- We reaffirm our BUY recommendation on Kossan Rubber Industries with an unchanged fair value of RM5.85/share, based on an FY15F PE of 17x.

- Kossan’s 9MFY14 net profit of RM106mil accounted for 65% of our and consensus estimates. We deem the results to be in-line as we expect the group’s 4Q earnings to be stronger underpinned by the progressive commissioning of its new lines.

- On a sequential basis, the group’s 3QFY14 earnings were flat despite an 8% revenue growth. While its glove division had performed well (QoQ: revenue +12.5%, pretax profit +6%, volumes: +7.5%), its TRP business was affected by the weak global economy during the quarter.

- Lower exports of industrial and automotive parts had resulted in sequential declines of 19% and 35% in the division’s revenue and pretax profit. That said, we gather that export of infrastructure products and sales of marine and dock fenders remain strong. Business is also set to pick-up once contribution from the MRT project kicks in.

- YoY, Kossan’s cumulative 9M revenue was lower by 4.5% dragged mainly by lower glove ASP (in tandem with declining raw material prices) and lower sales at its TRP division. Latex prices had continued to weaken, with natural rubber and nitrile prices down by 8% and 9% QoQ. YoY, it was lower by 26% and 21%.

- Nonetheless, the group managed to grow its 9MFY14 earnings by 4% YoY, thanks to a 1.3-ppt EBITDA margin improvement. The expansion can be attributed to its lower cost structure (opex: -5.3% YoY), more efficient operations and improved product mix.

- Note that Kossan’s 3QFY14 earnings were also negatively impacted by a provision for unrealised forex loss of RM1.8mil.

- As expected, Kossan declared a tax-exempt interim dividend of 3.5 sen/share. This places it on course to meet our FY14F gross DPS forecast of 8.5 sen/share. Yields are presently at ~2%.

- Our investment thesis on the stock remains. We believe that Kossan’s earnings growth will continue to be capacity-driven. We understand that the group’s plan to build three new plants in Meru is progressing well with Plant 1 having commenced commercial production in Aug 2014 while Plant 2 and Plant 3 (6 lines each) will begin operations as scheduled, i.e. in Nov 2014 and Jan 2015, respectively.

- At the current price, Kossan’s valuation remains undemanding. It is currently trading at FY14F-FY15F PEs of only 13x-18x compared to the sector’s average of 17.5x.

Source: AmeSecurities