We are positive on Kossan’s earnings prospect, underpinned by take-ups for its Plant 16 and Plant 17 and also expect margins improvement due to better operational efficiencies from the new plants. We like Kossan because it is trading at an unwarranted 25% discount to peers’ PER average considering that its net profit growth is the highest compared to peers. TP is RM5.25 based on 25.5x FY20E EPS (+1.0SD above 5-year historical forward mean). Maintain OP.

Expect solid YoY 2Q19/1H19 earnings growth. We expect its core 2Q19 PATAMI, which results are due to be released by end-Aug 2019, to be higher QoQ and YoY due to: (i) new capacity expansion and better margins due to high operating efficiencies from new plants, and (ii) a favourable USD/MYR rate (+3% QoQ). For illustration purposes, if we deduct our full-year net profit forecast of RM248.4m against 1Q19 PATAMI and divide by three (remaining three quarters), we expect 2Q19 PATAMI to be RM63m (+7% QoQ; +45% YoY). This brings 1H19 PATAMI to RM121.7m (+38%), which is within expectations at 49%/51% of our and consensus full-year forecasts.

Sturdy new plants, margins to improve. We expect gradual margins expansion from the fully-completed Plant 16, Plant 17 and eventual completion of Plant 18 and 19 by 2019. This is simply because the new plant is designed to save heating and electricity cost via the use of computerised control system and efficient usage of a single boiler instead of two as in the older plants. Additionally, the introduction of robotic packing system would lead to two-third lesser manpower requirements at the packing division. The older plants could see stable margins emanating from lower downtime due to their focus on larger orders for single product type and specification, thus reducing idle downtime from frequent machinery setting adjustments to accommodate diverse specifications.

Plant 16,17,18 and 19 to boost earnings over next two years. Looking ahead, Plant 16 and Plant 17 are expected to anchor subsequent quarters’ earnings, which was fully commissioned in Aug 2018 and end 2018. Construction works for Plant 18 (2.5bn pieces) and Plant 19 (3.0bn pieces) are currently on track, with expected full commissioning by 3Q 2019 (two lines currently commissioned) and 4Q 2019, respectively. Upon completion, these two new plants will add an additional 5.5b pieces of gloves per annum, bringing the group’s total installed capacity to 35bn (+19%) pieces of gloves per annum by endFY19. The Group expects construction, which will start somewhere in 2019, to take eight years to complete, costing RM1.5b (works out to RM190m capex per annum) for an integrated glove manufacturing project in Bidor, subject to all relevant approvals being obtained. The expected capacity at the Bidor plant is estimated at 34bn pieces per annum, which will more than double from 32b pieces currently (once Plant 18 and Plant 19 are fully commissioned).

Stock under-appreciated, unwarranted PER discount valuation to peers, Maintain Outperform. We maintain our FY19E/FY20E earnings forecasts. Our TP of RM5.25 is based on 25.5x FY20E EPS (+1.0SD above 5-year historical forward mean). We like Kossan because it is trading at an unwarranted 25% discount to peers’ PER average considering that its net profit growth is the highest at 23.7% compared to peers average at 9%. Reiterate Outperform.

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

Source: Kenanga Research - 5 Aug 2019