Investment Highlights

• We upgrade our recommendation to BUY from HOLD on Kossan Rubber Industries (Kossan) with a higher FV of RM4.80. Our valuation is based on a higher P/E of 22x FY20F P/E (historical average 3-year forward PE). We believe this is justified as Kossan has demonstrated its capability to continue growing despite a challenging 1HFY19.

• Kossan’s 1HFY19 net profit of RM114.6mil (+30.3% YoY) met both our and street’s estimates, accounting for 47.2%– 48.2% of full-year forecasts respectively.

• Kossan’s 1HFY19 topline grew 13.4% YoY to RM1,112.0mil (TRP +1.5%; gloves +14.5%; cleanroom 16.5%) as shown in Exhibit 1 while PBT margin improved 2.0ppts to 13.0% (TRP -0.8ppt; gloves +2.2ppts; cleanroom -3.7ppts).

• The glove division’s revenue rose 14.5% YoY to RM975.0mil resulting in a PBT of RM129.9mil (+38.4% YoY) with a PBT margin of 13.3% (+2.3ppts). This was largely on the back of a 14.9% YoY increase in sales volume, a 4.6% YoY drop in the MYR against the USD and a decrease in raw material prices (NR -1% and natural rubber -5-7%).

• Comparing 2QFY19 against 1QFY19, revenue eased 3.8% to RM478.0mil due to scheduled revamp and upgrading works across the group’s plants. These affected 5–7% of production output. PBT dropped 8.9% to RM61.9mil while PBT margins shrank slightly by 0.7ppt to 13.0% as nitrile price soared 15–17% although mitigated by a 1–2% drop in natural rubber price.

• Kossan’s technical rubber product (TRP) division enjoyed higher sales deliveries and sales of higher margin products resulting in a revenue of RM89.4mil and PBT of RM14.3mil (+8.4% YoY)

• Compared with 1QFY19, its PBT improved 9.4% QoQ to RM7.5mil despite a continued decline in revenue to RM42.7mil (-8.5% QoQ) due to sales of higher margin products.

• YTD, Kossan’s EBITDA climbed 32.0% to RM200.3mil while EBITDA margin improved by 2.5ppts. This was attributed to lower raw material prices (-1% nitrile rubber and -5% to -7% natural rubber) and a better product mix (nitrile:natural latex is 78:22).

• We like Kossan for its expansionary plans and efforts in improving quality and operational efficiency through the revamping and upgrading works on its older plants as well as improved efficiency in its newer plants. It is also currently trading at a 24% discount compared with its peer’s average PE.

• Moving forward, we anticipate an even better 2HFY19 on the back of favourable raw material price movements, cost savings initiatives, incorporation of an advanced manufacturing technology and continuous improvements in operating efficiency. These are expected to mitigate the risk of higher gas tariffs.

• Kossan’s Plant 18 (2.5bil pieces) is expected to be fully commissioned by 4QFY19 while Plant 19 (3bil pieces) is expected to begin commissioning by 4QFY19. Kossan’s total production capacity is expected to reach circa 29bil pieces by end-FY19.

Source: AmInvest Research - 23 Aug 2019