We are positive on Kossan (KRI’s) growth prospect going forward, underpinned by demand uptick with nascent signs of a strong volume growth rebound. With the lacklustre demand of the past 12 months behind us, we see restocking activities ramp-up as the current outbreak of the Wuhan virus enforces higher hygiene standards. TP raised from RM5.25 to RM5.90 based on 28.5x FY20E EPS (at +1.5SD above 5-year historical forward mean). Reiterate OP.

Expect a solid 4QFY19. Tell-tale signs of pent-up demand for nitrile gloves, potentially on re-stocking activities are pointing towards a better sequential quarter in 4QFY19. We expect its core 4QFY19 PATAMI, which is due to be released by end-Feb, to be higher QoQ and YoY due to: (i) new capacity expansion from plant 18, (ii) back-to-normal overall production after resolving labour shortage issue in 3QFY19, and (iii) better margins due to high operating efficiencies from new plants. For illustration purposes, assuming partial commencement of Plant 18, recommissioning of plants following revamp and upgrading works and absence of labour shortage in 2QFY19 and 3QFY19, respectively, net margin of 10%, and ASP of 9.5 sen/piece, 4QFY19 PATAMI could come in at RM59-62m (+19% to +26% QoQ; +0.5% to +4.0% YoY). This brings FY19 PATAMI to RM222m-RM226m (+11%+13%), which is within expectations at 98%/99% of our and consensus full-year forecasts.

Nitrile gloves' market share to gain momentum. Based on our analysis, we expect nitrile gloves to continue growing and grabbing market share from latex gloves. The growth in nitrile segment is evident. For illustration purposes, going forward, assuming nitrile:latex breakdown of 80:20 (67:33 currently) and based on estimated global demand of 324b pieces in 2020 (forecast for 2019 is 300b pieces and assuming 8% growth rate in 2020), this implies nitrile growth rate of 30% or an additional 51b pieces from switch to nitrile gloves. From our ground checks, demand for nitrile gloves is picking up again where players’ new capacities are being swiftly taken up. The application of higher hygiene standards to rein in the outbreak of the new Wuhan virus is expected to help ramp up re-stocking activities. Ceteris paribus, a 1% increase in volume sales will raise our FY20E Net Profit by 1%.

Plant 18 and 19 to boost earnings over next two years. Plant 18 (2.5b pieces) has commenced operations in 3Q 2019. And looking ahead, the timeline for the commissioning of Plant 19 (3.0b pieces) remains on track - latest by 1HCY20. Upon completion, Plant 17, 18 and 19 will bring the group’s total installed capacity to 32b pieces (+28%) of gloves per annum. The group expects construction of the Bidor plant to take eight years to complete, costing RM1.5b (works out to RM190m capex per annum) for an integrated glove manufacturing project.

Unwarranted PER discount valuation to peers, Maintain OP. The stock has risen 18% YTD. We continue to remain bullish and expect the stock to trade close to +2.0SD in anticipation of a ramp-up in demand from restocking activities; hence, expectation of higher earnings growth in subsequent quarters. Our TP is raised from RM5.25 to RM5.90 based on 28.5x FY20E EPS (at +1.5SD above 5-year historical forward mean). We like Kossan, reiterating the fact that it is trading at an unwarranted 20% discount to peers’ PER average considering that its prospective net profit growth is the highest at 15% compared to peers’ average of 7%. Reiterate Outperform.

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

Source: Kenanga Research - 3 Feb 2020