1Q16 net profit of RM51.3m (+13% YoY; -7% QoQ) came in within expectations, at 22% of both our and consensus full-year forecasts. Maintain OUTPERFORM and TP of RM8.00 based on unchanged 19x FY17E EPS. No dividend was declared in this quarter. We like Kossan for: (i) its undemanding valuations at 16.3x FY17E EPS compared to its closest nitrile-centric peer, Hartalega which is trading at 23.2x CY17E EPS and (ii) its net profit growth averaging 14.2% for FY16E and FY17E.

Key Result Highlights QoQ, 1Q16 revenue fell by 6% to RM412m due largely to lower contribution from gloves division, which accounted for more than 86% of total revenue. Specifically, gloves revenue fell 6% due to lower ASPs by 6.9% but negated by volume growth (+1.7% QoQ). Pre-tax margin fell to 15.9% in 1Q16 compared to 17.9% in 4Q15 due to strengthening of RM against the US dollar, increased production cost (higher raw material prices and natural gas cost), and stiffer pricing competition. The product mix of nitrile and natural rubber for the current quarter stood at 70:30 (unchanged compared to 4Q15). This brings 1Q16 net profit to RM51.3m (-7% QoQ) mitigated by a lower effective tax rate of 20% compared to 28% 4Q15.

YoY, 1Q16 revenue rose 12% across the board namely rubber gloves (+10%), technical rubber products division (+18%) and clean room gloves (+33%). Gloves turnover was largely driven by an 8% volume growth. However, despite price competition and cost pressure from raw material prices and natural gas cost, 1Q16 pre-tax profit rose 11% to RM65.7m as pre-tax margin only fell marginally to 15.9% compared to 16% in 1Q15. This brings 1Q16 PATAMI to RM51.3m (+13% YoY) due to a lower effective tax rate of 20% compared to 22% in 1Q15.

Outlook. Looking ahead, over the medium-term, the industry could face intense price competition due largely to expended new capacities coming on stream into the market. In an effort to mitigate the impact from the pricing competition, the Group is currently emphasizing on its patented accelerator free nitrile glove and other unique types of glove. Notably, demand for both its patented accelerator free nitrile glove and other unique types of glove are growing strongly but the production capacity available is insufficient to cater for the rising orders from customers. Over the next subsequent quarters, earnings will be underpinned by the balance capacity of some 2.0b pieces of glove spilling over from two plants which were completed in July 2015. Beyond FY16, the Group is currently constructing one new plant at Jalan Meru (“Site 1”) which is capable of producing 3.0b pieces of glove per annum. The construction work has since commenced in May 2016 and is expected to complete in third quarter of 2017. For Bestari Jaya land (“Site 2”), there is plan to construct another new plant with output capacity of 4.5b pieces of glove per annum by end of the year and this plant is expected to complete within the first quarter of 2018.

Maintain Outperform with TP of RM8.00 RM8.00 based on unchanged 19x FY17E EPS. We like Kossan for: (i) its undemanding valuations at 16.3x FY17E EPS compared to its closest nitrile-centric peer, Hartalega, which is trading at 23.2x CY17E EPS, (ii) its net profit growth averaging 14.2% for FY16E and FY17E, and (iii) its gradually rising dividend payout ratio (Kossan recently declared a final 6.5 sen tax-exempt dividend which brings its total full-year FY15 DPS to 12.0 sen, implying a 38% payout ratio – well ahead of its <20% payout ratios in the past five years), and (iv) the unprecedented earnings growth over the next two years underpinned by rapid capacity expansion. 

Source: Kenanga Research - 25 May 2016