Earnings Blip on TRP and Cleanroom Decline

Despite strong revenue growth, Kossan only managed to eke out a sequential earnings growth of 4% in 1Q17, largely aided by the firmer performance of its Glove division while its Technical Rubber Products (TRP) and Cleanroom divisions faltered on lower margins. Kossan’s capacity expansion should begin in 2H17 with the commissioning of its Meru plant with a planned capacity of 3bn, which will likely be supportive of its sequential earnings growth. Maintain HOLD as valuations looked stretched.

Firmer Sales Growth in Gloves Division

Kossan’s 1Q17 revenue rose 14% qoq to RM500m, primarily underpinned by firm topline growth from all divisions. The glove division revenue rose 14% qoq on higher volume sales and higher ASP, and benefited from the weaker Ringgit during the quarter. Its TRP and Cleanroom divisions also saw a similar rise in the topline, on demand recovery. Despite the absence of new capacity, Kossan’s volume sales rose qoq after the completion of the revamp and upgrading works seen in 4Q16, which led to a higher utilisation rate and 2ppts improvement in the nitrile gloves mix to 72% .

But PBT Dragged by TRP and Cleanroom Divisions

Kossan’s 1Q17 core net profit of RM47m was below expectations, constituting only 21% of our previous estimate. The deviation was mainly due to the underperformance of the TRP and Cleanroom divisions, as they reported 38% and 34% qoq declines in PBT respectively, mainly on their inability to pass on the higher raw material prices, as well as the reversal of the forex translation gain. That said, the Glove division performed fairly well with a 16% qoq increase in PBT, with margin improvement on the higher operating leverage, as well as improved efficiency post the upgrading works completed in 4Q16. On the whole, Kossan’s EBITDA margin declined sharply by 6ppts to 15%.

Maintain HOLD. 12M TP Raised to RM6.30

We have lowered our 2017-19 earnings estimates by 4-9%, after taking into account lower margin assumptions for the TRP and Cleanroom divisions. After a lull period of capacity expansion, Kossan’s new plant in Meru will be progressively commissioned with a planned capacity of 3bn, beginning in July 2017. Beyond that, Kossan is also looking to construct two new plants with a combined capacity of 4.5bn, and has targeted the first commissioning date in 2Q 2018. Despite the cuts in earnings forecasts, our TP is up slightly to RM6.30 (from RM6.10), as we roll forward our valuation to CY18E on an unchanged PE of 17x.

Source: Affin Hwang Research - 26 May 2017