• Having underperformed the sector in terms of capacity and earnings the past 2 years, Kossan is set to experience a strong FY18 and FY19 earnings growth of 28% and 17% respectively following the completion and utilisation of its newly commissioned Plant 16. For FY17-20, we forecast Kossan earnings to expand at above-sector CAGR of 18%.

• We believe the market will begin to rerate Kossan, as its underwhelming capacity risk diminishes beginning 2H18. We expect higher 2HFY18 earnings underpinned by additional 3bn pieces from Plant 16, augmented by resilient global demand, greater automation, and better overall cost efficiencies.

• We think Kossan’s earnings multiple should gravitate towards sector average as key metrics, i.e. growth, ROE, DPS, are comparable to Hartalega and Top Glove. We upgrade Kossan’s TP to RM5.50 with a target PE of 26x based on FY19 EPS.

Higher sales growth on capacity expansion

Kossan total sales growth is expected to increase by 18% (FY18) and 11% (FY19) from back-on-track capacity expansion which will result in a total of 31.5bn pcs pa (+43%) by end-2019. The company’s future expansion plan is to build an integrated glove manufacturing facility at Bidor, Perak (824 acres) with an additional capacity of 34bn pcs pa.

Greater impact to be seen in 2H18 earnings

Robust global demand and increase in production capacity from Plant 16 (+14% pa) are expected to boost Kossan’s 2H18 earnings by c.33% versus 1H18, based on our estimate. With respect to costs, lower latex prices and favourable currency rate will help ease pressure from higher nitrile glove raw material prices (+c.40% yoy). Other costs such as natural gas and increase in minimum wages can be alleviated by the “cost pass-through” mechanism and shifting to greater automation for better cost and operational efficiencies.

Positive earnings outlook

We expect earnings to grow at above-sector average at CAGR of 18% between FY17-20F supported by resilient demand, greater production capacity, increase in automation and higher overall cost efficiencies. We also estimate Kossan to pay higher DPS compared to its peers – from 5.5sen in FY17 to 9.0sen in FY20.

Valuation re-rating with higher TP of RM5.50

Constraints in earnings growth caused by delay in capacity expansion have caused Kossan shares becoming a laggard versus its peers; while FY18F PE stays at 24x as opposed to sector average of 26x. With capacity expansion set to be highly utilised by FY19, Kossan’s greater earnings potential will induce a rerating in its multiple, in our opinion. We upgrade our TP to RM5.50 (previously RM4.80) and maintain BUY.

Source: BIMB Securities Research - 8 Aug 2018