We came away from a meeting with Tan Sri Dato’ Lim Kuang Sia, Managing Director/CEO of Kossan Rubber (Kossan), feeling less upbeat on the group’s overall outlook in 2023. Management expects earnings to remain depressed in 1HFY23 due to downward pressure on ASPs amid intense competition from China gloves players and escalating costs i.e natural gas, electricity and labour costs. Kossan is halting its capacity expansion plan for now as it is still operating at a low utilization rate of ~50%. We cut our FY23-25F earnings forecast by 39- 40% to reflect lower ASPs and higher operating cost. We downgrade our call on Kossan to Underperform and our TP is subsequently lowered to RM0.75 (previous TP: RM1.23), based on 16x PER on 2-year average forward earnings.

• The worst is not over. Earnings are expected to narrow in FY23 due to dampening ASPs and escalating costs. As such, we believe the group could be loss-making in 1QFY23 with utilisation rate remains low at ~50%. As Chinese nitrile producers slashing prices to as low as USD13.50/1k pieces in November last year, ASPs are expected to remain under pressure in the coming quarters. Meanwhile, the average natural gas price has increased to RM64/MMBtu in Jan 2023 from RM55/MMBtu, while electricity cost increased by over 30%. In addition, labour cost remains elevated due to supply shortage. Although latex prices have eased, it is not sufficient to offset the impact of rising energy and labour costs (currently, energy cost alone accounts for 30% of production cost). However, its Technical Rubber Product (TRP) segment should provide some cushioning effect (revenue +77.2% YoY in 3QFY22) though contribution is unlikely to grow, but to remain stable in the near term.

• Lacklustre demand for gloves. Overall market demand remains weak with consumption falling below pre-pandemic level, mainly due to stockpiling and inflationary pressure. Therefore, we believe major customers would not have the urgency to place huge orders in the near term. Even though China is currently facing an outbreak due to the highly contagious Omicron variant known as XBB.1.5, a sudden surge in demand for imported gloves is not expected to occur as China has sufficient capacity to meet the potential increase in consumption.

• Conserving cash. Kossan is taking steps to reduce cost as well as conserve cash. Despite its strong net cash position of RM1.9bn, Kossan has placed its near-term expansion plan on hold amid oversupply issue. The number of its total workforce has also been cut from 7k to 5k. We believe staff strength will continue to fall as Kossan adopts greater digitalization in its production process. The group is still aiming to maintain its dividend payout at ~30%.

Source: PublicInvest Research - 18 Jan 2023