Waiting for Plant 16 to Commence

Kossan’s (KRI) 1Q18 net profit of RM45.2m (-1.6% qoq, -2.9% yoy), came in within our expectation but fell short of consensus, delivering 22% and 20% of our respective full-year forecasts. Profit margins for the quarter were negatively impacted by the strengthening RM and higher fuel costs. The lower earnings were, however, partially mitigated by a lower tax rate. We are not concerned about the margin compression, as it is merely a time-lag issue, and with the new capacity starting production, we are maintaining our EPS forecasts. Our RM8.40 target price and BUY call are unchanged.

Weaker Margin (qoq) Due to Time Lag

Similar to its peers, KRI’s EBITDA margin for 1Q18 was lower by 1.3ppts to 15.5% vs 4Q17 due to strengthening of the RM and also an increase in natural gas prices. The margin compression is not due to overcapacity but is merely a time-lag issue, as management has indicated that they have successfully passed on the cost in subsequent months. We believe that current demand for rubber gloves remains robust with incremental demand coming through from the conversion of vinyl glove users to latex or nitrile.

New Capacity to Achieve Full Production by 3Q

The lack of capacity growth has hindered KRI’s ability to churn out higher revenue and profit growth, as its existing plants are already operating at around 90% utilisation rates. Management has guided that Plant 16 has started operation and is on track to achieve full production by July, as the former issue on the glove production line would be fully resolved. Plant 16 will increase its annual capacity of 25bn pcs by 12%. There are also no changes to the estimated completion date for Plant 17 (Aug’18) and Plant 18 (Jan-Feb’19).

Maintain BUY Call With An Unchanged TP of RM8.40

We are keeping our forecasts unchanged, as we are expecting a stronger earnings growth in the 2H18 with the new capacity coming on stream. Our TP of RM8.40 is based on a 2019E PER of 22x, which is at +1stdev above its historical average. We believe the stock is still undervalued, trading only at 18.6x 2019E PER.

Source: Affin Hwang Research - 25 May 2018