Trying to Make Sense Bursa Investments

Author: Ben Tan   |   Latest post: Sun, 7 Mar 2021, 4:53 PM


Gloves - Some Significant Problems with JP Morgan's Report

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Yesterday an article published by The Edge mentioned a report by JP Morgan with a very grim expectation expressed on the glove sector. To be more precise, The Edge's article was based on a "research note" by JP Morgan dated January 11. I managed to view the original report, through a membership I have, and it is actually dated January 6.

As with AmInvest's report (you can read my notes on it here), I will not comment on the assumptions made, no matter how inconsistent with real world data and trends they are. I will solely focus on the numerical values from which the target prices are derived. To reiterate, JP Morgan's target prices are RM3.50 for Top Glove, RM8.50 for Hartalega, and RM3.80 for Kossan. These target prices are substantially lower than the consensus target prices, and even substantially lower than the target prices of the next most bearish analyst. For instance, for Top Glove, the nearest most bearish analysts are Macquarie at TP RM5.80, and the infamous AmInvest at TP RM6.50. Coincidentally, Macquarie have outstanding structured warrants that would be in the money if the market price of Top Glove goes above RM6.627, expiring on January 29 (see here).

We will once again focus our attention on the figures for Top Glove, because that is the company that has released the largest amount of data about its current and expected financial position publicly and therefore the company for which revenue and earnings are most predictable.

Referring to my notes on AmInvest's analysis, the part that made the least sense was the calculated net profit for FY21. The case with JP Morgan is not the same. In fact, the estimated revenue and earnings in their report are above the consensus level of RM20.5 billion and RM10.5 billion respectively. JP Morgan's analysts expect FY21 revenue to come at RM22.956 billion, and net profit to come at RM11.674 billion. This translates into a net profit margin of 50.9%, which is perfectly in line with the consensus (see my AmInvest report notes for reference). Let's assume that JP Morgan's estimated EPS of RM1.46 for FY21 is accurate. As Top Glove recently released news on increasing the dividend payout to 70% for the financial year, and having in mind that the payout for 1QFY21 was 56%, dividend per share (DPS) for FY21 will come to RM0.97 according to JP Morgan's own estimate. At target price of RM3.50, this is a dividend yield for the year equal to a whooping 27.7%!!! Warren Buffett, arguably the greatest investor in the modern history of the world, has only been able to achieve 17.1% CAGR since 1985 (reference), so such a dividend yield would beat him by an enormous margin. Additionally, the report (again, it is dated January 6, 2021) provides outdated information to the clients of JP Morgan, because the dividend payout is estimated at 50% whereas the 70% payout announcement was made on January 4 (reference).

Did JP Morgan make a very significant miscalculation somewhere?

While JP Morgan did not deviate from the consensus at all with their estimate from the consensus estimate for FY21, the deviation is drastic for FY22. Their estimated revenue is RM11.971 billion, in line with the consensus RM13.4 billion. However, their estimated net profit is RM1.686 billion, way off from the consensus RM4 billion. In other words, the consensus profit margin for FY22 is 30%, while JP Morgan's is 14.1%, or more than twice lower. Even more drastically, for FY23, their estimated net profit margin is 6%, compared to consensus average 20%, or more than three times lower. There is no explanation on why the profit margin of the company is so much below the consensus average. The last time Top Glove has reported profit margin below 6% was in November 2011 - 9 years ago (reference). This is important, because JP Morgan peg their valuation to FY22 earnings, ignoring FY21 and any consequences this financial year might have on the financial position of the company.

Is JP Morgan saying that the largest glove manufacturer in the world will operate at entry level profit margins?

Note that JP Morgan believe that Top Glove will report RM11.674 billion in net profit for FY21. Additionally, they believe that the cash pile of the company by FY22 will be RM4.107. If we take these two figures, and we apply one of the most basic and most conservative valuation methods - discounted cash flow, we get that at RM3.50, 55% of that target price's value is contained in what the company is expected to earn this year alone.

Ironically, yesterday Stephane Bancel, the CEO of Moderna, talking about COVID-19 at JPMorgan Healthcare Conference, said that "we are going to live with this virus, we think, forever." (reference)

Important disclaimer: Any views expressed are for informational and discussion purposes only. None of this information is intended as, and must not be understood as, a source of advice. It is imperative that you always do your own research and that you make any decisions based on your personal situation and your own personal understanding.

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  10 people like this.
Ben Tan GillianTan78, thank you for your comment.

I read your post on the same topic, which was focused on the information provided in The Edge's article. I liked it.
14/01/2021 3:57 PM
wkc5657 i would hazard guess with further confidence that the foreign money is not in the glove game anymore....

or it is somewhat an indirect political play to malaysia because of :
1) malaysia not really siding much towards US
2) US pissed off that they are the wrong end of the market game where they are now paying the premium (much of the time, for quite a lot of products, other markets are paying premium to US). In short, i think US sour grapes, so just throw the dumpster and hoping it will stick and stink around.

Despite what US say about free markets, their governments will and shall have a hand when it displeases them. But they are smart with playing the legal game to make it legitimate.

Contrast with mercator and sri trang, their sell down quite subdued.
14/01/2021 5:24 PM
Gaussian Both individuals should be investigated
14/01/2021 5:27 PM
AdCool Yet JP Morgan still holding Top Gloves and most of the gloves shares. why is it so?
14/01/2021 6:16 PM
witan Obviously JP Morgan want to collect cheap ticket. Bashing their no1 holding?? Hahaha
14/01/2021 6:57 PM
treasurehunt JPM YY Cheah, CFA .

Not happy. feel free making a complain to CFA

The Code of Ethics
Members of CFA Institute (including CFA charterholders) and candidates for the CFA designation (“Members and Candidates”) must:
Act with integrity, competence, diligence, and respect and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets.
Place the integrity of the investment profession and the interests of clients above their own personal interests.
Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, tak- ing investment actions, and engaging in other professional activities.
Practice and encourage others to practice in a professional and ethical man- ner that will reflect credit on themselves and the profession.
Promote the integrity and viability of the global capital markets for the ulti- mate benefit of society.
Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.
14/01/2021 7:19 PM
treasurehunt Report Misconduct By a Member or Candidate

You can help protect the integrity of CFA Institute membership and designations by reporting conduct that does not meet the CFA Institute Code of Ethics and Standards of Professional Conduct.

The Professional Conduct Program reviews all complaints on a confidential basis.

How To Report Misconduct
You may submit your conduct complaint anonymously; however, the Professional Conduct Program may need more details so we encourage you to provide contact information.

There are several different ways to report misconduct:

Submit the Report Misconduct form
Email us at professional_conduct@cfainstitute.org
Fax the information: +1 (434) 951-5450
Mail the information:
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Please remember to include a description of the allegation(s) and information and/or documentation supporting the allegation(s).

CFA handbook
14/01/2021 7:21 PM
super_newbie Well done Ben! Looking forward for your update on the percentage deposit part.
14/01/2021 7:28 PM
MatKoh Both Gillian and Ben should join forces. Delivering with facts always! Well done both
14/01/2021 7:42 PM
treasurehunt Is it Jeffrey Ng CFA qualify?
14/01/2021 7:44 PM
Ben Tan wkc5657, Gaussian, AdCool, witan, treasurehunt, super_newbie, MatKoh, thank you very much for your comments.

Please, let's not get carried away. I personally don't think there is a breach in the code of ethics of CFA in this case. However, the report is odd enough for there to be merit for us to comment on it.

My personal interest was to discover specifically which parts of the analysis were off, and it turns out it's the part with the FY22 and FY23 net profit projections. There are no specific explanations on why the profit margins are expected to be so low, and this is what bothers me as a reader of the report. I would be interested in getting an explanation on that in particular.
14/01/2021 7:56 PM
bullpiano @
Despite what US say about free markets, their governments will and shall have a hand when it displeases them. But they are smart with playing the legal game to make it legitimate

@brother wkc5657. U spot on. US government actually is evil with angel face
14/01/2021 8:49 PM
Keyman188 Keyman188 not professional or expertise....

Keyman188 always spend more time listen to Professionals & Expertise to avoid burning Keyman188 hard earned money....

Keyman188 very scared to become warrior or hero...

Keyman188 no harm better listen more to Professionals & Expertise to avoid become shark & crocodile victim...

Keyman188 not the professional or expertise...Let the expertise give more advise to the market...

为什么想投资科技股就必须关注美国大选最终结果?马股橱窗粉饰之后会有调整吗? - 陈剑


业绩这么好为何股价涨不动?近期手套股业绩和股价走势背离最完整讲解!- 陈剑
## https://klse.i3investor.com/blogs/kianweiaritcles/2020-11-20-story-h1536526427.jsp

新冠疫苗面世后,股市里的聪明钱会去哪里?对手套板块有多大影响?- 陈剑
## https://klse.i3investor.com/blogs/kianweiaritcles/2020-11-14-story-h1536429185.jsp


That's reason why some investment banks (IB) had started to revise glove sector outlook.........

Hereby to enclose the latest glove preview & outlook by IB...

Macquarie downgrades Top Glove to 'underperform', halves target price as earnings could normalise in 2H21

(theedgemarkets.com / September 10, 2020 17:36 pm +08)


JP Morgan pegs these glove makers' fair value at up to half their market price, says supernormal cycle is over

(theedgemarkets.com / December 12, 2020 00:16 am +08)


PublicInvest Research downgrades Top Glove to 'neutral' on ESG concerns

(theedgemarkets.com / December 18, 2020 10:38 am +08)


AmBank Research sees 'limited upside' to glovemakers at current prices, cuts target PER by 10%

(theedgemarkets.com / January 13, 2021 12:58 pm +08)


Glove bear JP Morgan tells clients gloves ain’t needed during vaccinations

(theedgemarkets.com / January 13, 2021 13:22 pm +08)


Revision :-

Macquarie - TP : 5.45

JP Morgan - TP : 3.50

PB IB - TP : 7.30

AmInvest - TP : 6.50


Keyman188 comment is only for those need to heard & perceive...

Save your hard earned money to avoid fighting with Big Funds...

Sometime need to follow the "wind" where to come...where to blow....
14/01/2021 8:52 PM
Ben Tan bullpiano and Keyman188, thank you for your comments.

Keyman188, 3 of the 4 reports you mentioned were mentioned in my article above. These are of course only 4 of more than 20 reports. The PublicInvest report was not mentioned, because it includes an "ESG discount". However, as I have mentioned elsewhere previously, ESG matters predominantly when it affects the financial performance of the company. In this case, there are no ESG concerns as of January 2021. There were such concerns in July 2020, and in November 2020, but the report was issued at a later date.
14/01/2021 9:42 PM
qqq33333333 esg discount is just an excuse when don't know how to write already..................
14/01/2021 9:45 PM
observatory Ben,
Towards the end of your analysis, you brought up the issue of the percentage of deposit paid. I’ve read The Edge report. Let me first quote the relevant section of the report here:

Investors argue that the revenue growth is secured as most glove producers claim to have two or more years of order backlog, but JP Morgan begs to differ.

"It is crucial to understand order backlog and secured revenue. Orders are merely an agreement to buy a certain volume with prices determined or undecided. Buyers can walk away from it,” it wrote, noting that secured revenue is when customers have paid fully or partially for future delivery.

"As shown in Top Glove's quarterly results, we have indeed seen a sharp spike in deposits collected, from RM60 million a year ago to the latest quarter’s RM1 billion.

"However, the deposit paid is merely 4.7% of projected revenue for the financial year ending Aug 31, 2021 (FY21). It is not even equal to a month’s worth of glove sales," said JP Morgan.
Source: https://www.theedgemarkets.com/article/glove-bear-jp-morgan-tells-clients-gloves-aint-needed-during-vaccinations

Rightly or wrongly, JPM has suggested that the order backlog does not translate into secured revenue since the order price is not finalized. In other words, they have suggested that while the volume is secured, the price (and therefore revenue) is still undetermined. Future revenue will drop if ASP reverts downward. The supporting evidence put forward by JPM is the relatively low amount of deposit paid by customers (RM1 billion as of last quarter or 4.7%) versus their projected revenue for FY21.

Both of us have actually discussed this point earlier. You’ve highlighted the balance sheet item “contract liabilities” of RM 1,089.404 million the Top Glove’s latest quarterly report ending 30-Nov 2020. I believe “the latest quarter’s RM1 billion” referred to by JPM points to the same number.

Given that the last quarter revenue was already RM4,759 million, and the FY21 whole year revenue may be around or exceed RM20 billion, the RM 1,089.404 million contract liabilities are indeed just about 5% of the annual projected revenue. If the deposit is spread over a period of 2 years of order backlog, the deposit percentage is even lower.

This in fact is my concern too.

It’s good to read that Top Glove has provided you with the info on the percentage deposit collected from orders. Hopefully you can get the green light from Top Glove to share the info and thereby addressing this doubt. Or better still, I think Top Glove should release a statement providing the same info to all investors based on Q&A they have with individual investors.
15/01/2021 1:37 AM
Ben Tan qqq33333333 and observatory, thank you for your comments.

observatory, I just want to point out that I am not arguing with the arithmetic skills of the JPM analysts. The collected deposits indeed come to RM1 billion as of the latest financial report, which is about 5% of the projected revenue for FY21 (according to JPM's projections). However, a lot of adjustments need to be made, and this arithmetic explanation is way too simplistic. Some things that need to be taken into account which we don't have complete information on, are:

- What part of the collected deposits represent deliveries due FY20 versus deliveries that flow into the next financial year;

- What part of the collected deposits are for to spot orders versus standard orders;

- How much deposit the company collects for spot and for standard orders;

- What is the cancelation outlook and have there been any material cancelations recently.

Without this data, the 4.7% quoted in JPM's report is largely meaningless.

On another note - my personal expectation was that the RM880 million in contract liabilities reported in the FY20 annual report of the company was going to be the peak level as they reported lead times of 620 days at that point. However, additional RM200 million in contract liabilities were reported in the 1QFY21. This likely means that the excess RM200 million comprises almost entirely deposits for spot orders.
15/01/2021 10:25 AM
Sales Ben Tan, your article are truly amazing. Thank you! Gbu!
15/01/2021 10:52 AM
Vairocana9999 Thank you for the great and excellent write up. Looks like these so-called IBs (JPM & Ambank etc) are getting more and more RESTLESS or RECKLESS by producing these kinds of reports. They still BELIEVE THAT THE INVESTORS TODAY ARE UNEDUCATED AND UNCIVILIZED, LIVING IN THE CAVES? Ha ha.
15/01/2021 10:52 AM
15/01/2021 10:53 AM

@wkc5657 i would hazard guess with further confidence that the foreign money is not in the glove game anymore....
15/01/2021 10:56 AM
Ben Tan Sales, Vairocana9999, dusti, thank you for your comments. I hope my posts help somehow.
15/01/2021 11:12 AM
stockraider Listen to the daring JP Morgan advice, it make sense mah!
15/01/2021 12:02 PM
Ben Tan stockraider, thank you for your comment, although I can see you have copy-pasted it in a number of other places.
15/01/2021 1:56 PM
observatory Hi Ben. Thanks for your very informative reply.

Yes, I got your point. The data you’ve outlined would have provided a lot more insight. However, it might be difficult for outsiders to get such info as it’s probably commercially sensitive.

I believe JPM and you are looking into two different aspects. JPM uses the ballpark 4.7% deposit to projected FY21 revenue as their supporting evidence that the 2 year or longer order backlog does not lock in future revenue. The backlog is a good news, but not a guarantee for future (say FY22, FY23) high revenue. On that point, I tend to agree with them.

However, you’ve provided a very good input which I have never considered. If RM880 million in contract liabilities with ~600 day order backlog indeed represents the peak deposit, the excess amount of contract liabilities can be mostly attributed to spot orders. As we know spot orders enjoy much higher ASP, the excess contract liabilities amount may serve as another leading indicator to ASP trend, while ASP itself is the key determinant of margin and profit.

This will be an important metric to watch in the next quarterly results!
15/01/2021 4:48 PM
Ben Tan observatory, thank you once again for your comment.

I just want to reiterate again - I didn't question JPM's skills of being able to calculate the contract liabilities in the company's quarterly report as percentage of their expected revenue for the financial year. I just gave the example, because JPM could have likely relatively easily gotten the information on what the company's policy on deposits is and what the order cancelation outlook is, by simply asking. They provided this information to me, so it doesn't appear to be commercially sensitive.

Their general point is clear. However, this means that we cannot trust any future prospects data, ever, because the future is always uncertain. Deposits are the closest thing to a guarantee that a provider of goods or services has that if he produces and allocates certain products/services for future delivery, the buyer will accept the delivery and will pay in full. The practice of taking deposits as guarantee for future delivery and payment dates back at least a millennium and it is essential to any type of business where delivery of production is not immediate. Questioning the validity of that practice for forecasting business decisions is the closest thing to hokum I can think of.
15/01/2021 4:57 PM
enigmatic Your article is more persuasive than GillianTan78's name-calling article.
16/01/2021 3:27 PM
Ben Tan enigmatic, thank you for your comment.

I think GillianTan78 was mostly venting his frustration. My goal with this article was really to look in the exact things that might be off with JP Morgan's report and see if I may be able to find a logical answer to these things.
16/01/2021 4:30 PM

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