Kossan’s (KRI) 9M17 net profit came to RM137.7m (+9.0% yoy), below our and consensus expectations, constituting only 68% and 66% of respective forecasts. Like other rubber glove manufacturers, KRI has benefited from strong glove demand. However, gains were offset by the weaker performance at its other division. As such, we are fine tuning our EPS for 2017-19E by -3%/+0.7%/+0.8%, which leads to a higher TP of RM7.40. We maintain our HOLD call, as we believe the current valuation has priced in the better earnings prospects of KRI.

Rubber Glove PBT Growth Supported by Stronger Demand

KRI’s lower-than-expected earnings were mainly due to the absence of contribution from its new plant (Plant 16), which was scheduled to start operation by 1H17, but has now been delayed to January 2018. The new capacity was expected to increase its capacity by around 15-20%. Despite the lack of new capacity, PBT for the rubber glove segment in 9M17 grew by 15% yoy, as KRI was able to keep the savings from the lower raw material cost due to strong demand for gloves. We believe that growth for the segment is sustainable, due to the stronger demand for gloves coupled with the new capacity. This note marks a transfer of analyst coverage.

Weak Performance From Technical Rubber Products Offsets Gains

Despite strong performance in its rubber glove segment, the group’s overall PBT in 9M17 only grew by 7.3% yoy, due to a sharp decline in PBT for its Technical Rubber Product (TRP) segment by 15.3% yoy. Profitability in the TRP segment is negatively correlated to rubber prices, as production is based on a project-basis with sales prices locked-in at contract start. We expect profitability of the segment to improve in coming quarters, as rubber prices are on a downward trend, since peaking at the start of the year.

Maintaining HOLD; Fine-tuning Our TP to RM7.40

Although we trim our 2017E EPS to build in the weak performance, we are still optimistic about earnings growth, as the new capacity should be fully operational by January 2018, and strong rubber glove demand should help support margins. Despite our slightly higher 12-month TP of RM7.40 (from RM7.30), based on a 2018E PER of 19x (from 18x), the past-3-year rolling average, we maintain our HOLD call as we see KRI shares as fairly valued. Downside risk: adverse currency swing; upside risk: TRP margin recovery.

Source: Affin Hwang Research - 24 Nov 2017