Investment Highlights

• We downgrade Kossan Rubber Industries (Kossan) to SELL from HOLD previously after the share price appreciated 11% over the past month despite weak fundamentals. Nevertheless, we maintain our fair value (FV) of RM1.00/share. This is based on a rolled-forward FY24F PE of 14x, at parity with its 10-year average. No ESG-related FV adjustments based on an unchanged 3-star rating.

• Kossan’s 1QFY23 core loss of RM25mil was below expectations, as compared to our earlier FY23F net profit of RM182mil and consensus’ RM59mil. The deviation from our estimate was mainly due to a lower plant utilisation rate (PU) and higher operating expenses.

• Hence, we reverse FY23F earnings to a loss of RM11mil and cut FY24F-25F net profit by 12%/11%, mainly attributable to lower PU assumptions of 55%-80% (from 68%-85%).

• No interim dividend has been declared in this quarter. Furthermore, we assume no dividend to be paid out in FY23F from 3 sen/share previously, given our loss expectation.

• Kossan’s 1QFY23 core loss widened to RM25mil from RM5mil in 4QFY22. This was primarily attributed to an 18% QoQ decline in revenue. The weaker revenue mostly stemmed from the glove division, which experienced declines of 3%-5% in ASP and 14%-18% in sales volume. The loss was exacerbated by rising operating expenses, mainly from natural gas (+14%- 15%).

• In terms of PU, Kossan was running at 40%-45% in 1QFY23, which was lower than 40%-50% in 4QFY22. This contrasts with other glove makers under our coverage which recorded an improvement of 6%-20% in sales volumes between 4Q2022 and early 2023.

• This could imply rubber glove distributors still have inventories and pose a risk that they still have the discretion to delay replenishment longer or even later than our assumption by 3Q2023.

• Kossan’s 1QFY23 blended ASP fell 3%-4% QoQ to US$21.3/1K pcs (vs US$22.1/1K pcs). However, based on our channel checks, Top Glove has increased the price of nitrile medical rubber gloves from a 5-year low of US$17/1K pcs in Feb 2023 to US$20/1K pcs in Apr this year, a US$3/1K pcs increase.

• In contrast, another glove maker under our coverage increased ASP by a mere US$0.5-1/1K pcs (+<5%) to US$19- 20/1K pcs between 1Q to 2Q2023.

• Chinese glove makers have increased ASPs from as low as US$14-15/1K pcs to US$16-17/1K pcs (inclusive of US tariff of 7.5%) during the same period. This could imply Kossan could be raising ASP as well. However, we gathered that the increase in ASPs was accompanied by lower PU among Malaysian glove makers. This raises concerns about the sustainability of ASP hikes in 3Q2023.

• Natural gas prices are expected to decrease by 15% in 2QFY23F (translating to US$0.2-0.4/1K pcs). Combined with rising ASPs in 2Q2023, this suggests that losses will narrow from 2QFY23F onwards. However, as our forecasted earnings cannot yet support current high valuations, we advise investors to take profit.

• The stock currently trades at a FY24F PE of 18x, which is 29% above its 10-year average of 14x with no dividend prospects for this year.

• Even so, we note that Kossan has adequate financial resources with a substantive net cash of RM2bil (translating to RM0.77/share) or 61% of the current market cap. This offers the strongest buffer against negative shocks.

Source: AmInvest Research - 28 Apr 2023