• Kossan’s 9MFY16 net earnings of RM126.3m is below our’s and consensus expectation, making up 60% of our full year forecast (consensus: 60%).

• Despite a 3% increase in sales quantity, 9M net earnings is 14.7% lower due to sudden surge in production costs.

• Earnings will improve next quarter due to additional capacity and favourable currency exchange.

• We reduced our FY16 and FY17 earnings forecast and our target price is adjusted to RM8.00. Still a BUY. Lower 9M earnings. 9M earnings fell by 14.7% yoy mainly due to sudden increase in nitrile cost (+5%); production overheads such as natural gas price (+5%); and loss of production in two of its plant due to scheduled revamp. The scheduled revamp and upgrading works involved replacing biomass system to natural gas and upgrading of 12 older production lines.

Earnings will improve. Kossan is running at full capacity at the moment. Nonetheless, we expect earnings to improve in the next quarter as the company has just completed the revamp work in one of its plants which will bring additional capacity by about 2%. Moreover, sudden surge in USD against MYR will improve the profit margin as sales are mostly denominated in USD.

Reducing our numbers. We are reducing our FY16 and FY17 earnings forecast to RM172.5m (-19%) and FY222.5m (-8%) respectively by factoring higher production costs and overheads.

Valuation and recommendation. Following the earnings revision, our target price is adjusted to RM8.00 from RM8.69 previously) based on PER of 23x. Nevertheless, the stock still offer potential upside of more than 10%, hence, we maintain our BUY recommendation on Kossan

Presently, Kossan has a production capacity of 22bn pieces of gloves per annum and with all the plants operating at almost full capacity. Product mix for nitrile and natural latex glove stood at 70:30 respectively as of 9MFY16. The company is currently constructing one new plant at Jalan Meru, Selangor, which is capable of producing 3.0bn pieces of glove per annum. Construction work has started in May 2016 and is expected to complete by 3QFY17. Beyond that, a new plant with a capacity of 4.5bn pieces of glove per annum at Bestari Jaya, Selangor will begin construction by end of the year and is expected to complete by 1H2018.

Source: BIMB Securities Research - 23 Nov 2016