Investment Highlights

• We maintain our BUY call on Kossan Rubber Industries (Kossan) with a lower FV of RM4.65 (RM4.80 previously). Our valuation is based on a P/E of 22x FY20F EPS (historical average 3-year forward PE). We have cut our earnings forecast for FY19F, FY20F and FY21F by 8.4%, 3.3% and 0.9% respectively to account for the labour shortage and lower ASP.

• Kossan’s 9MFY19 core net profit of RM163.8mil (+15.9% YoY) missed both our and street’s estimate, accounting for 68%–69% of full-year earnings forecasts respectively. The variance was largely due to a shortage in labour, which affected the group’s production volume.

• Kossan’s 9MFY19 top line grew 5.7% YoY to RM1.6bil (TRP +1.3%; gloves +7.0% cleanroom -12.4%) as shown in Exhibit 1 while PBT margin improved 1.2ppt to 12.6% (TRP +1.6ppt; gloves +1.2ppt; cleanroom –0.2ppt).

• The glove division’s revenue rose 7.0% YoY to RM1,452mil in 9MFY19 and Kossan recorded a PBT margin of 12.7% (+1.6ppt). The growth was driven largely by a 9.2% YoY increase in sales volume.

• Production capacity was boosted by Plant 17 (1.5bil pieces, +6%), which was commissioned in November 2018. ASP declined 4–6% despite the MYR weakening by 3.6% YoY against the USD. Raw material prices were lower (nitrile rubber –9-11% and natural rubber -2-4%).

• Comparing 3QFY19 against 2QFY19, revenue dropped 7.9% to RM531.3mil. PBT fell 12.7% while PBT margins shrank 1.2ppt to 11.6% even though nitrile and natural rubber prices slipped by 1-2% and 7-9% respectively. The erosion in revenue and PBT margin was due to a labour shortage in 3Q, which also resulted in 1–3% lower sales volume.

• There were strict regulatory issues in hiring foreign workers. However according to the company, the problem has been resolved and we expect an improvement in the subsequent quarters. We believe that Kossan would have a full workforce and would be able to fully commission Plant 18, which commands a capacity of 2.5bil (+9.4%) pieces.

• Kossan’s technical rubber product (TRP) division enjoyed higher sales deliveries and sales of higher margin products resulting in a 1.3% YoY increase in revenue and 12.0% increase in PBT. Compared with 2QFY19, its revenue grew 9.0% and PBT improved 9.6% while PBT margin remained flattish at 17.5%.

• Kossan’s cleanroom division’s revenue slid 12.4% YoY while its PBT fell 17.6%. Its cleanroom division’s product is processed in China for its China market.

• 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.

• Moving forward, we expect a stronger 4QFY19 due to the full commissioning of Plant 18. In the long term, we anticipate further improvements in Kossan’s performance on the back of favourable raw material price movements, cost-savings initiatives and continuous improvements in operating efficiency. We believe that Kossan will also benefit from the US-China trade war as 50% of its exports goes to the USA.

• Kossan’s Plant 18 (2.5bil pieces) was fully commissioned in November 2019. This increased total production capacity by 9.4% to 29bil pieces. Plant 19 (3bil pieces) is expected to be commissioned by FY20F and will increase capacity by 10.3% to 32bil pieces.

Source: AmInvest Research - 22 Nov 2019