We came away from our recent meeting with Kossan, feeling increasingly pessimistic over the Group’s near-term prospects, plagued by soft ASPs, low utilisation rate and cost pressures. We cut our earnings forecast for FY22f/23f/24f to RM179.3m/-RM29.4m/RM150.9m, as we (i) lower our utilisation rate assumption, (ii) tweak cost assumptions, and (iii) recalibrate our RM/USD assumption to be in line with house view. We believe Kossan will likely to start reporting losses in FY23f, therefore we are changing our valuation method to a P/B methodology that is more appropriate. We value Kossan at a P/B multiple of 0.66x (at -1.5SD of recent 5-year average), on its FY23f BVPS of RM1.51. TP is subsequently lowered to RM1.00 (from RM1.12). Despite the headwinds, we maintain our HOLD rating on Kossan as we believe its strong cash position will help the Group to better navigate the downturn.

Increasingly pessimistic. Glove ASPs have continued to remain soft, following normalising demand post-pandemic and glove buyers are still paring down on existing stockpiles. We gather that the Chinese nitrile glove players have slashed prices to c.USD13.50 per thousand pieces to continue defending market share, while Kossan’s nitrile gloves are priced at c.USD16 presently. With idle capacity available, Kossan also took the opportunity to decommission 2-3 older manufacturing plants that are less efficient, and to only focus on newer and faster lines in order to improve cost efficiency. The total supply in the market will be further reduced as some of the smaller-scale, local glove makers have either halted operations or entirely exiting the market. Nevertheless, we think that ASPs will remain depressed in the coming quarters, as the demand-supply imbalance would take time to dissipate.

Cost pressures. Plagued by the minimum wage revision and foreign labour shortage previously, Kossan’s labour costs has remained elevated. The situation will be further aggravated moving into FY23, as we are expecting fuel costs and electricity costs to increase as well. Natural gas cost has increased from RM55/MMBtu in 4QFY22 to RM64/MMBtu in 1QFY23, accounting for 30% of the cost of production. Separately, electricity cost has also gone up by c.30%. Judging from the difficult operating conditions, we think the increase in costs will continue to exert downward pressure on Kossan’s earnings, as it is rather unlikely for Kossan to raise its ASPs significantly to pass on the additional costs.

Cash is king. Based on its latest disclosures, Kossan is currently sitting firmly on a cash pile of RM2.02bn (includes cash of RM1.33bn and money market investments of RM0.69bn). Despite the challenging operating environment, management remains committed to pay out dividends for profitable financial years, adhering to its dividend policy of 30%. Kossan’s expansion plans will also be put on the back burner, as the low utilisation rate of c.50% is sufficient to cater for existing orders. Its cash pile accumulated during the upcycle will be crucial to help Kossan weather through the down-cycle.

Forecast. Cut forecasts for FY22f/23f/24f to RM179.3m/-RM29.4m/RM150.9m (from RM182.8m/RM192.4m/RM266.8m), as we (i) lower our utilisation rate assumption, (ii) tweak cost assumption, and (iii) recalibrate our RM/USD assumption to be in line with house view.

Maintain HOLD, TP lowered to RM1.00. Kossan is likely to start reporting losses in FY23f, therefore we are changing our valuation method to a P/B methodology. We ascribe a P/B multiple of 0.66x (at -1.5SD of recent 5-year average) to its FY23f BVPS of RM1.51. TP is subsequently lowered to RM1.00. Maintain HOLD on Kossan as we believe its strong cash position will help the Group to better navigate the downturn.

Source: Hong Leong Investment Bank Research - 13 Feb 2023