- We reiterate BUY on Kossan Rubber Industries but place our fair value under review pending our meeting with management. Kossan’s share price had extended its FY14 uptrend, rising by 39% YTD to close at our fair value of RM6.20/share yesterday. It has outperformed both its peers and the FBM KLCI by 19ppts- 37ppts.

- The group posted a solid 1QFY15 net profit of RM45mil on the back of revenue of RM369mil. The results were within expectations, accounting for 23% of our and street estimates.

- YoY, Kossan’s earnings had jumped by 23% in tandem with the 21% increase in its revenue. The improved performance was mainly driven by the 30% rise in its glove sales volume due to new capacity (Plant 1) coming on-stream, which had more than offset the 10% decline in its ASP (due mainly to the 18.3% fall in natural rubber [NR] latex prices).

- To recap, Kossan’s three new plants (total installed capacity of 6bil pcs) will be fully commissioned by June 2015. This will raise its installed capacity by 38% to 22bil pcs p.a. The additional capacity (all earmarked for the nitrile [NBR] segment) will shift Kossan’s NBR:NR production mix from 57:43 to 69:31.

- Sequentially, the growth in sales volumes was smaller at 4.5% as this mainly came from the revamping of 2 old plants and not from new capacity at Plants 2 and 3 (cumulative 4bil NBR pcs). We understand that these two plants will only begin contributing positively to the group’s bottom line in 2HFY15.

- Nonetheless, with its improved product mix and greater production efficiency, Kossan’s QoQ net profit growth had outpaced that of its revenue in 1QFY15 (20% vs. 2%). This was despite ASP being lower by 6.3% and NR latex cost rising by 3.5% QoQ (EBITDA margin rose 2.6ppts QoQ to 21% in 1QFY15).

- While Kossan’s glove business continued to shine, its TRP division had a disappointing quarter in 1QFY15. While this may be partly due to seasonality, other reasons for the division’s weak performance both QoQ and YoY include the absorption of group senior management’s overhead costs (RM2mil) due to accounting regulations and completion of projects, to which Kossan supplied the infrastructure products.

- We opine that Kossan’s strong share price performance was spurred in part by the USD rally (vs. the RM), of which exporters like Kossan are prime beneficiaries. As we expect the imminent US rate hike to continue to exert further downward pressure on the RM, we believe that valuations of the rubber glove players will remain inflated. The stock is currently trading at an FY15F PE of 21x - the higher end of its 5-year PE band of 13x-21x.

- No change to our FY15F-FY17F earnings forecasts at this juncture. As usual, the group did not declare any dividends for this quarter. In view of its share price appreciation, its forward yields have compressed to an average of 2%.

Source: AmeSecurities Research - 22 May 2015