Investment Highlights

• We maintain our BUY call on Kossan Rubber Industries with an unchanged FV of RM8.64/share. Our valuation is based on an unchanged target PE of 22x on FY18F EPS. We make no changes to our earnings forecast.

• We expect earnings to improve from 2HFY17 onwards. Plant 16 has been fully commissioned at the end of July 2017, bringing annual production capacity from 22bil pcs to 25bil pcs, with an increase of 3bil pcs of nitrile gloves with the patented Low Derma technology.

• Kossan reported 2QFY17 revenue of RM490.5mil (QoQ: -1.9%, YoY: +21.5%). Correspondingly, net profit of RM45.5mil (QoQ: - 2.2%, YoY: +11.1%) brought 1HFY17 core earnings to RM92.0mil (YoY: -0.2%). This came in slightly below expectations, with its YTD core earnings accounting for 42% and 43% of our full-year forecast and full-year consensus estimates respectively.

• The group’s 1HFY17 revenue grew by 21.4% YoY to RM990.5mil from RM816.1mil. This was largely attributable to: (1) an 11.2% YoY increase in gloves ASPs, following the sharp hike in latex prices (approx. 62.5% and 52% rise in natural latex and nitrile latex prices respectively); (2) a 6.7% YoY growth in sales volume; and (3) stronger USD vs. MYR.

• The flattish earnings of RM92mil in 1HFY17 (YoY: -0.2%) was mainly due to: (1) the 25.8% YoY growth in operating cost which outpaced the YoY revenue growth of 21.4%; and (2) absence of new capacity. Nonetheless, earnings could have been better were it not for the weakness in the Technical Rubber division (TRP). The longer time-lag effect in passing on the substantial 55.3% increase in natural rubber costs to customers caused a 44% decline in the division’s PBT. The TRP division made up 5% of the group’s 1HFY17 earnings.

• The group’s EBITDA margin narrowed to 15.3% in 1HFY17, a 3.7ppts contraction compared with a year ago (i.e. 19% in 1HFY16). The 3.4% decrease in 1HFY17 PBT was partially mitigated by the lower effective tax rate of 19.3% (vs. 1HFY16’s 22.2%) from the availability of tax incentives, resulting in only 0.2% YoY decline in earnings.

• We estimate earnings to rise by 15% in FY18F on the back of an increase in production capacity. Production capacity is anticipated to rise from 25bil to 29.5bil pcs with the commencement of Plants 17 and 18 in 2018F.

• The Integrated Research and Development-cum-Training Centre (RDTC) is expected to complete by year-end. We believe this would enhance the group’s R&D efforts. We continue to like Kossan for: (1) its strength in product innovation, which will underpin higher margin glove variants; (2) its continual R&D and increased automation, which will enhance operating efficiencies; and (3) diversified earnings, which will help counter cyclical downturns.

Source: AmInvest Research - 25 Aug 2017