- We maintain our BUY recommendation on Kossan Rubber Industries but raise our fair value to RM5.85/share, post revisions to our FY14F-FY15F earnings estimates and the rolling forward of our valuation base to FY15F. Our fair value is based on a PE of 17x (+2SDs above its 5-year mean of 11x).

- Following our recent meeting with management, we cut our FY14F earnings estimate by 10% to RM162mil to account for a 6-month delay in the commissioning of its new production lines. At the same time, we have tweaked our FY15F earnings upwards by 4% in line with its improving margins.

- Notwithstanding the near-term setback, Kossan remains our top sector pick given its:- (1) superior FY14F-FY16F earnings CAGR of 23% (double that of its peers’); (2) margin expansions (+2-3ppts); (3) booming TRP division; and (4) undemanding valuations.

- We believe that Kossan’s earnings growth will continue to be capacity-driven, underpinned by its target to have an installed capacity of 32 bil pcs by 2017.

- Unlike its peers who are hinting at demand constraints, pricing pressures, and margin risk, Kossan does not appear to be experiencing such issues. Its utilisation rate remains high at more than 82% and its ASP has been fairly stable.

- The group’s plan to build three new plants in Meru, Klang in FY14F is progressing well after the delay which resulted from labour issues and longer plant construction periods.

- Full commercial production for Plant 1 had commenced in August 2014, while Plant 2 and Plant 3 will commence in November 2014 and January 2015, respectively. The three plants (total capacity of 5-6 bil pcs) will be fully operational in FY15F and may potentially add ~RM400mil to its topline.

- Encouraged by the strong demand of its products (e.g. 3g nitrile glove), the group is looking to begin construction of two new glove plants (earmarked for nitrile variants) at its 9.3-acre land in Kapar, Klang by year-end with positive contribution expected from FY16F onwards.

- The performance of Kossan’s TRP operations (13% revenue contribution) is also set to trace that of its gloves’ in view of rising demand for infrastructure, automotive and marine rubber products as well as margin expansions from lower input costs and greater automation. Plans to build a new facility in Jakarta are also presently underway.

- At the current price, Kossan’s valuations remain attractive. It is trading at FY14F-FY15F PEs of only 12x-17x. This is below the sector’s average of 17.5x. We believe that its share price will also be supported by decent dividend yields of 2%-3.5%. The group had officially announced a dividend payout policy of 30% of earnings recently

Source: AmeSecurities