· We downgrade Kossan Rubber Industries from BUY to HOLD with a revised fair value of RM9.40/share. This is based on an unchanged PE of 27x over rolled-forward FY16F earnings. Our downgrade is mainly due to its rich valuations and the limited upside potential to our fair value (+6%) post its strong share price performance this year.

· Kossan’s share price has doubled YTD. The stock’s rally was in tandem with its peers’ average YTD increase of +78%. In comparison, the FBM KLCI had declined by 5.8% over the same period. Correspondingly, Kossan’s PE has expanded to 25x-28x its FY15F-FY16F earnings, +3.5SD to +4SD above its 5-year mean of 12x.

· We opine that further upside from its favorable USD exposure, which in part spurred the surge in rubber glove stocks (including Kossan’s), may be limited moving forward as the exchange rate appears to have stabilized. Additionally, we believe that the share price has already incorporated its strong earnings growth momentum (3-year CAGR of 22%).

· Kossan's 9MFY15 results were in line with our and market’s expectations. It reported a 3QFY15 net profit of RM55mil to extend its 9MFY15 earnings to RM148mil. · Its dividend quantum, however, surprised on the upside as it declared an interim DPS of 5.5 sen vs the usual 3.5 sen. Based on management’s guidance of a 40% payout for FY15F and 50% payout for FY16F, we have tweaked upwards our gross DPS to 12.5 sen and 17.5 sen. Yields are ~2%.

· The significant jump in Kossan’s 9MFY15 bottom line (YoY: +40%) came on the back of a healthy 28% growth in turnover as the ASP declines (in tandem with lower raw material costs) were outweighed by the sizeable increase in sales volumes (+34%). The latter was due to the availability of new capacity from its Plants 2 and 3 which began commercial operations in June 2015.

· On a sequential basis, 3QFY15 net profit rose by 16%, tracking its 15% increase in revenue. The quarter’s strong performance was also aided by growing contribution from its clean room division and improvements in its TRP business.

· Kossan’s 9MFY15 EBITDA margin had increased by 1.3ppts YoY to 20.5%, surpassing its previous peak of 19% back in FY09/10. The margin expansion can be attributed to the group’s lower input costs, more efficient operations (including high utilisation rates) and improved product mix (9MFY15 NBR:NR glove split of 68:32 vs 9MFY14’s 60:40).

· Looking ahead, we expect Kossan’s earnings growth momentum to remain intact in 4QFY15 and to carry through to FY16F as its new capacities progressively come on stream and its older lines are overhauled. We gather that glove demand remains robust given that its upcoming capacities have all been contracted for.

Source: AmeSecurities Research - 20 Nov 2015