We remain positive on Kossan’s prospects in FY21 following a meeting with management together with other sell-side analysts. The highlights are as follow:- (i) minimal impact to bottom-line from COVID cases in its plants (ii) management is confident of sustained strong demand with orders filled up till end-CY21, with ASP playing catch-up in 4QFY20 and 1QFY21, and (iii) given that gloves shortage will likely persist until end-2021 and management’s view that a decline in ASP in 2022, if any, is expected to be gradual driven by re-stocking activities. We maintain our target price of RM9.36 based on 11x FY21 EPS. Reiterate OP.

Hit by COVID infections but minimal impact to FY20E net profit. The group conducted a voluntary COVID-19 screening test in its Glove division from Dec 4 to Dec 10. Out of a total of 7,004 workers, five out of six locations registered zero cases with only one site reporting 427 positive cases out of 2,104 employees. The factory stopped operations for sanitisation which has been completed. Presently, the 1,667 workers are undergoing quarantine and will undergo a 2nd round of test on 16 and 17 Dec and the results are expected to be out on Dec 18. Thereafter, the group will undergo random sampling for antigen test due to asymptomatic symptoms in every two weeks (20% of workers). The operation is expected to gradually ramp up productions by Dec 20. The temporary loss in production comprised 25% of total output volume for two weeks which is expected to impact FY20E bottom-line by 2%.

ASP to rise in 4QFY20 and 1QFY21. The group is confident of sustained strong demand with orders filled up till end-CY21, reassuring us that lag impact from ASP hike will be felt in 4Q 2020 (50% QoQ)) and 1Q 2021 (+30% QoQ). Management highlighted that it is difficult to predict when ASP will retrace but they stopped short of believing ASP hikes will gradually ease sometime in 4Q 2020, but more likely a case in 2022 (rather than facing a steep decline) depending on the outcome of the effectiveness of COVID vaccines. A retracement in ASP then, if any, would likely in their view, be gradual to be driven by restocking activities.

Planned capacity expansion. The planned capacity over the next two years are: (i) Plant 20 located adjacent to Plant 18 and 19 with 1.4b pieces capacity is expected to come on stream by early 2021, (ii) recently acquired land in Meru adjacent to one of its current plants is earmarked for a single plant with 5b pieces capacity and to be completed in two phases i.e. Phase 1 – 6 lines, 2b pieces commence in 2H 2021 and Phase 2 – 10 lines, 3b pieces commence in 1H 2022, and (iii) Bidor – 12 lines with 4b pieces capacity to fully commission in 2H 2022.

Maintain OP. We highlight that to reduce the spread of COVID-19 infection; vaccine coverage should reach at 60%-70% to build some form of herd immunity. Typically, herd immunity occurs when enough people in a population develop protection against a disease that it can no longer spread easily among them. Elsewhere, to scale up production of vaccines and distribution could pose a challenge which means the pandemic is likely to remain over the medium term. We maintain our target price of RM9.36 based on 11x FY21 EPS. Reiterate OP.

Key risk to our call is lower-than-expected ASP and demand beyond FY21.

Source: Kenanga Research - 16 Dec 2020