Investment Highlights

• Kossan Rubber is on the cusp of burgeoning capacity after a year in the lull. We await its earnings delivery for a rerating to existing valuations, which we think is fair at this juncture. We maintain our HOLD recommendation with a DCF-derived FV of RM7.16/share (WACC: 6.5%, terminal growth: 2.5%). It implies a P/E of 18x CY19F.

• Kossan registered a 1Q18 profit of RM45.1mil (QoQ: -1.7%) against a revenue base of RM484.2mil (QoQ: 1.3%). It came in line with consensus forecasts, at 20% of estimates.

• Kossan’s result key highlights included:

1. Topline for the quarter mildly contracted 3.2% YoY against a higher volume growth of 2.7% and ASPs. The USD/MYR dragged as it was 11.7% lower YoY.

2. On a sequential basis, profit declined 1.7% despite revenue growing 1.3% largely due to a time lag in the cost pass-through of natural gas and nitrile butadiene.

3. We expect earnings to be stronger come 2H18 with the full commissioning of Plant 16 (3bil pcs p.a. or 14%). Plant 16 initially had some teething operational issues back in Dec and did not contribute for the quarter, but we gather 5 lines are now in operation. It will gradually ramp up 8 more lines by July 18.

4. Over the mid-term, Kossan will aggressively ramp up production after a quiet 2017 which saw no capacity addition. Plants 17 (1.5bil pcs p.a.) and 18 (3bil pcs p.a.) are both slated to be completed by end-2018. It would enlarge capacity to 29.5bil pieces p.a or by 18% heading into FY19.

5. By 2023, Kossan plans to almost double capacity to 47.5bil from the existing 25bil. Aside from Plants 17 and 18, expansion will be through 4 phases per year at Bestari Jaya amounting to 4.5bil pcs each.

6. Aside from that, Kossan recently purchased 824 acres of land in Bidor, Perak. While it is large (almost 15x bigger than Bestari Jaya), it is contiguous as well, making it highly strategic for efficient production and expansion. On the flipside, it is almost a 100km away from the nearest port in Lumut, Perak.

7. The cleanroom and technical rubber products (TRP) segment sustained its performance, albeit under challenging market conditions.

• We are positive over Kossan’s ambitious expansion plans. However, we await the execution and delivery of its plants coming to fruition. Teething issues undermined Kossan in the past, with Plant 16 being delayed for a year. Key risks include a sharp appreciation in cost or the USD and an acceleration in capacity additions.

Source: AmInvest Research - 25 May 2018