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.
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