Although Kossan (KRI) reported weaker results for the quarter, as 2Q19 PATAMI of RM55.9m is lower by 4.8% qoq, overall performance in 1H19 was still within expectations, as 1H19 PATAMI of RM114.6m (+30% yoy) is 48% and 47% of consensus and our full-year estimates. The weaker-than-expected 2Q19 performance was due to major revamp and upgrading works carried out on their plant, which disrupted production for around 5 days (5-7% output). However, we expect stronger quarters ahead, as Plant 18 &19 will start contributing in 2H19. Reiterate BUY with unchanged TP of RM6.00.

Better Quarters Ahead With Plant 18 & 19

For the 1H19, PBT for the glove division rose by 38% yoy driven by the 15% yoy increase in sales volume, supported by the full contribution from Plant 16 & 17, which commence operations in 2H18. Although volume growth in 2Q19 contracted by around 7% qoq due to the upgrading works, management guided that the impact is likely to be one-off and it was scheduled in conjunction with the seasonally soft demand month. We believe volume will continue to grow in the coming quarters, as Plant 18 & 19 are expected to start contributing. Plant 18 & 19 will add another 15-17% to KRI’s current capacity.

Being Rationale Key to Sustain Profitability

We view the decision to schedule upgrading works during the seasonally low demand period as positive, as it will reduce the pressure on ASP and maintain the utilisation rate of the factories. We believe that the weaker demand was partly due to the increase in China glove imports into US, as buyers stock up in anticipation of the 10% tariff hike. Nevertheless, it is crucial for the Malaysian manufactures to act rationally and adjust their capacity according to market demand in order to maintain their profitability, in our view. We are expecting a stronger 2H, as the hike in tariff on China gloves is likely to boost demand for Malaysia produced gloves.

Reaffirm BUY Call With An Unchanged TP of RM6.00

We are keeping our forecasts unchanged, as the 1H19 results are broadly in line with our expectations. We are also keeping our BUY call unchanged and TP at RM6.00 (based on 27x 2020E PER). Kossan remains our top sector and country BUY.

Source: Affin Hwang Research - 23 Aug 2019