Period  2Q13/1H13

Actual vs. Expectations  Kossan Rubber Industries (“KRI”)’s 1H13 net profit of RM66.6m (+46% YoY) came in within expectations, at around 52% of our and the consensus full-year net profit estimates.

Dividends  No dividend was declared during the quarter.

Key Result Highlights  Sequentially, 2Q13 revenue came in flat at RM321m compared to the preceding quarter as volume sales hit close to full capacity. Similarly, 2Q13 net profit came in flat at RM33.5m due to a slightly lower pre-tax profit contribution from the gloves division (-0.9%) but mitigated by a lower effective tax rate.

 However, as compared to 2Q12, net profit rose 42% YoY driven by higher gloves sale volume (+23%) due to capacity expansion and margin expansion on lower raw material costs.

 1H13 YoY, revenue rose 9% to RM648.8m driven by its gloves division (+10.3%) due largely to a higher sales volume (+21%), which more than offset the lower ASPs as well as slightly lower contribution from the technical rubber product (“TRP”) division. Net profit grew faster than the turnover due to margins expansion driven by the lower average latex input price catapulting 1H13 net profit higher by 46% to RM66.6m.

Outlook  Going forward, Kossan plans to build new lines once its capacity utilisation hit 80% instead of 90% as in the past. This strategy will allow Kossan the spare capacity to capitalise on potential new sale enquiries as well as meeting specific requirement needs from its clients. Plans to build three new plants are on track targeting nitrile gloves, which are expected to boost its capacity by additional 5b pieces of gloves or 31%, bringing its total installed capacity to 21b pieces p.a. The first plant is expected to be completed by end 4Q13 and the remaining two by May 2014. For illustrative purposes, assuming 8% net profit, ASPs of RM95/1000 pieces and utilisation rate of 80%, this new capacity could generate a total net profit of RM30m or 19% of our FY14 forecast.

Change to Forecasts  No changes to our FY13 and FY14 forecasts.

Rating & Valuation  Maintaining our OUTPERFORM call and target price of RM6.88 based on 14x FY14 EPS.

 We like Kossan because: (i) of its superior net profit growth of 18% and 27% in FY13E and FY14E respectively compared to an average of 13% and 12% for Top Glove and Hartalega in FY13E and FY14E, (ii) Kossan’s unprecedented earnings growth is underpinned by rapid capacity expansion over the next two years, (iii) it is gradually raising its dividend payout ratio (Kossan recently declared a final 7.0 sen tax-exempt dividend. This brings its total full-year FY12 DPS to 12.5 sen, implying a 38% payout ratio – well ahead of its <20% payout ratios in the past three years); and (iv) the fact that Kossan is not just a rubber glove play but a bet on its TRP division, which is growing over the past few quarters.

Risks  Delay in commissioning of new production lines.

Source: Kenanga