-  We maintain our BUY recommendation on Kossan Rubber Industries with an unchanged fair value of RM5.00/share. This is based on an unchanged forward PE of 17.5x.

-  Kossan reported 2QFY14 earnings of RM35mil (-6% QoQ; +4% YoY), which brought its 1HFY14 total to RM71mil (+7% YoY). This accounted for 40% of our and 42% of street estimates.

-  We deem the results to be within expectations given that Kossan’s results are seasonally stronger in 2H and management’s earlier guidance of 1HFY14 numbers coming in at 40%-45% of the full year’s earnings.

-  Kossan’s revenue slipped marginally QoQ to RM304mil in 2QFY14. This was mainly due to lower production volumes following a state-wide, month-long water rationing exercise in April 2014. Its output value for the quarter was subsequently reduced by ~RM18mil (6% of 2QFY14’s revenue).

-  We believe that the negative impact of this news may have been priced in by management given their conservative guidance.

-  That said, we suppose that the lower volumes could have been partially offset by the re-commissioning of eight production lines that were shut down for conversion works (from powdered latex to powder-free nitrile lines). Switching works were completed back in April 2014.

-  Meanwhile, the group’s non-core TRP division posted encouraging numbers in light of higher exports of automotive parts and dock fenders. YoY, the division’s 1HFY14 pretax profit rose 10% on the back of a similar 11% increase in revenue. QoQ, it was 16% and 17%, respectively.

-  Despite the 6% YoY decline in its topline, Kossan managed to expand its EBITDA margin by 2ppts to 20% in 1HFY14 thanks to its continuous move up the value chain, lower input prices, improved production efficiencies, and tight cost control.

-  Moving forward, we expect Kossan’s sales volume and net profit to trend upwards in view of the progressive commissioning of its three new plants in Meru (combined capacity of 6bil nitrile pcs, 17 production lines).

-  We understand that the full commercial production for Plant 1 had commenced in August 2014 while for Plant 2 and Plant 3, it will be in November 2014 and January 2015, respectively. The three plants will be fully operational in FY15F.

-  We are maintaining our numbers for now. The stock is trading at undemanding PEs of 12x-14x its FY14F-FY15F earnings, below the industry’s average of 14x-16x.

Source: AmeSecurities