Investment Highlights

• We maintain SELL on Kossan Rubber Industries (Kossan) with an unchanged fair value (FV) of RM1.00/share, based on FY24F PE of 14x, at parity to its 10-year average. No ESG-related FV adjustments based on an unchanged 3-star rating.

• Kossan’s 1HFY23 core loss of RM41mil was worse than expectations as 2QFY23 loss narrowed at a slower-thanexpected pace. Our earlier FY23F loss was RM11mil while consensus estimated a net profit of RM56mil. The deviation from our estimation was mainly due flattish average selling prices (ASP) QoQ and lower-than-expected sales volume.

• Hence, we widened FY23F loss by 21% to RM58mil after factoring in a flattish ASP in 2QFY23 and a potential decrease in ASP in 3QFY23F due to lower raw material prices, bringing FY23F ASP to US$21/1K pcs (from US$23/1K pcs previously). However, we maintain FY24F-25F earnings, on continued assumptions that inventory replenishment will occur by 4QFY23F.

• Notably, after a RM4mil PPE write-off in 2QFY23, we estimate that there could be another one-off RM30mil write-off (52% of our FY23F core loss) from the decommissioning of 44 production lines with a total annual capacity of 6bil pcs in FY23.

• No interim dividend has been declared given Kossan’s losses, which is in line with our assumption.

• Kossan’s 2QFY23 core loss narrowed to RM16mil from RM25mil in 1QFY23. This was primarily attributed to the rubber glove division, which benefited from lower energy costs, particularly natural gas (-15% QoQ).

• We expect 3QFY23F loss to be comparable to 2QFY23 given the high probability that Kossan will experience a decline in ASP despite natural gas prices could moderate 11% QoQ, and to improve in 4QFY23 as customers begin to replenish inventories.

• Kossan’s 2QFY23 sales volume experienced a QoQ decline of 3%-5%. In terms of PU, Kossan was running at 40%-45% in 2QFY23, similar to 1QFY23. This is better than Top Glove’s significant decline of 21% QoQ in 2QCY23 sales volume. We believe this was attributed to Kossan not increasing ASP this year to maintain sales.

• Kossan’s 2QFY23 blended ASP was unchanged QoQ at US$21.3/1K pcs. However, we gathered that some Malaysian glove makers have lowered ASP for 3.0-3.5g nitrile medical rubber gloves in 3QCY23 to pass on lower raw material costs (Exhibit 3). This is consistent with our hypothesis in Top Glove’s result update dated 19 Jun.

• Based on Kossan’s 43rd AGM minutes, Kossan has decommissioned 2 plants with a total annual capacity of 3bil pcs which incurred a RM5mil write-off in FY22. In FY23, the group plans to decommission another 44 production lines with a total annual capacity of 6bil pcs. This will mean that the group have to write off RM34mil in FY23F. After this decommissioning, Kossan’s installed capacity will drop by 27% from 33.5bil to 24.5bil pcs/annum. To be conservative, we have not factored any decommissioning cost savings from higher economies of scales in FY24F-25F.

• Nevertheless, we believe combined efforts among Malaysian glove makers in decommissioning production lines could underpin gradual improvements to earnings/losses in the near term and expedite supply-demand equilibrium in the glove sector over the medium-to-long term.

• Kossan has adequate financial resources with a substantive net cash of RM2bil (translated to RM0.78/share) or 57% of current market cap, which provides the strongest buffer amongst peers against negative shocks.

• The stock currently trades at a FY24F PE of 19x, which is 36% above its 10-year average of 14x with no dividend prospects for this year. Hence, we advocate investors to take profit at this juncture.

Source: AmInvest Research - 28 Jul 2023