Period  3Q13/9M13

Actual vs. Expectations Kossan Rubber Industries (KRI)’s 9M13 net profit of RM102.1m (+37% YoY) came in above our expectation, at 83% of fullyear forecast. However, it is within the consensus expectation at 77% of full-year estimate. The variance from our result is due to better-than-expected margin expansion.

Dividends  An interim tax-exempt dividend of 3.5 sen was declared during the quarter which will go ex-div on 6 Dec 2013.

Key Result Highlights Sequentially, 3Q13 revenue came in 4% higher to RM334m as utilisation rose to 85% from 83% and volume sales hit close to full capacity. However, 3Q13 pre-tax profit grew stronger by 8% to RM48m (+8% QoQ) due to margin improvement from 13.7% in 2Q13 to 14.3% in 3Q13, emanating from sustained low raw material price, efficiency improvement from automation, and economies of scale from capacity expansion. Specifically, the growth at pre-tax profit level was largely due to solid improvement at the technical rubber product division (+65% QoQ) due to increased sales volume of higher value infrastructure products and lower input latex cost. This brings 3Q13 net profit to RM35m (+6% QoQ).

 9M13 YoY, revenue rose 7% to RM982.4m driven by its gloves division due largely to a higher sales volume (+21%) and solid contribution from the TRP division (+21%). Net profit grew faster than the turnover due to margins expansion driven by the lower average latex input price, efficiency improvement from automation, and economies of scale from capacity expansion which catapulted 9M13 net profit higher by 37% to RM102m.

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. We understand that the first plant with an estimated installed capacity of 1.5b-1.8b pieces is on track to commence operations by end Dec.

Change to Forecasts We maintain our FY14 net profit forecast for now. However, we are raising our FY13 net profit forecast by 9% due to this better-than-expected quarter.

Rating & Valuation     Maintain our OUTPERFORM call and target price of RM3.93 based on 16x FY14 EPS.

 We like Kossan because: (i) of its superior net profit growth of 29% and 16% 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 FY13 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 rapidly.

Risks to Our Call  Delay in commissioning of new production lines.

Source: Kenanga