grow in an unexpected way that rejects the appropriateness of financial forecasting. Nonetheless, it is impossible to eliminate all the risks associated with forecasting as undiversified risks influence not only Top Glove but the entire of the financial market. Therefore, forecasting is contingent to the purposes and needs of the studies or research with regard the assumptions made.

32 AFW364 Financial Statement Analysis | Top Glove

7.0

Equity Evaluation

7.1

Dividend Discount Model (DDM)

The dividend discount model calculates the intrinsic value of a firm based on the dividends the company pays its shareholders. The justification for using dividends to value a company is that dividends represent the actual cash flows going to the shareholder, thus valuing the present value of these cash flows should give the value for how much the shares should be worth. In the valuation of Top Glove by using dividend discount model, the discount rate is computed as below: Market Risk Premium The risk free rate is assumed to be the rate of return a 10-year Malaysian Government Securities at the closing of the reporting period. Besides, the market risk premium is the rate that stands for the market return in excess of the return earned on risk free asset. It is determined as: Market risk premium = market return - risk free rate. Risk Free Rate: 3.63% (31 August 2011) The market risk premium is assumed to be 6.5%. Top Glove Beta Beta = 0.81

33 AFW364 Financial Statement Analysis | Top Glove

Required Rate of Return (Discounting Rate) R = Risk Free rate + Beta (Market Risk Premium) = 3.63% + 0.81(6.5%) = 8.895% Top Glove’s Forecasted Future Dividend per Share (DPS) 2012(F)

2013(F)

2014(F)

Dividend(RM’000)

120,590

167,970

233,965

Number of shares

938,778

1,424,876

2,162,678

0.13

0.12

0.11

DPS(RM)

With the forecasted DPS as shown above and the assumption of the DPS continues to grow at a rate of 7% after year 2014, the value of Top Glove can be determined by using the following equation: Value of equity = Present value of expected dividend to time T + Present Value of expected terminal value at T Or Value = * d = expected dividend, g = growth rate, R= require rate of return or discount rate, T = Period Value of Top glove = = RM 5.12 per share Total Market Value = RM5.12 x 618, 513, 000 shares = RM3, 166, 786, 560

34 AFW364 Financial Statement Analysis | Top Glove

In this method, forecasted dividends per share to 2014 are discounted to present value at the discount rate of 8.895%. Then the present value of the continuing value is added to complete the valuation of the firm. With the assumptions, the equity value of Top Glove is calculated to be RM3, 166, 786, 560 on 618, 513, 000 shares, or RM 5.12 per share in August 2011.

35 AFW364 Financial Statement Analysis | Top Glove

7.2

Method of Comparables

The Method of Comparables is used to value the Top Glove Corporation Bhd. The following table lists the annual sales, earnings, and book value of equity for Top Glove and two of its competitors which are Kossan Rubber Industries Bhd. and Hartalega Holdings Bhd. The price-to-sales (P/S), price-to-earnings (P/E) and price-to-book (P/B) ratios for Kossan and Hartalega are based on their market value in August 2011. Table: Pricing Multiples for Comparable Firms to Top Glove Corporation Bhd (RM’000) in 2011 Company Kossan Rubber Industries Bhd Hartalega Holdings Bhd Top Glove Corporation Bhd * *** ⁄

Sales

Earnings

Book Value

Market Value

* P/S

** P/E

*** P/B

1,089,969

89,687

496,853

895,255

0.82

9.98

1.80

734,921

190,297

494,444

2,032,284 2.77 10.68

4.11

2,053,916

113,091

1,121,803

?

** ⁄

?

?

?

⁄

⁄

Top Glove is valued by applying the average of multiples for comparison firms to its sales, earnings and book values as shown in the table below.

36 AFW364 Financial Statement Analysis | Top Glove

Table: Applying Comparable Firms’ Multiples to Top Glove Corporation Bhd (RM’000) Top Glove’s Number

Average Multiple for Comparables

Top Glove’s Valuation

Sales

1.80

x

2,053,916

=

3,697,049

Earnings

10.33

x

113,091

=

1,168,230

Book Value

2.96

x

1,121,803

=

3,320,537

Average Valuation

*2,728,605

*Average Valuation= Top Glove’s actual valuation on August 2011 was RM3, 005,973,000 with 618,513,000 shares.

Based on the three multiples, the valuations are averaged to give a value of RM2, 728,605,000 on 618,513,000 shares or RM4.41 per share. In fact, Top Glove was trading at RM4.86 per share at the time with RM3, 005,973,000 of market value. On the basis of the average valuation, it says that the stock is expensive.

37 AFW364 Financial Statement Analysis | Top Glove

7.3

Explanation for the Differences in Valuation

In assessing the equity valuation of Top Glove, the value of the company is RM3, 166, 786, 560 by using the Dividend Discount Method (DDM) and it turns to be RM2, 728,605,000 when Method of Comparables used. These results show that there are slight differences between the two methods.

The differences between the valuations occurs as DDM is a method that attempts to find the intrinsic or "true" value of the based only on dividends and growth rate for a single company and not worry about any other companies whereas Method of Comparables operates by comparing the company in question to other similar companies. Method of Comparables does not attempt to find the intrinsic value for the stock like the DDM valuation method; it simply compares the stock's price multiples to a benchmark to determine if the stock is relatively undervalued or overvalued.

Moreover, Method of Comparables uses present date while DDM requires forecasting of future cash flows – dividends. Method of Comparables method searches and compares for similar companies which is difficult to do so since no two firms are exactly identical and firms in the same business can still differ on risk, growth potential and cash flows.

In addition, Method of Comparables is very sensitive to various accounting choices and alternatives. Different methods of revenue recognition adopted by the company might distort the multiplier quite badly. DDM does not suffer this shortfall as the company's dividends are not affected by accounting for revenue for the long term.

38 AFW364 Financial Statement Analysis | Top Glove

In conclusion, no one valuation method is perfect for every situation. However, by knowing the characteristics of the company, a valuation method that best suits the situation can be selected. Several valuations should be performed to create a range of possible values or average all of the valuations into one.

39 AFW364 Financial Statement Analysis | Top Glove

8.0

Assumptions/ Limitations/ Obstacles

This study paper used absolute and relative valuation models, namely the Dividend Discount Model (DDM) and the Method of Comparables in evaluating Top Glove equity value. These two methods are parsimonious in that they are relatively straightforward and they require a few piece of information that is important. These two valuation model yielded two different values for Top Glove’s equity which are RM5.12 per share from DDM and RM4.41 per share from the Method of Comparables. Different valuation methods will yield different value but it does not mean that any of the valuation models is superior to the other. It is advisable to use more than one valuation models when evaluating a target company so that any shortfall from a particular model can be even out. Values derived from various valuation models is then computed to obtain an average value. A valuation model is chosen based on it suitability to the target company’s characteristics. A point to bear in mind is that the value calculated from the valuation model serves just as a guide or benchmark in comparing with current market price. It does not mean that the calculated value is the “correct” value of any particular equity. It is also recommended that a follow up studies or a “continuation studies” to be conducted from this study paper to calculate Top Glove’s equity value for future years in order to determine which model is better for a company with the characteristics of Top Glove. The model that fits the consistency criterion in which it consistently derives a value which the market value tends to converge to should be adopted. In the Method of Comparables or Multiple Comparison Analysis, Kossan Rubber Industries Bhd and Hartalega Holdings Bhd were chosen as the comparable firms or “comps”. A comparable firm is businesses that are of similar size and in the same

40 AFW364 Financial Statement Analysis | Top Glove

industry (rubber glove industry) and that they have product, cash flows, growth potential, and risk similar to the firm being valued. In Method of Comparables, it is assumed that the market is efficient in setting prices for the comparable firms. Method of Comparables is straightforward and easy to implement. However, it also has problems in implementing. Below are some of the problems that one might encounter when applying the Method of Comparables: 

Identifying comparable firm with the same operating characteristics is difficult. More and more firm are structured in the form of a conglomerate which makes such firms difficult to be classified under a particular sector.



Different multiples give different valuations.



Negative denominators can occur. A firm can has negative earnings and thus has its P/E ratio would be of little significance.

Dividend Discount Method (DDM) was chosen over the Discounted Cash Flow Method (DCF) because Top Glove has target dividend payout ratio of around 40% of profit attributable to equity. Thus, Top Glove dividends are relatively easy to forecast. DCF is best used when a firm has relatively stable, positive and predictable free cash flow. However, Top Glove does not have a stable cash flow as it is investing a lot of its cash back to the business in order to generate growth in the future. The discounting rate used is calculated to be 8.895% using the rate of 10-year Malaysian government Securities as the risk free rate and a market risk premium of 6.5%. A highly risk averse investor might choose to has a higher market risk premium. Different discount rate would yield different value from the model and this can make the value calculated from

41 AFW364 Financial Statement Analysis | Top Glove

the model seems highly speculative. Another shortfall with the DDM is that it ignores the capital gain component from the payoffs.

42 AFW364 Financial Statement Analysis | Top Glove

9.0

Conclusion

Research shown that analysts have tended to be overwhelmingly positive in their assessment of the prospects of firms. Barber, Lehavy, McNichols and Trueman (2001) find that on a scale of 1 (strong buy) to 5 (strong sell), the average recommendation for 5,628 covered firms in 1996 was 2.04. Hence, one must not take positive recommendations from analyst blindly. Potential investors are suggested to conduct own research on a particular stock before investing in it. This paper thus serves as a simple tool for analyzing stocks for potential investors. This paper derived values of RM5.12 per share from the Dividend Discount Model (DDM) and RM4.41 per share from the Method of Comparables for Top Glove from financial data as of 31th August 2011. Top Glove was trading at RM4.86 per share at the time. On the basis of the average valuation, Top Glove is slightly overpriced. With reference to this study paper, interested investors of Top Glove are advised to take a short position on Top Glove and to be on the lookout for price reversal before investing in Top Glove. Moving forward to 2012, Top Glove’s share is trading at RM5.64 as at 30th November 2012. This market price far exceeds the price we arrived from the two valuation model. This may due to aggregate investors having a more positive outlook for Top Glove. Top Glove plans to invest RM3bil over the next 15 years, to, among others, build 40 new factories. Top Glove’s Chairman Tan Sri Lim Wee Chai said the RM3bil investment would generate estimated export sales revenue of RM75bil for Malaysia. This may has perceived by the aggregate investors as good news as current investments may yield profits in the near future and thus the increase in share price.

43 AFW364 Financial Statement Analysis | Top Glove

Once investors have calculated an intrinsic value for a stock, it is advised to be patient as it may take some time for prices to gravitate to fundamentals.

44 AFW364 Financial Statement Analysis | Top Glove

References http://www.topglove.com.my/ http://hartalega.com.my/ http://www.kossan.com.my/GloveDivision/main.html http://www.bursamalaysia.com/market/securities/equities/prices/#/?filter=BS02 http://www.investopedia.com/articles/fundamental-analysis/11/choosing-valuationmethods.asp#ixzz2CJ9ZLw1N http://www.theedgemalaysia.com/in-the-financial-daily/217353-top-glove-any-day-is-agood-day.html http://biz.thestar.com.my/news/story.asp?file=/2012/9/26/business/12082019&sec=busi ness Financial Statement Analysis and Security Valuation by Stephen H. Penman, 5th Edition, McGraw Hill, 2011

45 AFW364 Financial Statement Analysis | Top Glove