We Recently Met Up With the Company. Kossan Saw a 15% YoY Rise in Low Derma Glove Sales and Expects This to Grow From the Ramp Up in Plant 16. While Plant 16 Is Completed, Commissioning Was Delayed Due to Teething Issues, Resulting to Kossan Missing on the Sector Upcycle Last Year. We Are Cautious on Kossan’s Ability to Complete Plant 17 & 18 on Schedule (4.5bn Pieces P.a.) The Timeline for Completion Since Been Delayed to End-2018. We Lower Our FY18-20 Forecast by 9-13% to Account for a More Staggered Ramp Up From Plant 16 and Also Longer Time Horizon for Plants 17 and 18 to Come Online. Maintain HOLD Rating With a Lower RM7.80 TP (20.3x FY19 Earnings).

Recently we had the opportunity to meet with the company and the following are some key takeaways:

Results Recap. To recap, in FY17 revenue grew to RM1.96bn (+17.4% YoY) due to higher volumes (c. +6.0%) and ASP (+7%). Whilst PATAMI grew by 11.2% to RM185.8m, EBITDA margins declined by 1.4ppts to 16.1% (FY16: 17.5%) attributed to higher raw material prices (NR +30.0%, NBR +14.1%) and other key cost drivers.

Low Derma. The group saw an increase of c.15% YoY in their low derma gloves sales (our back of the envelope calculation implies that c. 2.8bn pieces of sold in FY17) and expects this segment to grow moving forward as the ramp up in plant 16 commences (which will completely focus on the low derma gloves).

Plant 16. It has been guided that plant 16 is fully completed with a total of 8 lines and 3bn in additional installed capacity (+14% YoY). However teething issues has resulted in the delay of commissioning of the new plant, consequently resulting in the group missing on the sector upcycle of FY17. In FY18 we can expect a staggered ramp up in the 8 lines from Plant 16 as we expect Kossan to ramp up the capacity “conservatively”. On the back of this revelation, we are more cautious on the group’s completion schedule for plant 17 and 18 (4.5bn pieces p.a.). To recap, earlier guidance was for commercial production by 2Q18 (Plant 17) and 4Q18 (Plant 18), however we understand that both plants will be completed by end FY18 and commercial production will commence thereafter.

The China Effect. Kossan however, did not directly benefit from the “China effect” as (i) the main base of their clientele are in developed markets (North America c.45% & Eurozone c.30%) and (ii) Kossan was already operating at an optimal utilization rate of above 80% and did not have the spare capacity unlike its other rivals in the industry. Nonetheless, the “China effect” did push up the demand for gloves from Malaysia, increasing ASP sector wide thus benefitting Kossan indirectly.

Forecast. We adjust our FY18-20 earnings downward by 9%-13% as we factor a more conservative onset of capacity from Plant 16 and expected delays from the completion of plant 17 & 18 into our forecast. We also take the opportunity to adjust upwards our NBR price assumptions in tandem with the recent price movements.

Maintain HOLD, TP: RM7.80. Our TP decreases to RM7.80 (from RM8.90) post forecast adjustments. Our TP is a function of FY19 EPS pegged to a PE multiple of 20.3x (0.5SD above the stocks 5 year historical mean).

Source: Hong Leong Investment Bank Research - 17 Apr 2018