- We reiterate BUY on Kossan Rubber Industries with an unchanged fair value of RM8.40/share. This is based on an unchanged FY15F PE of 27x.

- Kossan reported a strong set of results for its 2QFY15. Net profit for the quarter came in at RM47mil (QoQ: +4%; YoY: +37%) to extend its 1HFY15 earnings to RM93mil (YoY: +30%). This is in line with our and consensus estimates.

- The significant jump in the group’s bottom line can be attributed to the strong performance of its glove division. The group’s new capacity (mainly from Plant 1) has been fully taken up, as evidenced by the 36% YoY increase in its volumes for 1HFY15. This ensured a positive revenue growth of 24% despite the fall in ASP in tandem with the downtrend in raw material prices.

- Most of the group’s increase in revenue was filtered down to its bottom line with its EBITDA margin expanding 1ppt YoY to 21%. This follows:- (1) its better product mix (nitrile:natural rubber split of 68:32 vs. 59:41 for 1HFY14); (2) its greater production efficiency; and (3) lower cost structure.

- On a sequential basis, sales volumes were higher by a smaller 4% as contributions from Plant 2 and Plant 3 were insignificant in the quarter. Commercial operations of these two plants only begun in June.

- As such, we expect Kossan’s earnings growth momentum to accelerate in 2HFY15 and FY16F as 4bil pcs progressively come on stream and its older lines are overhauled. Its installed capacity at end-FY16F is projected to be 24bil pcs p.a. (YoY: +16%). We understand that these new capacities have all been contracted for.

- Meanwhile, the performance of its TRP division continued to be marred by lower demand, higher production costs and the absorption of group senior management’s overhead costs due to accounting regulations. Nonetheless, signs of a turnaround have been seen given the sequential improvements in its revenue (+11%) and PBT (+77%).

- As usual, no dividends were declared this quarter. Kossan’s strong share price performance (+64% YTD vs peer’s average of 45% and FBM KLCI’s -10%) resulted in its yields compressing to below 2%. That said, we do not rule out payouts moving above our 35%-40% assumption given its strong balance sheet and stable cash flows.

- In tandem with its share price appreciation, Kossan’s PE has expanded to 23x. This is nearly 3SD above its 5-year mean of 12x. We believe valuations of the rubber glove players, including Kossan, will remain elevated in the near term given the present USD rally and anticipated Fed rate hike. Kossan’s share price may also be relatively less volatile given its low foreign shareholding of only 11% as at end-July 2015.

Source: AmeSecurities Research - 21 Aug 2015