News  In an announcement to Bursa Malaysia, Kossan Rubber Industries (Kossan) said it is buying a piece of freehold industrial land measuring approximately 5.4 hectares (13.3 acres) located in Mukim Kapar, Daerah Klang, Selangor for a cash consideration of RM39m (RM67 per sq ft). This piece of land is located within the vicinity Kossan’s existing plants in Klang.

 The acquisition is expected to be completed by 1Q15.

Comments  This acquisition is in line with Kossan’s strategy to replenish its land bank in order to build more gloves production lines. However, Kossan has sufficient capacity to sell from its new plants over the next two years.  The land acquisition will be funded via internally generated funds. For illustrative purposes, the RM39m acquisition will not have a material impact on Kossan’s net debt and net gearing of RM66m and 8% as at 30 Sept 2014. Additionally, this acquisition could be easily funded from its operating cashflow, which we forecast will average RM242m p.a. over FY15 and FY16. We have factored in this capex into our earnings model.

 We understand the land is earmarked to construct two manufacturing plants for production of gloves, including a warehouse somewhere in FY16. For illustrative purposes, two plants are capable of producing an estimated 3.6bn pieces of gloves. Assuming ASPs of US$25/1000 pieces, 80% utilisation and net margin of 7%, this new capacity could generate a total net profit of RM18m or 7% of our FY16 forecast.

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 1Q15. 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 No changes to our 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 14% 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