Kossan’s 9M18 core PATAMI of RM135.6m (+15.8% YoY) was below ours and street’s expectations due to the divergence in the velocity of ASP revision and rocketing input costs amidst a less favourable MYR/USD YTD. We are leaving our forecast unchanged as we expect the ramp up in Plant 16’s contributions to make up for the earnings shortfall. We fear that Kossan’s capacity expansion came at the peak of this glove expansion cycle and as such it may have been late to the glove sector party. Maintain our SELL rating and TP of RM3.72 (20.3x FY19 earnings).

Below expectations. 9M18 core PATAMI of RM135.6m (+15.8% YoY) came in below expectation at 70.5% and 64.8% of ours and consensus full year estimates. The results were below mainly due to (i) the lag in passing on the higher energy costs (natural gas, +22.5% YoY) and (ii) nitrile (+8.5%) amidst a less favourable MYR/USD environment (-8.2% YoY).

QoQ. Revenue grew +15.5% to RM573.9m (2Q18: RM496.8m) on higher sales volume (+7.7% QoQ) and higher ASP’s (+1.8%). EBITDA improved by 24.2% to RM93.4m (2Q18: RM75.2m) whilst EBITDA margins improved by 1.2ppts to 16.3% (from 15.1%). Core PATAMI grew by 53.9% to RM58.2m QoQ in tandem with EBITDA growth namely attributed to maiden contributions from Plant 16.

YoY. Revenue grew +17.3% (3Q17: RM489.2m) on volume growth (+11.9% YoY) and higher ASP’s (+11.5%) despite a less favourable MYR/USD YoY (-3.9%). EBITDA margin improved by 0.4ppts to 16.3ppts (3Q17 15.9%) despite the higher NBR prices (+38.4%) and natural gas (+23.7%) YoY on the back of greater efficiencies across the manufacturing process and greater contributions from the TRP segment (revenue: +21.6%; PBT: +89.5%) on increased sales deliveries and higher margin products. Consequently, core PATAMI improved by 59.9% to RM58.2m as a result.

YTD. Revenue improved by +5.1% to RM1554.9m (from RM1479.7m) whilst EBITDA performance mirrored the topline, growing 5.5% to RM242.6m (from RM230.0m). For the glove segment, despite the higher volumes (+7.9%) and ASP (+4.8%), PBT margins deteriorated by 0.5ppts to 11.5% (9M17:12%) on the above mentioned sectoral headwinds. The group’s overall performance was buffered by a stronger showing from the TRP segment YoY (revenue: +12.1%; PBT: +69.7%; PBT margin: 14.9% vs. 9.9% in 9M17).

Outlook. Plant 16 (+3bn pieces capacity, c. +13.6%) was fully commissioned in August; as such it was able to contribute c.1.5months in 3Q18. We continue to expect utilization rate to remain stable at c.85% for the rest of FY18 on the back of robust global demand. Whilst we do expect the ramp up in Plant 16’s contributions to make up for the earnings shortfall, we may see further margin deterioration from the glove segment as more nitrile gloves capacity come on stream thus putting downward pressure on ASP in 4Q18 and beyond.

Forecast. We are leaving our forecast unchanged as we expect the ramp up in Plant 16’s contributions to make up for the earnings shortfall.

Maintain SELL, TP: RM3.72. Maintain TP of RM3.72. 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). Whilst we appreciate that Kossan has finally delivered on plant 16, we fear that it has done so at the peak of this glove expansion cycle and as such may have been late to the glove sector party.

Source: Hong Leong Investment Bank Research - 19 Nov 2018