We dialled into Kossan’s 1QFY20 conference call and here are some takeaways. 1Q did not have much impact from Covid-19 as prices were locked in 1-1.5 months earlier (before the price run up). We expect 2HFY20 to be stronger, as demand increases and ASPs would be higher (more than 10% increase). We increase our FY20-21 forecasts by 22%-27% to reflect higher ASPs (c. +8% YoY) and lower raw material costs (c. -6% YoY). We introduce FY22 numbers. We upgrade our call to BUY (from Hold) with a higher TP of RM10.22 (from RM8.11). Our TP is based on FY21 earnings pegged to PE multiple 31x (+2SD above 5 year mean). We believe relative to the other glove stocks, Kossan’s PE is trading at a significant discount of 28x (vs. Top Glove: 45x, Hartalega: 102x).

Recap. 1Q20 revenue improved to RM611.5m (+5.7% QoQ, +8.9% YoY) thanks to improved sales volume (+8.3% QoQ, +7.4% YoY) and ASPs (+0.5% QoQ, +1.5% YoY). Despite higher top line, core PATMI fell to RM50.7m (-24.9% QoQ, -12.8% YoY) due to increase in finance costs (+68.9% QoQ), depreciation (+9.3% YoY) and tax (+61.3% QoQ, +10.6% YoY). The results accounted for 15% of ours and 18% of consensus estimates. We deemed the results to be within expectations as we expect stronger contribution in 2Q20 and 2H20.

Covid-19 impact in 1Q minimal. 1Q20 results did not capture a hike in earnings arising from the Covid-19 outbreak. This is due to the ASPs being locked in 1-1.5 months prior to the run up and Kossan had to honour these orders first. The performance in 1Q only saw a marginal increase in ASPs end-March. That being said, we do not foresee a significant jump in price in 2Q as prices would have been locked in 1Q but this should be seen in a more profound matter in 2H20 onwards.

Margins. Covid-19 has given significant rise in demand which started in April, causing a supply shortage, and thus driving prices higher. Kossan’s ASP has increased (c.4% since Feb) while utilisation has increased to above 90% (from 80% pre-Covid-19). We believe that Kossan will be able to see higher ASP adjustments leading to margin expansion slowly in 2Q20, but more profoundly in 2H20 (more than 10% increase). We feel the upward trend of ASPs will be felt up to 1Q21. Apparent in 1Q, NBR prices has fallen, (1Q20: c.-7% QoQ, c.-11% YoY); we feel Kossan would be able to see margin expansion in 2Q20 thanks to the drop in raw material price.

Capacity. Plant 19 is expected to run with full 10 lines by Aug 2020. Current capacity as at 1Q20 stood at 29bn pieces. Total capacity for 2020 is expected to be at 32bn pieces. With the new capacity from the new plant, Kossan would be able to allocate c.15% of production for spot orders (urgent orders) that are offered at higher ASPs (c.2x-4x higher, based on urgency).

Outlook. With the increase of global gloves demand (c.30% vs. on a normalized 8- 10% growth YoY) resulting in a shortage of gloves; we expect Kossan to record better earnings in 2Q20 (thanks to the lower raw material prices) and more intensely in 2H20 (thanks to lower raw material prices and increasing ASPs) with margin expansion. Furthermore with no vaccine found yet, and health experts are of opinion that it would take 12-18 months for a vaccine to be developed, we believe demand for gloves would remain robust.

Forecast. We increase our FY20-21 forecasts by 22%-27% to reflect the higher ASP revision (c. +8% YoY) and & lower raw materials (c -6% YoY) in line with stronger demand due to Covid-19 outbreak, and the subsequent supply shortage as we foresee better 2H20. We included annual report figures and introduce FY22 numbers.

Source: Hong Leong Investment Bank Research - 9 Jun 2020