KOSSAN’s FY22 results missed expectations due to weak sales volume and margins. Given a depressed utilisation rate of only 50% across the industry, the weak earnings undertone is expected to persist in subsequent quarters. Hence, we now project a FY23F net loss of RM28m instead of a profit. Despite changing our valuation to asset-base from earnings previously, we maintain our TP at RM0.85 and reiterate UNDERPERFORM.

FY22 core net profit of RM151m (-95% YoY) fell short of our forecast and the consensus estimates by 7% and 10%, respectively, weighed down by a core net loss of RM8m in 4QFY22. The variance against our forecast came largely from weaker-than-expected sales volume and margins.

QoQ, 4QFY22 revenue fell 14% due to lower ASP (-12%) and volume sales (-3%). EBITDA plunged 51% due to: (i) excess capacity leading to reluctance of customers to commit sizeable orders and hold substantial stocks on expectations of further price decline, (ii) the sale of high-priced inventory at falling market prices which could well mean that certain shipments were sold at a loss, and (iii) reduced economies of scale, particularly, poor cost absorption. This brings 4QFY22 core net loss to RM8m compared to a profit of RM23m in 3QFY22. A 1st interim dividend of 2.5 sen was declared which came in below our expectation. YoY, FY22 revenue fell 65%, due to lower ASP (-60%) and sales volume (- 23%). As a result, FY22 PATAMI fell 95%.

Outlook. MARGMA projects 12%-15% growth in the global demand for rubber gloves annually from 2023, following an estimated 19% contraction to 399b pieces in 2022. It believes the supply-demand equilibrium may return in 6-9 months. However, we beg to differ, expecting the overcapacity situation to persist at least over the next two years. Based on our estimates, the demand-supply situation will only start to head towards equilibrium in 2025 when there is virtually no more new capacity coming onstream while the global demand for gloves continues to rise by 15% per annum underpinned by rising hygiene awareness. Still, capacity is seen to expand further in 2023. We project the demand for gloves to rise by 15% in 2023, which is consistent with MARGMA’s forecast. However, this will do little to ease the overcapacity situation as the global glove production capacity will grow by 16% to 595b pieces during the year as more capacity planned by incumbent and new players during the pandemic years—enticed by super-fat margins that had evaporated—finally come on-line. This will result in the excess capacity rising by 22% to 137b pieces from 112b pieces in 2022. The expanded overcapacity means low prices and depressed plant utilisation will likely persist in 2023. Not helping the already dire situation is the reluctance of customers to commit to sizeable orders and hold substantial stocks on expectations of further decline in prices.

Loss of RM28m now expected for FY23F, a reversal from a profit forecast as we reduce utilisation rate assumption to 45% from 55% and cut EBITDA margin assumption to 5% from 12%. We also introduce FY24F numbers into our earnings model.

Reiterate UNDERPERFORM. We rationalise our valuation basis to asset-based (from earnings-based previously) as we believe its earnings will remain depressed at least over the next 12-18 months. Our TP is unchanged at RM0.85 based on 0.6x FY24F BVPS, at a 60% discount to the sector’s average of 1.7x charted during previous downturns in 2008-2011 and 2014- 2015 as we believe the current downturn could be one of the deepest ever after imputing a 5% discount for a 2-star ESG rating as appraised by us (see Page 4). We are cautious due to: (i) the glove oversupply seen persisting over the next two years as a result of massive industry-wide capacity expansion, amplified by low utilisation rate averaging 40%-50% implying weakening demand, and (ii) ASPs yet to bottom out.

Key risks to our recommendation: (i) the industry turning the corner sooner on stronger-than-expected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (ii) industry consolidation reducing competition among players, and (iii) epidemic and pandemic occurrences.

Source: Kenanga Research - 17 Feb 2023