Period  1Q14

Actual vs. Expectations Kossan Rubber Industries (KRI)’s 1Q14 net profit of RM36.8m (+11% YoY) came in at 21% of our fullyear forecast as well as the consensus. We consider the results to be within expectation as subsequent quarters’ earnings are expected to be ramped up due to new capacity expansion.

Dividends  No dividend was declared during the quarter.

Key Result Highlights

 Sequentially, 1Q14 revenue came in 7% lower to RM306m due to the staggered conversion of 8 lines from powdered natural latex gloves to powder-free nitrile gloves, which resulted in lower volume production and sales (-6%). Note that the revamp was completed in end-April and is currently on trial run. Higher production efficiency, product mixed skewed towards nitrile coupled with lower depreciation and finance costs led to pre-tax margin rising by 1.4% to 15.4% QoQ, despite higher electricity tariff effective 1 Jan 2014. Overall, 1Q14 PATAMI fell 4.5% to RM36.8m due to higher effective tax rate of 20.8% compared to 14% in 4Q13.

 YoY, 1Q14 revenue fell 6% due to the same reasons given above. Net profit grew faster than the turnover growth due to margins expansion driven by efficiency improvement from automation, economies of scale from capacity expansion, product mix skewed towards higher margin nitrile gloves and a lower effective tax rate (20.8% in 1Q14 compared to 23.5% in 1Q13) which saw 1Q14 net profit grew 10%.

Outlook  Looking ahead, earnings growth is expected to be driven by new capacity expansion. A new plant (Plant 1) with 5 lines had been commissioned in April 2014 and shall provide a small contribution towards revenue and earnings in 2Q14. Full commercial production is expected in the 2H14. Another new plant (Plant 2) with 6 lines is expected to be commissioned in July 2014 with contributions in the 3Q14 and 4Q14. Plant 3 also with 6 lines, is expected to be commissioned in September or October 2014 with a small contribution in 4Q14. The three plants, when fully operational in FY15, will have an installed capacity of 6bn pieces of gloves. Together with the existing installed capacity of 16b pieces, the Group’s total installed capacity in 2015 would be 22b pieces of gloves per year.

Change to Forecasts No changes to our forecasts.

Rating & Valuation   Maintain our OUTPERFORM call and TP of RM5.13 based on 16x FY15 EPS.

 We like Kossan because: (i) of its superior net profit growth of 26% and 16% in FY14E and FY15E, compared to peers average of 12%, (ii) Kossan’s unprecedented earnings growth over the next two years underpinned by rapid capacity expansion, and (iii) the fact that Kossan is not just a rubber glove play but also a bet on its TRP division, which has grown steadily over the past few quarters.

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

Source: Kenanga