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

2 AFW364 Financial Statement Analysis | Top Glove

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.


AFW364 FINANCIAL STATEMENT ANALYSIS - Top Glove Project Outline

1.0 Executive Summary 4

2.0 Description of Company’s Background

2.1 Company Background 6

2.2 Board of Directors ` 7

3.0 SWOT Analysis 10

4.0 Common-Size Analysis

4.1 Vertical Analysis of Income Statement 15

4.2 Horizontal Analysis of Income Statement 16

5.0 Accounting Issues 17

6.0 Financial Health of Company

6.1 Trend Analysis of Income Statement 20

6.2 Forecasted Pro-Forma Income Statement 21

6.3 Trend Analysis of Balance Sheet 22

6.4 Forecasted Pro-Forma Balance Sheet 24

6.5 Trend Analysis of Cash Flow Statement 26

6.6 Forecasted Pro-Forma Cash Flow Statement 29

6.7 Risks Associated With Forecasting 32

7.0 Equity Evaluation

7.1 Dividend Discount Model (DDM) 33

7.2 Method of Comparables 36

7.3 Explanation for the Differences in Valuation 38

8.0 Assumptions/ Limitations/ Obstacles 40

9.0 Conclusion 43

Reference


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.


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.


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.”


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.


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


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.


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


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.


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.


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.


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.


4.0 Common Size Analysis

4.1 Vertical Analysis

Top Glove Corporation Berhad

Income Statement

For the Financial Year Ended August 31

2011 2010 2009

RM’000 RM’000 RM’000

Sales revenue

Cost of goods sold

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

Other operating income

Distribution and selling costs

Administrative and general expenses

Finance cost

235,149 11.45% 438,882 21.11% 373,102 24.40%

26,689 1.30% 10,372 0.50% 6,979 0.46%

(67,121) 3.27% (66,008) 3.17% (95,484) 6.24%

(60,495) 2.95% (80,987) 3.89% (53,091) 3.47%

(242) 0.01% (639) 0.03% - 0.00%

Operating profit

Interest expense

Share of (loss) / profit of associate

133,980 6.52% 301,620 14.50% 231,506 15.14%

10,573 0.51% 4,288 0.21% (8,530) 0.56%

917 0.05% (947) 0.05% (984) 0.06%

Profit before tax

Income tax expense

145,470 7.08% 304,961 14.67% 221,992 14.52%

(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%


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

Sales revenue 2,053,916 2,079,432 1,529,077 134% 136% 100%

Cost of goods sold (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%

Finance cost (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%


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


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. Straight-

line 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


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.


6.0 Financial Health of Top Glove Corporation Berhad

6.1 Trend Analysis of Income Statement

2009 % Change

2010 % Change

2011 Average

(RM'000) (RM'000) (RM'000) (%)

Revenue 1,529,077 35.99 2079,432 -1.23 2,053,916 17.38

(-)Cost of goods sold 1155975 41.92 1,640,550 10.86 1818767 26.43

Gross profit 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

Profit attributable to:

Equity holders of the Company 169,133 44.99 245,231 -53.88 113,091 -4.45

(+)Minority interests -1,063 587.3 5,180 -60.59 2,041 263.36

168,070 48.99 250,411 -50.02 115,132 -0.52


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

Profit attributable to:

Equity holders of the Company 113,091 129,544 195,624 360,575

Minority interests 2,041 7,416 26,947 97,916

115,132 136,960 222,571 458,491


6.3 Trend Analysis of Balance Sheet

2009 % 2010 % 2011 Average

(RM'000) Change (RM'000) Change (RM'000) (%)

Assets

Non-current assets Property, plant and equipment 564,380 2.92 580,867 13.74 660,692 8.33

Land use rights 14,200 53.10 21,741 -9.81 19,608 21.65

Investments in associate 9,366 -46.02 5,056 39.22 7,039 -3.40

Investment securities 12,853 -98.87 145 0.69 146 -49.09

Goodwill 20,113 - 20,113 - 20,113 -

620,912 1.13 627,922 12.69 707,598 6.91

Current assets Inventories 119,053 40.70 167,511 4.79 175,532 22.75

Trade and other receivables 206,596 29.54 267,617 -0.44 266,445 14.55

Tax recoverable - - 5,473 141.70 13,228 70.85

Investment securities - - 40,557 167.55 108,512 83.78

Derivative assets - - - - 2,954 -

Cash and bank balances 185,848 41.48 262,930 -43.42 148,760 -0.97

511,497 45.47 744,088 -3.85 715,431 20.81

Total assets 1,132,409 21.16 1,372,010 3.72 1,423,029 12.44

Equity and liabilities Non-current liabilities Borrowings 8,960 -66.24 3,025 -5.75 2,851 -36.00

Deferred tax liabilities 33,413 2.83 34,360 29.20 44,393 16.02

42,373 -11.77 37,385 26.37 47,244 7.30


Current liabilities

Loans and borrowings 11,573 -95.33 541 -70.98 157 -83.16

Trade payables 92,430 13.72 105,116 0.80 105,955 7.26

Other payables 104,554 7.70 112,602 9.50 123,300 8.60

Tax payable 14,721 - - - - -

Dividends payable 20,781 - - - - -

244,059 -10.57 218,259 5.11 229,412 -2.73

Equity attributable to equity holders of the company

Share capital 151,879 103.50 309,081 0.06 309,256 51.78

Share premium 243,677 -30.00 170,563 0.71 171,780 -14.65

Treasury shares -38,427 - - - - -

Other reserves 21,964 -38.76 13,451 10.26 14,831 -14.25

Retained earnings 445,420 34.57 599,407 4.43 625,936 19.50

Shareholders' equity 824,513 32.50 1,092,502 2.68 1,121,803 17.59

Minority interests 21,464 11.18 23,864 2.96 24,570 7.07

Total equity 845,977 31.96 1,116,366 2.69 1,146,373 17.33

Total equity and liabilities 1,132,409 21.16 1,372,010 3.72 1,423,029 12.44


6.4 Forecasted Pro-Forma Balance Sheet

2011(A) 2012(E) 2013(E) 2014(E)

(RM'000) (RM'000) (RM'000) (RM'000)

Assets Non-current assets

Property, plant and equipment 660,692 715,728 775,348 839,934

Land use rights 19,608 23,853 29,017 35,300

Investments in associate 7,039 6,800 6,772 6,542

Investment securities 146 74 38 19

Goodwill 20,113 20,113 20,113 20,113

707,598 766,568 831,288 901,908

Current assets

Inventories 175,532 215,466 264,483 324,654

Trade and other receivables 266,445 305,213 349,621 400,491

Tax recoverable 13,228 22,600 28,612 65,969

Investment securities 108,512 199,423 366,500 673,554

Derivative assets 2,954 - - -

Cash and bank balances 148,760 105,082 205,703 554,574

715,431 847,784 1,214,919 2,019,242

Total assets 1,423,029 1,614,352 2.046,207 2,921,150

Equity and liabilities Non-current liabilities Borrowings 2,851 1,825 1,168 747

Deferred tax liabilities 44,393 21,646 42,244 69,329

47,244 23,471 43,412 70,076


Current liabilities

Loans and borrowings 157 26 4 0.75

Trade payables 105,955 83,788 104,386 264,045.62

Other payables 123,300 104,045 127,908 291,223.63

Tax payable - - - -

Dividends payable - - - -

229,412 217,718 232,298 555,270

Equity attributable to equity holders of the company

Share capital 309,256 469,389 712,438 1,081,339

Share premium 171,780 146,614 125,135 106,803

Treasury shares - - - -

Other reserves 14,831 12,718 10,905 9,351

Retained earnings 625,936 747,994 893,852 1,068,153

Shareholders' equity 1,121,803 1,376,715 1,742,330 2,265,646

Minority interests 24,570 26,307 28,167 30,158

Total equity 1,146,373 1,403,022 1,770,497 2,295,804

Total equity and liabilities 1,423,029 1,614,352 2.046,207 2,921,150


6.5 Trend Analysis of Cash Flow Statement

2009 % Change

2010 % Change

2011 Average

(RM'000) (RM'000) (RM'000) (%)

Operating activities

Profit before tax 221,992 37.37 304,961 -52.29 145,470 -7.46

Adjustments for : Gross dividend -

-

-

Depreciation and amortization Property, plant and equipment 56,744 36.83 58,834 4.26 61,343 20.55

Amortization of land use rights 218 4.13 227 -1.32 224 1.41

Gain on disposal of property, plant and equipment -366 131.97 -849 71.14 -245 101.55

Property, plant and equipment written off 10,198 -98.84 118 261.02 426 81.09

Reversal of provision for doubtful debts -17 -100 0 0 0 -50

Share options granted under ESOS 13,461 -26.23 9,930 -100 0 63.12

Provision for doubtful debts 0

14 -100 0 -50

Unrealized foreign exchange loss -416 276.88 13,763 -36.97 8,675 119.96

Impairment on investment in associate 0

2,800 -98.36 46 -49.18

Share of results of associate 984 -3.76 947 -196.83 -917 100.29

Net fair value gains on derivative 0

0

-1,737 0

Net fair value gains on available-for-sale 0

0

-1,057 0

Negative goodwill written off 0

0

-1,767 0

Reversal of impairment loss 0

0

-397 0

Finance costs 8,530 -92.51 639 -62.13 242 77.32

Interest income -2,233 92.03 -4,288 146.57 -10,573 119.3

Total adjustments 87,103 -5.7 82,135 -33.93 54,263 19.82 Operating cash flows before changes in working capital 309,095 25.24 387,096 -48.4 199,733 -11.58


Changes in working capital Increase in inventories 38,713 -225.17 -48,458 -87.61 -6,004 -156.39

Increase in receivables 22,411 -418.63 -71,409 -94.96 -3,597 -256.795

Increase/(decrease) in payables 9,000 130.02 20,702 -49.73 10,407 40.15

Total changes in working capital 70,124 241.41 -99,165 -100.81 806 70.03

Cash flows from/(used in) operation 379,219 -24.07 287,931 -30.35 200,539 -27.21

Interest paid -8,530 -92.51 -639 -62.13 -242 -77.32

Income taxes paid -38,851 89.95 -73,797 -61.82 -28,176 14.07 Net cash flows from/(used in) operating activities 331,838 -35.66 213,495 -19.38 172,121 -27.52

Cash flows from investing activities

Purchase of property, plant and equipment -67,229 -32.15 -88,840 -59.02 -141,273 -45.59

Additional land use rights -2,773 -193.54 -8,140 -100 - -146.77

Purchase of other investments -12,708 11.35 -27,849 47.82 -68,267 29.59

Interest received 2,233 92.03 4,288 146.57 10,573 119.3

Dividends income from subsidiaries 0

0

0 Proceeds from disposal of property, plant and

equipment 2,895 -2.87 2,812 -37.69 1,752 -20.28

Additional investment in an associate

-

-336 Issuance of share capital to minority shareholders

of a subsidiary 823 -100 0

0 -0.5

Net cash inflow on acquisition of a subsidiary -

-

624 Net cash flows (used in)/from investing

activities -76,759 -53.37 -117,729 62.27 -196,927 4.45

Cash flows from financing activities

Proceeds from issuance of ordinary shares 11,365 175.81 31,346 -96.76 1,015 39.53


Share issue expenses 0

-71 -91.55 -6 -45.78

Proceeds from sale of treasury shares 0

81,575 -100 0 -0.5

Dividend paid on ordinary shares -32,389 117.35 -109,098 -38.77 -86,575 39.29

Dividend paid to minority shareholders 0

0

-1,280 Repayment of obligations under finance leases -1,181 95.51 -53 62.27 -20 78.89

Repayment of bank loans -48,809 -93.44 -3,204 -79.46 -658 -86.45

Repayment of medium term notes -58,500 -80.34 -11,500 -100 0 -90.17

Decrease in short term borrowings -56,889 -96.12 -2,210 -100 0 -98.06

Net cash used in financing activities -186,403 -92.91 -13,215 562.3 -87,524 234.69

Net increase/(decrease) in cash and cash equivalents 68,676 20.2 82,551 -236.07 -112,330 107.94

Effects of foreign exchange rate changes -3,298 65.83 -5,469 -66.36 -1,840 -0.27

Cash and cash equivalents at beginning of year 120,470 54.27 185,848 41.48 262,930 47.88 Cash and cash equivalents at end of year (Note 20) 185,848 41.48 262,930 -43.42 148,760 -0.97


6.6 Forecasted Pro-forma Cash Flow Statement

2011(A) 2012(E) 2013(E) 2014(E)

(RM'000) (RM'000) (RM'000) (RM'000)

Operating activities Profit before tax 145,470 160,390 240,666 472,466

Adjustments for : Gross dividend -

Depreciation and amortization Property, plant and equipment 61,343 73,949 89,146 107,465

Amortization of land use rights 224 227 230 233

Gain on disposal of property, plant and equipment -245 -494 -995 -2,006

Property, plant and equipment written off 426 771 1,397 2,529

Reversal of provision for doubtful debts 0 0 0 0

Share options granted under ESOS 0 0 0 0

Provision for doubtful debts 0 0 0 0

Unrealized foreign exchange loss 8,675 19082 48,951 92,153

Impairment on investment in associate 46 23 12 6

Share of results of associate -917 -1837 -3679 -7368

Net fair value gains on derivative -1,737 0 0 0

Net fair value gains on available-for-sale -1,057 0 0 0

Negative goodwill written off -1,767 0 0 0

Reversal of impairment loss -397 0 0 0

Finance costs 242 429 761 1,349

Interest income -10,573 -23,187 -50,848 -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


Changes in working capital Increase in inventories -6,004 3,386 -1,909 1,077

Increase in receivables -3,597 5,639 -8,843 13,866

Increase/(decrease) in payables 10,407 14,585 20,441 28,647

Total changes in working capital 806 20,560 9,689 43590

Cash flows from/(used in) operation 200,539 249,913 335,530 598907

Interest paid -242 -55 -12 -3

Income taxes paid -28,176 -32,140 36,663 41,821

Net cash flows from/(used in) operating activities 172,121 217,718 372,181 640,725

Cash flows from investing activities

Purchase of property, plant and equipment -141,273 -76,867 -41,823 -22,756

Additional land use rights - 0 0 0

Purchase of other investments -68,267 -88,467 -114,645 -148,568

Interest received 10,573 23,186 50,848 111,510

Dividends income from subsidiaries 0 0 0 0

Proceeds from disposal of property, plant and equipment 1,752 1,397 1,113 888

Additional investment in an associate -336 0 0 0

Issuance of share capital to minority shareholders of a subsidiary 0 0 0 0

Net cash inflow on acquisition of a subsidiary 624 0 0 0

Net cash flows (used in)/from investing activities -196,927 -140,751 -104,507 -59,814

Cash flows from financing activities Proceeds from issuance of ordinary shares 1,015 1,416 1,976 2,757

Share issue expenses -6 -3 -2 -1

Proceeds from sale of treasury shares 0 0 0 0


Dividend paid on ordinary shares -86,575 -120,590 -167,970 -233,965

Dividend paid to minority shareholders -1,280 0 0 0

Repayment of obligations under finance leases -20 -36 -64 -114

Repayment of bank loans -658 -89 -12 -2

Repayment of medium term notes 0 0 0 0

Decrease in short term borrowings 0 0 0 0

Net cash used in financing activities -87,524 -119,302 -166,072 -231,325

Net increase/(decrease) in cash and cash equivalents -112,330 -42,335 101,602 349,586

Effects of foreign exchange rate changes -1,840 -1,343 -981 -715

Cash and cash equivalents at beginning of year 262,930 148,760 105,082 205,703

Cash and cash equivalents at end of year (Note 20) 148,760 105,082 205,703 554,574

*Note: A- Actual, E-Expected


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.


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


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

DPS(RM) 0.13 0.12 0.11

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


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.


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 Sales Earnings Book Value

Market Value

* P/S

** P/E

*** P/B

Kossan Rubber

Industries Bhd 1,089,969 89,687 496,853 895,255 0.82 9.98 1.80

Hartalega Holdings

Bhd 734,921 190,297 494,444 2,032,284 2.77 10.68 4.11

Top Glove

Corporation Bhd 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.


Table: Applying Comparable Firms’ Multiples to Top Glove Corporation Bhd

(RM’000)

Average Multiple

for Comparables

Top

Glove’s

Number

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.


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.

http://www.investopedia.com/terms/i/intrinsicvalue.asp

http://www.investopedia.com/terms/c/cashflow.asp


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.


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


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


the model seems highly speculative. Another shortfall with the DDM is that it ignores the

capital gain component from the payoffs.


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.


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.


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-valuation-

methods.asp#ixzz2CJ9ZLw1N

http://www.theedgemalaysia.com/in-the-financial-daily/217353-top-glove-any-day-is-a-

good-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

http://www.topglove.com.my/

http://hartalega.com.my/

http://www.kossan.com.my/GloveDivision/main.html

http://www.investopedia.com/articles/fundamental-analysis/11/choosing-valuation-methods.asp#ixzz2CJ9ZLw1N

http://www.investopedia.com/articles/fundamental-analysis/11/choosing-valuation-methods.asp#ixzz2CJ9ZLw1N

http://www.theedgemalaysia.com/in-the-financial-daily/217353-top-glove-any-day-is-a-good-day.html

http://www.theedgemalaysia.com/in-the-financial-daily/217353-top-glove-any-day-is-a-good-day.html

project top glove completed

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