Kossan anticipates glove prices to bottom out in 2Q22 and begin to rebound in 2H22, supported by cost inflation. Also, utilisation rate could potentially recover to 75-80% in 2H22 (from 70% currently) following the completion of inventory drawdown activities by glove buyers. While the outlook for glove makers seemed to be gradually improving, we believe that they are not entirely out of the woods yet, given persisting inflationary cost pressure s. No doubt the ability to raise prices will slightly ease off some margin pressure, but we are also of the view that it will remain challenging for the manufacturers to entirely pass on the cost increase, considering the massive glove supply availability in the market. We keep our FY22f earnings forecast largely unchanged, but we raise our FY23-24f forecasts by 12-14% as we factor in the positives into our projections. We roll over our valuation base year to FY23f and our TP is subsequently raised to RM1.97 (from RM1.53 previously). PE multiple has also been raised to 14.9x (at -1.5SD of Kossan’s pre-pandemic mean), as it better reflects the normalised profit expectations in FY23. Upgrade to HOLD.

We Hosted a Virtual Meeting With Kossan Recently With the Following Key Takeaways:

Hitting inflection point. We understand that ASPs in 1Q22 averaged around USD30 per thousand pieces of gloves. Moving into 2Q, Kossan is still expecting a slight decline in ASP but anticipates glove prices to rebound in 2H22. The rebound in ASPs is supported by the increase in costs (note that there will usually be a 2 -3 months’ time lag in passing on cost increase), due to higher energy, packaging and labour costs. We highlight that Kossan’s average utilisation rate is currently hovering around 70%, and management believes that it could potentially recover to 75-80% in 2H22, following the completion of inventory drawdown activities by buyers. Based on our channel checks, the glove buyers’ inventory levels have normalised to c.2 months now.

Not in a hurry for expansion. Kossan is also not rushing to expand its capacity, owing to (i) available idle capacity, and (ii) higher investment costs to construct new plants. Given the spike in steel prices, we understand that it currently costs c.40% more to construct new plants, as opposed to normal times. Considering that Kossan’s production lines are not running at full utilisation currently, the Group should have sufficient production capacity to cater for the incoming orders. Refurbishment and upgrading of older production lines would also contribute to the incremental growth in manufacturing capacity. Its capacity expansion plan has also been pushed back slightly, with completion of P21 (+2bn pieces p.a.) and P22 (+3bn pieces p.a.) targeted to be in 1H23 and 2H23, whereas the 1st plant in Bidor (+4.2bn pieces p.a.) is expected to start commissioning 1H24. The entire Bidor expansion (+10 plants in total) should increase production capacity by c.42bn pieces in total, and is expected to complete in 8-10 years.

Plans for its cash pile. As at 1QFY22, Kossan is sitting on a cash pile of RM2.55bn (comprising of RM1.68bn cash + RM878m money market investments). While normal dividends will still be paid out (dividend policy of 30%, paid biannually), we understand that the management does not intend to declare special dividends with the available cash, but will retain the cash for reinvestment and future expansion. The Group will be focusing on full automation to reduce its reliance on general workers, while at the same time pursuing full digitalization to drive sustainability in its business.

Prosperity Tax. Minimal impact is expected from the implementation of Prosperity Tax as the earnings generated by the Group is spread across 4 different subsidiaries. The earnings for each individual entity is not expected to significantly exceed the RM100m threshold.

Outlook. Although the outlook has started to improve for glove makers like Kossan, we believe industry players are not entirely out of the woods yet, seeing that inflationary cost pressure continues to linger. The ability to raise prices will no doubt help ease some margin pressure going forward, however, we think that it would still be rather challenging for the manufacturers to fully pass on the entire cost increase to buyers.

Forecast. Post financial model updates, we keep our FY22f earnings forecast largely unchanged, but we raise our FY23-24f forecasts by 12-14% as we factor in the positives into our projections.

Upgrade to HOLD, TP: RM1.97. Following our earnings adjustment and as we roll over our valuation base year to FY23f, our TP is raised to RM1.97 (from RM1.53 previously). We have also raised our PE multiple to 14.9x (at -1.5SD of Kossan’s pre pandemic mean), as it better reflects the normalised earnings expected in FY23. Upgrade to HOLD.

Source: Hong Leong Investment Bank Research - 10 May 2022