- We maintain our BUY recommendation on Kossan Rubber Industries (Kossan) with a higher fair value of RM6.30/share to reflect our upwards earnings revision for FY13F-FY15F of 14%-22% and the rolling forward of our base year to FY14F. We continue to peg Kossan to a PE of 12.5x.

- Our bullish view on Kossan is underpinned by:- (1) its growing production capacity (FY13F: +20%; FY14F: +30%) amid robust global rubber glove demand (FY13F: +10%-15%, 1Q13 sales volume: +29% YoY); (2) its focus on differentiation and its move up the value chain through product innovations; (3) upbeat prospects for its technical rubber products (TRP) division; and (4) lower production costs.

- The group’s FY13F earnings will be bolstered by the March 2013 commissioning of its 9 surgical glove lines (+700mil pcs) and spillover capacity from the end-FY12 commercialisation of 9 nitrile glove lines (+1.5bil pcs).

- We understand that plans are afoot for the construction of 3 nitrile glove plants by May 2014 which will collectively expand Kossan’s installed capacity by ~5bil pcs (or 30%). This potentially translates into additional revenue of ~RM400mil. We gather that Kossan has sold forward the bulk of its new capacities.

- In the medium term, Kossan’s capacity growth will be centred on its recently acquired 56-acre land in Batang Berjuntai, where it plans to build 6-8 high productivity plants to achieve an installed capacity of 32 bil pcs per annum by 2018 (5-year CAGR of 15%).

- We are also encouraged to learn that management is planning to accelerate growth of its TRP business (~12% of revenue), backed by a strong foreign demand for infrastructure rubber products and automotive component parts. The construction of its Jakarta plant is slated to begin in the next 1-2 months.

- Factoring in lower production costs due to a lower latex price assumption (RM6.00/kg from RM6.50/kg), increased plant efficiency as well as greater contribution from higher margined products (eg. clean room and surgical gloves), we expect Kossan’s EBITDA margin to expand by 1-2ppts to ~17% for FY13F-FY14F.

- All in, we have incorporated capex of RM75mil which we believe can be internally funded given Kossan’s sound operating cash flows and manageable net gearing (1Q13: 0.1x).

- Our revised gross DPS forecasts of 16 sen for FY13F and 19 sen for FY14F are premised on a 38%-40% payout ratio. Although yields have declined following its strong share price performance (YTD: +49% vs FBM KLCI’s +5%), its 3-year average of 3.5% is the highest among its peers.

- Nonetheless, we believe the stock still has legs on the upside given the group’s solid fundamentals, improving liquidity (including possibility of bonus and warrants in FY13F) and still conducive operating environment.

Source: AmeSecurities