Highlights 

Kossan’s  70%-owned  subsidiary,  Doshin  Rubber  Products (M)  Sdn  Bhd  (Doshin),  has  entered  into  a  Memorandum  of Understanding  (MOU)  with  Institute  of  Rail  Transit  (IRT)  of Tongji  University  in China.

The  MOU  was  signed  to  form  a  strategic  alliance  between the  parties  to  design,  manufacture  and  market  rubber  pads for floating  tracks   applicable  to urban  rail projects in China.

Salient terms of the MOU are: 1.  Doshin  will  manufacture  the  rubber  pads  based  on designs from IRT; 2.  IRT will promote  Doshin’s products for China’s urban rail projects; and 3.  The  MOU will remain in effect  for two years.

Kossan’s  technical rubber  products  (TRP)  were used  during the construction of the Second Penang Bridge  as well as the ongoing  Klang Valley Mass Rapit Trans it  project.

Aside from China, it already  has  plan to build a TRP plant in Indonesia  to  capture  the  country’s  growing  demand  in infrastructure  and automotive  industries. Financial Impact

Given  the  limited  information,  our  earnings  forecast   will  be maintained  for the time b eing. We will keep a close watch on this  development  and  make  necessary  adjustments  when financial  impact  can be identified.

Comments 

We believe  that this alliance  will augur  well for Kossan.

The  reason being  that: 1.  TRP division is only contributing around 13% to  revenue and there is still a lot of room for  improvement;  and 2.  Rapid infrastructural development has been observed in China,  such  as  bridges,  highways,  rails  and  port construction. As such,  if the collaboration is successful, this will be  the division  to focus on going forward.

Risks 

• Surge in nitrile and latex prices.
• Spike in chemical prices.
• Depreciation  of USD  vs.  MYR.

Forecasts 

• Unchanged.

Rating  SELL 

• TP: RM3.70
• Positives  –  Management  team  with  extensive  engineering experience,  continuous investment  in R&D/automation.
• Negatives  –  Exposure to  possible supply glut as a result of over  aggressive  expansion by all glove  players .

Valuation 

In  view  of  the  recent  price  surge,  we  are  downgrading  our call from  Hold to SELL.  TP is  maintained at RM3.70,  based on unchanged  P/E of 12.8x CY15 EPS.

Nevertheless, we believe that this development is a positive step  moving  forward.  Thus,  our  rec ommendation  may change as the MOU progress es  further.

Our target P/E multiple of 12.8x was derived by discounting 4x  to  the  average  of  Hartalega  and  Top  Glove’s  P/E multiples.  On  average,  Kossan  has  been  trading  at  4x discount to peers for  past 5 years .

Source: Hong Leong Investment Bank Research - 22 Sep 2014