Investment Highlights

• We maintain our HOLD recommendation with a higher DCF-derived FV of RM3.88/share. We have increased Kossan’s FY19F and FY20F earnings by 1% and 4% respectively to account for its expansion plans.

• Our fair value for Kossan is based on DCF, which has a WACC of 6.5% and terminal growth of 2.5%. At our fair value of RM3.88/share, the implied FY19F P/E is 19.6x with 3-year earnings CAGR FY19F-FY21F of 11.9%.

• Key risks to Kossan are capacity delays and a sharp appreciation in cost.

• Kossan has started commissioning its Plant 16 in Aug 2018, introducing 3.0bil pieces while Plant 17 will be commissioned by 4Q18, expanding capacity by 1.5bil pieces. The expected total capacity by the end of FY18E is 26.5bil pieces per annum.

• Plant 18 and Plant 19 are expected to be commissioned by the end of FY19F, which would raise capacity by 2.5bil and 3.0bil respectively. This would bring total capacity to 32.0bil pieces per annum. We expect total capacity to increase to 41.0bil by FY21F.

• Moving forward, we expect robust sales volume growth of 19% in FY19F from the higher capacity. However, the topline growth would be slightly offset by downward pressure on ASP as industry supply increases. Top Glove and Hartalega will be introducing additional capacity of circa 10bil pieces of gloves per annum each by FY20F as shown in Exhibit 2.

• Natural rubber latex and nitrile latex make up around 50% of total production cost. As shown in Exhibit 1, average natural rubber latex price has declined by 11.6% YoY to RM4.43/kg in 9MFY18 from RM5.02/kg in FY17. Nitrile latex price was on a downtrend but has recently picked up by 15.8% YoY to RM5.28/kg in 9MFY18 from RM4.56/kg in FY17.

Source: AmInvest Research - 2 Oct 2018