- We maintain BUY on Kossan Rubber Industries but raise our fair value from RM5.65/share to RM6.20/share in tandem with our higher PE target of 20x as we narrow the discount to industry leader Hartalega’s 23x to 10% (from 20%) in view of its comparable performance (amid the commissioning of its new plants) and positive sentiment on the sector.

- Despite its lacklustre performance in FY14, we maintain our BUY on Kossan given:- (1) the step-up in its FY15F earnings underpinned by additional capacity (earnings growth of ~30% vs. peers’ average of 11%); (2) anticipation of a 4.5 sen final dividend (usually proposed in April); and (3) increasing investor interest given its favourable exposure to a rising USD:RM exchange rate.

- Kossan reported an FY14 net profit of RM144mil (YoY: +5%), which was below our and consensus estimates. This follows its weaker-than-expected earnings of RM38mil in 4QFY14 (QoQ: +10%; YoY: +3%), which can be mainly attributed to lower contributions from its new plants and abnormally higher operating expenses (QoQ and YoY: +RM30mil or +11%) during the quarter. We believe the latter may be due to higher start-up costs for its new plants.

- We understand that Plant 1 (5 lines) and Plant 2 (6 lines) had only begun full commercial production in Oct and Dec 2014, respectively (vs. our earlier assumption of Aug and Nov 2014). Operations at Plant 3 (6 lines) are scheduled to commence in Jan 2015. That said, we still expect full contributions from the three new plants in FY15F, thereby the maintaining of our earnings estimates (-0.2% from our previous forecast).

- Kossan’s installed capacity is expected to increase by 6bil pcs p.a. (or +38%) to 22bil pcs p.a. in FY15F. This translates to an incremental revenue of ~RM400mil for the year. The additional capacity (all of which is in the nitrile segment) will shift Kossan’s nitrile:natural rubber production mix from 57:43 to 70:30.

- This move up the value chain, together with the absence of significant cost pressures in FY15F (reduction in electricity tariff and status quo for natural gas tariff) and improved production efficiencies, should result in further margin expansions for the group (FY14 EBITDA margin: +1ppt YoY).

- On a cumulative basis, Kossan’s net profit rose by 5% YoY on the back of flattish revenue. The muted growth in its glove division was mainly due to capacity constraints and lower ASP in tandem with lower natural rubber (-29%) and nitrile prices (-10%). This was partly mitigated by a decent growth in its TRP division (pretax profit: +13%).

- YTD, the stock has outperformed both its peers (+5ppts) and the FBM KLCI (+20ppts). The latest run-up in its share price (+23% since Nov 2014) also coincided with the recent appreciation of the USD vis-à-vis the RM (+8%).

Source: AmeSecurities