Kossan’s 1Q18 core PATAMI of RM39.6m (-11.1% QoQ, -6.0% YoY) was within our expectation. We expect stronger quarters ahead namely attributed to the oncoming capacity from Plant 16 (+3bn pieces capacity, c. +13.6%). Our FY18- 20 forecasts are adjusted downwards by -2% as we update our model parameters based on the latest audited annual report. Maintain HOLD rating with a lower TP RM7.68 (20.3x FY19 earnings).

Broadly within expectations. 1Q18 core PATAMI of RM39.6m (-11.1% QoQ, -6.0% YoY) came in broadly in line at 18.8% and 17.6% of ours and consensus full year estimates. We deem the results to be in line as we expect stronger quarters ahead, attributed to (i) the oncoming capacity from Plant 16; and (ii) passing on the higher energy costs (natural gas).

QoQ. Revenue grew 1.3% to RM484.2m (4Q17: RM477.8m) on higher sales volume (+3.4% QoQ). Nonetheless, EBITDA declined by 7.9% to RM74.0m (4Q17: RM80.3) whilst margins narrowed to 15.3% from 16.8%. This evolution is mainly attributed to the time lag in the cost pass through of the increase in gas prices. Subsequently, core PATAMI declined by 11.1% to RM39.6m.

YoY. Revenue declined by 3.2% to RM484.2m (1Q17: RM499.7m) on more competitive pricing despite registering higher volumes (+2.7%). EBITDA margin grew marginally by 0.2ppts to 15.3ppts (1Q17 15.1%) on the back of greater efficiencies in the manufacturing process. The decline in core PATAMI by 6.0% YoY to RM39.6m is a function of higher finance costs of RM3.9m vs. RM2.4m in 1Q17.

Expansion. We expect the ramp up in the 8 lines from Plant 16 (+3bn pieces capacity, c.+13.6%) from June-July onwards. This should make up for the earnings shortfall come 2H18. We remain conservative on the timing of the contributions from plant 17 and 18 (4.5bn pieces p.a.) with the latest guidance being late FY18 for plant 17 and early FY19 for plant 18.

Bidor. Recall that the group purchased two parcels measuring 824 acres in Bidor recently. We only expect the group to commence construction for this site post 2020.

Halal Certification. Kossan is the first glove manufacturer to receive a halal certification from Jakim. The group views this milestone in a positive light as the certification further compounds the group’s strict adherence to safety and cleanliness in its factories. We understand that at this juncture only 1 factory is certified. We don’t expect this revelation to have any impact to the group’s earnings.

The China effect. We understand that some of the vinyl glove factories that were shut down as part of China’s environmental purge last year has since come back online. The expected increase in cost of doing business in China makes Malaysian gloves more competitive in the global market. To recap Kossan does not have exposure to the Chinese market at this juncture.

Forecast. Our FY18-20 earnings forecast are adjusted downward by 2% as we updated our model parameters based on the latest audited annual report.

Maintain HOLD, TP: RM7.68. Our TP decreases to RM7.68 (from RM7.80) post model update. 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 - 25 May 2018