Period  2Q14/1H14

Actual vs. Expectations Kossan Rubber Industries (KRI)’s 1H14 net profit of RM71.4m (+7.2% YoY) came in below expectations at 40-41% of our full-year forecast as well as that of the consensus. The variance to our numbers is due to slower-than-expected commercial production of the new plant as well as lower output due to water disruption in April 14.

Dividends  No dividend was declared during the quarter.

Key Result Highlights Sequentially, 2Q14 revenue came in flat to RM303m (-0.8% QoQ) due to lower ASP and lower volume sales (-2.4%). The lower volume sales was due to the staggered conversion of lines from powdered natural latex gloves to powder-free nitrile gloves, slower-than-expected commercial production of new plants and production output was also slightly affected during the state-wide water rationing in the month of April. EBITDA margin fell slightly by 0.6%-pts from 20.3% in 1Q14 to 19.7% in 2Q14 despite higher natural gas prices. Overall, 2Q14 PATAMI fell 6% to RM34.6m due to higher effective tax rate of 21.2% compared to 20.8 in 1Q14.

 YoY, 1H14 revenue fell 6% due to lower volume sales (-6%) due to the reasons stated 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 (21% in 1H14 compared to 23% in 1H13) which saw 1H14 net profit grew 7.2%. Product mix between nitrile and latex is 57% : 43% in 1H14 compared to 51% : 49% in 1H13.

Outlook  Looking ahead, earnings growth is expected to be driven by new capacity expansion. Three plants with a total of 17 production lines producing 6bn pieces of gloves will be completed in various stages. Plant (1) with 5 lines was completed in June with commercial production in August 2014. The remaining Plant (2) and (3) with a total of 12 lines are expected to be operational in September and November; and scheduled for full commercial production in Nov 2014 and Jan 2015, respectively. These three plants, when fully operational by end 2015, will enlarge installed capacity from the existing 16b to 22b pieces of gloves per annum.

Change to Forecasts We downgrade our FY14E and FY15E net profits by 8% and 5%, respectively, taking into account of the slower-than-expected commercial production of the new plant.

Rating & Valuation  Correspondingly, our TP is reduced by 5% from RM5.13 to RM4.86 based on 16x FY15 EPS.

Maintain OUTPERFORM.

 We like Kossan because: (i) of its superior net profit growth of 16% and 20% in FY14E and FY15E, compared to peers average of 10-12%, (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