Investment Highlights

• We maintain our HOLD call on Kossan Rubber Industries (Kossan) with a lower fair value (FV) of RM1.19/share (from RM1.23/share previously), based on FY23F PE of 14.9x, 1 standard deviation below the 5-year pre-pandemic (FY15-19) forward PE mean of 17x. There is no ESG-related adjustment based on our 3-star rating.

• The lower fair value mainly stems from reduced earnings estimates as Kossan’s 9MFY22 core net profit of RM149.3mil came in below expectations. This accounts for 72.6% of our earlier FY22F net profit and 73.6% of consensus, with 4QFY22 likely to be flattish sequentially.

• Hence, we cut FY22F-24F earnings by 19%/4%/8% mainly due to diminished economies of scale leading to a higher cost structure, especially in FY22F, and lower average selling price (ASP) assumptions of US$23-24/1K pcs (from US$24.5-25/1K pcs) for FY23F-24F, after taking into consideration the latest rubber glove market price and its trajectory.

• No interim dividend has been declared in this quarter, which is in line with our assumption of 3 sen/share in FY22F.

• Kossan’s 3QFY22 core earnings fell 62% QoQ, larger than a 4.5% revenue decline mainly due to the sharp PBT margin deterioration from the glove division, from 10.3% in 2QFY22 to a mere 0.2% in 3QFY22.

• This was mainly due to declining ASP coupled with rising operating costs, particularly natural gas, electricity tariff, labour costs and lower economies of scales.

• On a QoQ basis, Kossan’s 3QFY22 revenue fell 4.5% mainly due to lower contribution from the glove division, partially mitigated by the higher revenue from the technical rubber products (TRP) segment.

• The QoQ weaker glove revenue (-10%) stemmed from declining ASP and sales volume, amid excess supply and weak demand with customers bearing high inventories.

• Separately, stronger QoQ TRP revenue (+68%) was underpinned by the gradual recovery in economic activity, which boosted worldwide demand for automobiles and infrastructural expenditure.

• The blended ASP for this quarter fell 2%-6% to US$25.3/1K pcs (vs US$26.4/1K pcs in 2QFY22). Nevertheless, we gathered that the rubber glove ASP has stabilised in Sep to Nov.

• In terms of plant utilisation (PU) rate, Kossan was running at 40%-50% in 3QFY22 as compared to 75% in 2QFY22 and its normalised level of 85%. We believe that PU could improve in FY23F, in view of the upcoming inventory replenishment cycle from end-2022 to 1H2023, as guided by Hartalega and Top Glove.

• Notably, Kossan is armed with a net cash of RM1.9bil (translated to RM0.74/share) or 62% of current market cap.

• The stock currently trades at a fair FY23F PE of 15x, which is 1 standard deviation below the 5-year pre-pandemic (FY15-19) forward mean of 17x, amid ongoing ASP uncertainty and elevated costs.

Source: AmInvest Research - 3 Nov 2022