- Following our recent company visit, we reaffirm our BUY recommendation on Kossan Rubber Industries (Kossan) with a higher fair value of RM5.05/share (vs. RM3.80/share previously), to reflect our upward revised earnings forecast and higher PE target of 17.5x (+2SD above its 5-year mean).

- Although Kossan’s share price had performed exceedingly well in the last year (outperforming its peers and market by 125% and 147% respectively), we believe that the stock has further upside.

- Our upbeat view is premised on:- (1) the group’s superior earnings growth of 28% in CY14 vs. peers’ average of 11%; (2) margin expansion on the back of its move up the value chain and favourable operating environment; (3) growth in its TRP division; and (4) greater investor interest following the stock’s improved liquidity and decent yields.

- We believe that Kossan’s earnings growth will continue to be capacity-driven, underpinned by its target to have an installed capacity of 32bil pcs p.a. by 2017. It is presently constructing 3 new NBR glove plants which will collectively increase its capacity by ~5bil pcs (or 30%) in FY14F. This potentially translates into additional revenue of ~RM400mil for FY14F.

- We anticipate a similar revenue contribution and quantum of NBR gloves to come on-stream in FY15F as the group will be fast-tracking the construction of new plants at its recently purchased land in Kapar. Its initial plan to build 6-8 high productivity plants at Batang Berjuntai has been pushed forward by a year as ground works are yet to be completed.

- We envisage Kossan’s FY14F EBITDA margin to expand to 18% on the back of:- (1) low input prices; (2) strengthening of the USD (vs RM); (3) its NR:NBR product mix target of 20:80 by FY16F (45:55 now); and (4) greater production efficiency.

- Management deems the current cost headwinds (e.g. energy) to be manageable as the impact is mild compared to that of raw material prices (~50% of production costs).

- We concur with management’s view that the growth trend at its TRP division has staying power given the strong foreign demand for infrastructure rubber products and auto parts. We gather that construction for its Jakarta plant has commenced, with contribution from FY15F onwards.

- All in all, we have raised Kossan’s FY13F-FY15F earnings forecast by 6%-16%. In tandem with that, we have also adjusted our gross DPS forecasts while maintaining a payout ratio of 40%. Yields are still decent at 2%-3%.

- Valuation-wise, Kossan remains attractive. At the current price, it is trading at an FY14F PE of 14.7x, on par with Top Glove’s but at a 28% discount to Hartalega’s 20.6x.

Source: AmeSecurities