Period  3Q14/9M14

Actual vs. Expectations Kossan Rubber Industries (KRI)’s 9M14 net profit of RM105.8m (+3.7% YoY) came in below expectations at 65% 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 and higher-thanexpected start-up cost incurred.

Dividends  An interim 3.5 sen tax exempt dividend was declared, which will go ex-div on 8 Dec 2014.

Key Result Highlights Sequentially, 3Q14 revenue rose 8% to RM328m due to higher sales volume (+7.5%) which more than offset lower ASPs, on contribution from additional new 5 lines. EBITDA margin fell slightly by 1.3%bps from 19.7% in 2Q14 to 18.4% in 3Q14. This quarter marks the second consecutive quarters of margins decline. The decline could be due to a combination of both competitive pressure and start-up costs incurred in commercial production of the new plant. Overall, 2Q14 PATAMI came in flat at RM34.4m.

 YoY, 9M14 revenue fell 4.5% due to lower sales volume (-5%) due to the the staggered conversion of lines from powdered natural latex gloves to powderfree nitrile gloves, and slower-than-expected commercial production of new plants. Furthermore, production output was also slightly affected during the state-wide water rationing in the month of April. 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 9M14 compared to 23% in 1H13) which saw 1H14 net profit grew 4%.

Outlook  Looking ahead, earnings growth is expected to be driven by new capacity expansion. The current order for gloves is fully taken up for the remaining quarter of 2014. The remaining 2 plants i.e. Plant (2) with 6 lines delivered in September and we understand that buyers have been found; and Plant (3) with a total of 6 lines is scheduled to be delivered in Dec. The three new 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 are cutting our FY14E net profit by 8% to take into account of the slower-than-expected commercial production of the new plant and higherthan-expected start-up cost incurred. We maintain our FY15E forecasts.

Rating & Valuation Maintain OUTPERFORM and TP of RM5.23 based on 16x FY15 EPS. We like Kossan because: (i) of its superior net profit growth of 38% and 13% in FY15E and FY16E, compared to peers average of 10-12%, respectively, the 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