Likely to turn the corner in 4Q

Kossan’s 3Q came in unexpectedly weaker due to a decline in glove volume sales with the ongoing revamp. Margins fell on higher unit costs due to the lower production output, which led to a 3Q earnings miss. We expect 4Q to be sequentially stronger, as the revamped lines should resume production with higher sales volume growth.

Utilisation rate below optimal

3Q revenue unexpectedly contracted 6% yoy to RM414m on the back of lower sales volume in the gloves division. Kossan’s utilisation rate fell below the optimal 80% level due to the ongoing revamp and upgrading works at 2 of its production plants which impacted the production output. Sales volume fell 3.8% yoy in the gloves division in tandem with the lower capacity deployed during the quarter, as 12 production lines were being upgraded. The gloves ASP also fell in 3Q due to industry-wide price pressure, which led to the 7% yoy revenue decline in the gloves division.

3Q earnings miss

Kossan’s 3Q core net profit fell to RM34m (-17% qoq; -38% yoy), bringing the 9MFY16 core net profit to RM126m. The sequentially weaker earnings missed both our expectations and the consensus forecast; we had projected an earlier completion date for the revamp in 2Q and correspondingly higher sales volume growth. In tandem with the lower volume, the EBITDA margin fell to a low of 15% (-2% qoq; -5% yoy) on higher production costs due to the operating leverage effect, as fixed costs per unit increased in line with the lower utilisation. Notwithstanding that, the EBITDA margin was also impacted by the: (i) lower ASP, (ii) higher labour costs due to a supply shortage; (iii) increase in utilities charges on the natural gas price hike; and (iv) higher raw material prices. Separately, the cleanroom division’s PBT unexpectedly plunged 73% yoy on a softer ASP, which partly contributed to the overall earnings miss.

Better 4Q likely ahead. Retain HOLD

4Q should be sequentially stronger, as Kossan ramps up production output which would bring down unit production costs on the higher utilisation and increased efficiencies on the revamped lines. Nonetheless, we slashed our FY16 EPS forecast by 10% to account for the lower-than-expected sales volume growth. We retain our HOLD rating for Kossan as current valuations vis-à-vis earnings growth are unappealing from a risk-to-reward standpoint. There is no change to our 12M TP of RM6.40, pegged to 17x 2017E EPS.

Source: Affin Hwang Research - 23 Nov 2016