Investment Highlights

• We maintain HOLD on Kossan Rubber Industries (Kossan) and its fair value of RM1.23/share, based on FY23F PE of 14.9x, 1 standard deviation below the 5-year pre-pandemic (FY15-FY19) forward historical mean PE of 17x. There is no ESG-related adjustment based on our 3-star rating.

• Our forecasts are unchanged as Kossan’s 1HFY22 revenue of RM1.28bil was in line with our expectation but below street’s at 66% of our full-year forecast and 46% of consensus.

• We expect earnings to remain under pressure in 2HFY22 due to compressed profit margin from a declining average selling price (ASP) trend driven by a supply-demand imbalance and rise in production cost. No dividend was declared as expected.

• Kossan’s 2QFY22 earnings tumbled 49% QoQ to RM46mil, caused by diminishing margins from an estimated blended ASP decline of 13% to US$26.4/1K pcs. It was also hit by higher production costs, particularly natural gas, electricity tariffs and labour costs.

• 2QFY22 revenue fell 15% QoQ as a result of a 3–5% decline in sales volume together with the ASP contraction. This stemmed from ongoing logistics disruptions which led to lower sales volume while intensified competition from glove players continued to weigh on ASP.

• We understand that the 2QFY22 utilisation rate remained at 75%, still below its normalised level of 85%. Nonetheless, we do not expect a significant increase in orders for gloves in 2HFY22 given high customer inventories presently along with a tightly competitive market.

• Meanwhile, we maintain FY23F–FY24F assumptions that nitrile glove ASP will stabilise at US$25/1K pcs. The operating environment for the glove sector remains challenging for in the medium term.

• The supply-demand imbalance resulting from overstocking and inventory adjustments from clients could suppress ASP until 1HFY23 together with intensified competition from existing and new glove players. Hence the group has deferred near-term capacity expansion plans to adapt to market conditions and curtail excess supply.

• However, the group remains optimistic on the glove industry over the long term due to higher healthcare standards and hygiene awareness in both medical and non-medical sectors. Kossan also anticipates technical rubber products (TRP), which are used in infrastructure and automotive segments, to improve in 2HFY22 driven by an uptick in economic activities.

• The stock currently trades at a high FY22F PE of 16x amid a structural downturn vs. troughs of below 10x over the past 5 years.

Source: AmInvest Research - 27 Jul 2022