We came away from our recent meeting with management feeling positive on Kossan’s long-term prospects, driven by its i) automation and digitalisation initiatives, ii) ESG initiatives and iii) solid long term relationship with its customers. However, in the near-term, we remain wary of the impact of margin compression while the Russia-Ukraine conflict may worsen the condition of supply chain constraint. Management has also guided that Cukai Makmur is not expected to hit Kossan as the individual entities are not expected to exceed the RM100m threshold, as such we revise our FY22F earnings by +13% after removing the effect of Cukai Makmur. We maintain our Neutral call and TP of RM1.73 pegged to a PE multiple of 17x on CY23F EPS of 10.1sen per share.

• Automation and digitalisation. Labour shortage remains an ongoing issue for most of the manufacturing companies while the rising minimum wage should further elevate manpower cost. Due to labour shortage issue, we expect its utilization rate to be capped at the current level of c.70%. However, Kossan’s effort to continuously develop automated production lines could help to reduce its reliance on manual labour, improve efficiency, productivity as well as quality of its products. Its new plant in Meru is expected to be equipped with fully automated packing system and note that packaging is the most labour intensive area in the entire production process. Hence, as Kossan achieves greater automation, we expect to see a gradual improvement to its operating efficiency, which should lead to lower cost.

• Sustainable growth. Although, we expect oversupply condition to persist, we believe Kossan would be least impacted due to its conservative expansion plan. The expansion in Meru land with 15 lines and annual production capacity of 5bn pieces is targeted to complete sometime midFY23F, which was originally plan to be completed in FY22. In the long-term, we expect the demand for gloves to stay above pre-Covid level due to the growing awareness for hygiene following the global outbreak of Covid-19. Going forward, Kossan is targeting Far East countries where the growth potential is expected to be stronger due to lower per capita consumption (for example Japan’s glove consumption is only 106 pieces compared to the US’s 250 pieces).

• Margin compression. Due to the recent surge in fuel prices, gas prices are expected to increase by 13-14% in 2HFY22. With investors paying greater attention to ESG, management is taking the initiatives to become more ESG-compliant, which should lead to higher ESG-related cost in the future. Couple with a falling ASP, though at a slower rate of decline, we expect further margin erosion in the coming quarters. Having said that, we believe Kossan would be able to negotiate for better pricing given its strong business relationship with customers. During the pandemic, Kossan has restrained from raising ASP drastically to allow its customers to better manage their working capital needs.

Source: PublicInvest Research - 30 Mar 2022