Kossan Rubber Industries- Sustained ASP Lift-off

Date: 07/07/2020

Source  :  KENANGA
Stock  :  KOSSAN       Price Target  :  14.00      |      Price Call  :  BUY
        Last Price  :  6.07      |      Upside/Downside  :  +7.93 (130.64%)

We are positively excited on Kossan’s prospects for the next few quarters. Taking cue from the other glove players’ quarterly earnings announcements over the past two months, we are raising our assumptions for KOSSAN. To account for higher margins and ASP, we are enhancing FY20E/FY21E net profit by 32%/39%. TP is raised from RM11.20 to RM14.00 based on 27x FY21E EPS. Reiterate OP.

Consensus under-appreciating higher ASPs impact. We are positively excited on Kossan’s prospects for the next few quarters. Management is confident of strong demand at least till end 1Q 2021, wringing extra earnings from additional 10% utilisation from pre pandemic 85%-90% level and margins expansion from four new lines catering to spot customers. However, the lag impact from ASP hike can only be felt in 2H 2020. We highlight that market consensus is under appreciating the potential impact from higher-than-expected ASPs in this continuing pandemic and tight supply situation. Due to the tight supply situation, we expect buyers to jockey for position in order to secure allocation which will push up ASPs.

Buying industrial property for RM40m. Separately, in an announcement to Bursa Malaysia, KOSSAN’s wholly-owned IQ is buying an industrial property, comprising industrial buildings sited on land measuring about 10 acres (436k sq feet) for RM40m. The acquisition works out to RM92/sq feet which is about 8% cheaper than the last transacted acquisition located nearby. This land in Meru, is located adjacent to one of its current plants. Based on our past experience, a land of this size can house two to three plants with an installed annual capacity of 7b to 10b pieces. The acquisition is a small dent to KOSSAN’s net debt and net gearing of RM342m and 0.2x, respectively, as at 31 Mar 2020 which will be further reinforced with operating cash flows averaging RM500m per annum over the next two years.

Our analysis suggests sustained shortage in supply. We have done an analysis to dispel any concerns regarding gloves oversupply. Our analysis (see table overleaf) suggests that acute supply and supernormal demand could persist till end 2021.If we look at the capacity expansion numbers in isolation, it looks overwhelming. But viewed against the incremental new pandemic-driven demand in addition to the annual base level demand growth, the additional capacity is not a concern. In fact, the estimated new yearly capacity may not actually start as scheduled and hence the supply shortage will continue to be acute in 2021. Typically, to cater for normal demand, glove makers essentially need to build just one plant per year. However, from channel checks, to cater for this current pandemic driven demand, two to three plants are required for each glove maker (on average) annually in order to meet the supernormal demand, which takes between 12 to 24 months to complete.

Raised FY20E/FY21E net profit by 32%/39% taking into account (i) raised ASP from USD29/1,000 pieces to USD31.1 and USD31.50/1,000 pieces and (ii) higher EBITDA margin assumption in FY2E/FY21E from 19%/20% to 23%/25%.

Undemanding 20x PER vs average net profit growth of 80%. TP is accordingly raised from RM11.20 to RM14.00 based on 27x FY21E EPS (previously 30x) (at below +2.0SD above 5-year historical forward mean). We lowered our PER rating as we believe valuations are pegged to supernormal earnings; hence, upside to peak earnings should have been factored in. Reiterate Outperform. Key risk to our call is lower-than-expected ASP.

Source: Kenanga Research - 7 Jul 2020

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