Investment Highlights

• We maintain our BUY call on Kossan Rubber Industries (Kossan) with an unchanged FV of RM4.65/share. Our valuation is based on a P/E of 22x FY20F EPS (Kossan’s historical average forward PE).

• 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.

• We visited Kossan’s Plant 18 last week. Key highlights of the plant tour and meeting are as follows:
• 1. Kossan expects the newer plants to achieve higher efficiency levels;
• 2. Kossan can now run Plant 18 at full capacity as the group has hired ample workers;
• 3. The group is confident in its ability to pass on costs, despite the influx of capacity; and
• 4. Kossan’s first plant in Bidor, Perak is expected to be completed in FY22F.

• Kossan’s new plant is expected to achieve higher efficiency levels. The lines run at 40K pieces of gloves per hour and 2.6mil pieces of gloves for every worker. 

Currently, the packing line requires heavy manpower, which makes up around 50% of its production workers. Kossan plans to introduce an automated packing system to reduce reliance on labour. Plant 18 also uses a SCADA system to ensure that the lines are run optimally. This will help reduce operating costs in the long term. We believe that Kossan’s long-term profit growth would be underpinned by increased automation and efficiency.

Recall that there was a shortage of labour in 3QFY19. Kossan has now hired enough workers for Plant 18 and the upcoming Plant 19. Hence, we expect the new plants to run at full capacity.

We expect labour costs to increase in FY20F due to: i) the higher minimum wage; ii) zero-cost recruitment system; and iii) higher number of workers required as the workers have to be given a day off per week. However, we expect labour costs to decline gradually due to the instalment of the automated packing machine.

• The group is confident in its ability to pass on costs, despite the influx of capacity. However, we believe that in the next six to 12 months, there will be downward pressure on selling prices as a 14% increase in industry capacity exceeds the 8–10% growth in demand. Lower nitrile prices are also expected to exert downward pressure on ASP.
• Kossan’s Plant 19 is expected to be completed by FY20F with 10 lines and 3bil pieces of annual capacity. This will increase the group’s total capacity by 10.3% to 32bil pieces per year. Kossan plans to expand in Bidor next. The group plans to complete its first plant in Bidor in FY22F.

• We expect Kossan’s net profit margins in FY19E and FY20F to improve to 9.6% and 10.5% respectively from 9.3% in FY18 underpinned by capacity expansions, improved internal efficiency and strong demand growth.

Source: AmInvest Research - 14 Jan 2020