Although Kossan (KRI) reported a decent set of results for 9M19, with core-PATAMI of RM163.8m (+16% yoy), it is still for short of both consensus and our expectation, accounting for only 69% and 68% of respective full-year estimates. We were expecting a stronger 3Q19, as Plant 18 was supposed to be operational, but labour issues have delayed the full commissioning of the plant. The issue has since been fully-resolved. Meanwhile, we are keeping our BUY call unchanged, but with a lower TP of RM5.60 (from RM6.00) after trimming our 2019E-21E earnings by 5-7%.

Labour Issues at Plant 18 Limited Contribution to Operations

Initially, we were expecting Kossan to deliver stronger earnings (both qoq and yoy) in 3Q19, driven by the addition of Plant 18 to its operations (with an annual capacity of 2.5bn pcs, representing 10% of group’s capacity). However, workers for the new plant was insufficient, and the problem was only resolved around Nov19. We believe that the shortage issue was because of the allegation made by foreign papers on forced-labour in Malaysia. Management is now guiding that Plant 19 (3.0bn pcs), which will start commissioning by 1Q20, should not encounter the similar issue faced by Plant 18.

Higher Operating Costs Erode Profit Margin in 3Q19

The decline in 3Q19 EBITDA margin (16.5%, down 1.2ppts qoq) was due to the higher operating costs (ex-raw material cost), which can be attributed to the hike in natural gas prices and the start-up costs of Plant 18. However, we believe that as Plant 18 starts to run at its optimal utilisation rate, KRI should be able to achieve better profitability in the coming quarters. As the hike in gas prices is similarly faced by other manufacturers, we expect KRI to pass on the higher cost to its customers in 4Q19 (we think a price hike of less than 0.5% is suffice). As China gloves to the US are now subject to a 15% tariff, we reckon that demand for Malaysia’s gloves should improve too.

Reaffirm BUY Call With a Lower TP of RM5.60 (from RM6.00)

We are lowering our EPS forecast by 5.0%-7.2% for FY19-20E, to factor in some delay in the start-up of KRI’s Plant 18, due to the labour shortage issue. We are also revising down our TP to RM5.60 (based on 27x 2020E PER) due to the cut in earnings forecasts. We maintain our BUY call Kossan remains our preferred pick for the sector.

Source: Affin Hwang Research - 22 Nov 2019