1H16 PATAMI of RM92.3m (-0.7% YoY) came in below expectations, at 39% and 41% of our and consensus full-year net profit forecasts. The negative variance was due to lowerthan- expected (i) volume, from the unexpected plant revamp work on one of the plants, and (ii) ASPs. By the same token, we conservatively cut our FY16E and FY17E net profits by 7.7%. Correspondingly, our TP is cut from RM8.00 to RM7.23 based on unchanged 19x FY17E revised EPS. Maintain OUTPERFORM.

Key Result Highlights

QoQ, 2Q16 revenue fell by 2.1% to RM404m due largely to lower contribution from gloves division, which accounted for more than 86% of total revenue. Specifically, gloves revenue fell 2.4% due to lower ASPs and volume growth (-1.5% QoQ) as a result of the revamp work on one of the plants, which commenced in 2Q16 led to loss of production output. Pre-tax margin fell to 12.6% in 2Q16 compared to 15.9% in 1Q16 due to strengthening of RM against the US dollar, increased production cost (higher raw material latex prices +26% QoQ), and stiffer pricing competition. This brings 2Q16 net profit to RM41m (-20% QoQ) mitigated by a lower effective tax rate of 17.5% compared to 20% in 1Q16. No dividend was declared in this quarter.

YoY, 1H16 revenue rose 8% across the board namely rubber gloves (+7.4%) and technical rubber products division (+10.5%) and clean room gloves (+11.5%). Gloves turnover was largely driven by 5% volume growth. Due to price competition and cost pressure from raw material prices and higher natural gas cost, 1H16 pre-tax profit fell by 2.3% as pre-tax margin fell to 14.3% from 15.8% in 1H15. This brings 1H16 PATAMI to RM92.3m (-0.7% YoY).

Outlook. Looking ahead, over the medium-term, the industry could face intense price competition due largely to expanded 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. Elsewhere, revamp works on older plants are on-going in a continuous effort to automate and make them more efficient.

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 be completed in the third quarter of 2017.

Maintain OUTPERFORM, cut FY16E and FY17E net profits. Due to the poor set of results, we conservatively cut our FY16E and FY17E net profits by 7.7% to take into account the lower-than-expected ASPs. Correspondingly, our TP is lowered from RM8.00 to RM7.23 based on unchanged 19x FY17E EPS. We like Kossan for its undemanding valuations at 16.4x FY17E EPS compared to its closest nitrile-centric peer, Hartalega, which is trading at 23.2x CY17E EPS.

Source: Kenanga Research - 24 Aug 2016