Investment Highlights

• We upgrade Kossan Rubber Industries (Kossan) to HOLD from SELL with a higher fair value (FV) of RM1.34/share (from RM1.00/share previously) to account for higher earnings estimates from lower cost assumptions. Our FV is based on FY24F PE of 17x, at parity to its 10-year average. No ESG-related FV adjustments based on an unchanged 3- star rating.

• Kossan’s 9MFY23 core net profit of RM5.2mil came in above expectations against our earlier FY23F estimated core loss of RM58.2mil and street projected losses of RM66.5mil. The positive deviation was mainly attributable to lower raw materials cost and a decline in natural gas prices. Also, we believe that the improvement was contributed by cost savings from the decommissioning of less-efficient production lines, which had a combined annual capacity of 6bil pcs.

• Hence, we raised our FY23F earnings to a profit of RM51mil from a loss of RM58mil and increased our FY24F-25F net profit to RM202mil/RM242mil from RM184mil/RM205mil after factoring in lower cost assumptions. We continue to expect more stable orders from buyers for inventory replenishments to take place in 1QCY24.

• Notably, after a RM4mil PPE write-off in 2QFY23, we estimate that there could be another one-off RM30mil to be written-off in 4QFY23F from the decommissioning activities.

• No interim dividend has been declared in 3QFY23, which is in line with our earlier expectation. In tandem with higher earnings projections, we now expect a DPS of 1 sen in FY23F. DPS forecast for FY24F has been maintained while we raised our FY25F DPS estimate to 4 sen from 3 sen.

• On a QoQ basis, Kossan surprisingly registered a material improvement in 3QFY23 with a core net profit of RM46mil from a loss of RM16mil in 2QFY23. This was primarily attributed to the rubber glove division, which benefited from lower raw materials, natural gas prices (-11% QoQ), and cost savings.

• Based on our estimates, the PATAMI breakeven costs for Kossan's gloves and clean-room divisions have declined from US$23/1K pcs in 2QFY23 to US$19/1K pcs in 3QFY23.

• Kossan’s 3QFY23 blended average selling prices (ASP) decreased by 3%-5% to US$20-21/1K pcs (vs US$21-22/1K pcs in 2QFY23). We believe that this has been contributed by lower raw material prices and continued pricing pressure from Chinese players which is expected to continue going into 4Q23F. We gather that Chinese peers have been selling nitrile medical gloves at US$14-15/1K pcs since late 2022, which implies a discount of US$2-3/1K pcs compared to Malaysia’s US$16-18/1K pcs in 4QCY24.

• In contrast, Kossan’s 3QFY23 sales volume experienced a QoQ improvement of 5%-15%. We anticipate a higher QoQ sales volume in 4QFY23F but at the cost of a lower ASP as some customers with depleting inventories are expected to begin replenishing their inventory position. Besides, major Chinese competitors have operated at maximum production capacities for 2 consecutive quarters (2Q-3QCY23) without any material expansions in 3QCY23. Our expectation for the improvement of sales volume in 4QFY23F is consistent with other Malaysian glove manufacturers based on our channel checks.

• With Kossan's new cost structure, we anticipate that a higher plant utilisation rate resulting in an economy of scale will mitigate the negative impact from the decline in ASP in 4QFY23F, bringing the group's 4QFY23F profit comparable to 3QFY23.

• Kossan has adequate financial resources with a substantive 3QFY23 net cash of RM2bil (translating to RM0.80/share) or 54% of current market cap to withstand any increase raw materials cost without resorting to additional borrowings for working capital.

• Fundamentally, the stock’s valuation is unattractive trading at FY24F PE of 19x, which is 12% above its 10-year average of 17x.

Source: AmInvest Research - 16 Nov 2023