In an announcement to Bursa Malaysia, Kossan Rubber Industries (Kossan) is buying two pieces of leasehold industrial land measuring approximately a total 824.1 acres located in Bidor, Perak, for a cash consideration of RM82.4m. We maintain our FY18E/FY19E earnings forecasts as earnings contribution is only expected over the longer term. TP is RM7.35 based on unchanged 21.5x FY19E EPS (+1.0 SD above 6-year historical forward mean). Maintain UNDERPERFORM.

Buying land for future expansion. In an announcement to Bursa Malaysia, Kossan is buying two pieces of leasehold land measuring approximately a total 824.1 acres located in Bidor, Perak, for a cash consideration of RM82.4m from Perbadanan Kemajuan Negeri Perak. The two pieces of land are; i) a piece of vacant leasehold industrial land measuring 817.392 acres net of compulsory acquisition for RM81.8m (lease will expire on 22 November 2114), and ii) a piece of vacant leasehold commercial land measuring about 6.718 acres for RM0.7m. The price works out to RM100k per acre or RM2.29/sq ft. We expect Kossan to spend a bit more capex into this land, including widening the access road. This proposed acquisition is expected to be completed by 1Q 2019. This latest corporate development by Kossan is in line with the group’s strategy to replenish its land bank in order to build more gloves production lines in a centralised location over the medium to longer term, which are presently running at full capacity. However, we are surprised by the land size. Amplifying the strong demand for nitrile gloves, the land is highly likely to be used to house plants for the production of nitrile gloves.

Impact to financials. For illustrative purposes, the RM82.4m acquisition will not have a material impact on Kossan’s net debt and net gearing of RM84m and 12.7% as at 31 December 2017 with a strong operating cashflow averaging RM250m over the next two years. We do not have sufficient details and numbers to quantify future earnings enhancement to our earnings forecasts at this juncture.

Outlook. Going forward, headwinds including higher natural gas price hikes (average of 22%, which was announced back in Nov 2017), the strengthening of MYR against the USD (-8% QoQ Jan and Feb 2018 compared to 4Q 2017) and potential hike in minimum wage could derail earnings growth. Looking ahead, Plant 16, which was initially expected to be completed in July 2017, was completed end Dec 2017. Plant 16 has an installed capacity of 3b pieces per annum and it will focus on the Group’s patented Low Derma Technology gloves. With the completion of plant 16, the Group is now operating at 25b pieces capacity (+14%). In anticipation of higher demand for Low Derma nitrile gloves, the group has started the construction works for Plant 17 and 18. These two new plants which are equipped with high speed dipping technology and high degree of automation are capable of producing up to 4.5b pieces (+18% of current production capacity, at 1.5b and 3.0b pieces, respectively) of nitrile gloves per annum once completed in end 2018 or early 2019.

Reiterate Underperform. TP is RM7.35 based on unchanged 21.5x FY19E EPS (+1.0 SD above 6-year historical forward mean). The stock is trading at rich FY18E PER valuation of 25x and FY19E PER of 24x, compared to average growth of 8% per annum over the next two years.

Key risk to our call is faster-than-expected commissioning of the new plants.

Source: Kenanga Research - 13 Mar 2018