Kossan reported a sequentially weaker result where earnings declined by 2.2% qoq but grew by 11.1% yoy. The glove division continued its rebound with stronger revenue and margins during the quarter but was offset by the weaker performance at the Technical Rubber Products (TRP) and Cleanroom divisions. However, we believe that capacity expansion from 2H17 onwards will be supportive of future earnings growth, especially in 2018E-2019E. Maintain HOLD with a higher target price of RM7.30 as valuations have priced in the better prospects ahead.

Firmer Growth in Glove Division

Kossan’s 2Q17 revenue fell 1.9% qoq, mainly due to the absence of new glove capacity and weaker demand for its TRP and Cleanroom divisions. PBT margin was flat despite better margins from the glove division as TRP and Cleanroom divisions continue to suffer from the longer time lag in passing on higher raw material costs to customers. Utilisation rates at the glove plants remained high ~82% during the quarter while nitrile gloves mix was maintained at 72%. Overall, the 1H17 net profit was slightly below expectations, coming in at 42% and 43% of ours and consensus full year earnings forecasts mainly due to weaker than expected margins in 1H17.

Looking Ahead for Clearer Volume Growth

After some production interruptions and a relatively lull period of capacity expansion in 2016 and 1H17, we believe that there is now more clarity on capacity growth. The new Plant 16 in Meru with 3.0bn capacity has started since Jul-17 and expected to be fully commissioned by 4Q17. Meanwhile, two new plants, Plant 17 and 18 with capacity of 1.5bn and 3.0bn respectively are also earmarked to commission in 1H18 and 2H18.

Maintain HOLD; TP Raised to RM7.30

While we are positive on the addition of capacity, we however believe that the financial effects will only be more visible over 2018E-19E. As such, we have lowered our 2017E earnings by 6.2% to take into account the weaker 1H17 results but raised our 2018E-19E earnings estimates by 3.6-7.4%, to incorporate the impact of higher capacity and volume growth. We raise our target price to RM7.30 by pegging a rolling 3-year mean PER of 19x on our revised CY18E EPS. Nonetheless, we maintain our HOLD call as we believe that Kossan is currently fairly valued and has priced in the better prospects ahead.

Source: Affin Hwang Research - 25 Aug 2017