KOSSAN’s 9MFY23 results beat expectations with a surprise profit in 3QFY23 thanks largely to lower input costs. We now project a RM44m net profit in FY23 (from a RM76m loss), raise our FY24F earnings by 3x from a low base and lift our TP by 5% to RM1.34 (from RM1.28). Nonetheless, its valuations are lofty despite the improved outlook. Downgrade to UNDERPERFORM from MARKET PERFORM.

KOSSAN’s 9MFY23 results beat expectations with a small profit of RM13m vs. our full-year net loss forecast of RM76m and a full-year consensus net loss of RM66m. The variance against our forecast came largely from lower-than-expected input costs.

QoQ, its 3QFY23 revenue rose 4% due to higher volume sales (+10%) which more than offset a lower ASP (-5%). Its EBITDA rose >100% albeit from a low base effect in 2QFY23 and also due to, we believe, (i) lower natural gas price (-8%) and input raw material prices (-15%) and (ii) marginally improved utilisation rate. As a result, its 3QFY23 returned to the black registering a net profit of RM41m compared to a loss of RM3.3m in 2QFY23. No dividend was declared in this quarter as expected. YoY, 9MFY23 revenue dropped 35% due to lower ASP (-23%) and volume sales (-25%). This brings 9MFY23 net profit to RM13m compared to a profit of RM159m in 9MFY22.

Outlook. We expect the operating environment to continue to remain challenging as the sector continues to grapple with subdued ASP and low plant utilisation amidst intense competition, especially from Chinese producers. The ASP is expected to come under pressure in the next two quarters following lower natural gas prices, as competition will compel glove players to eventually pass on the cost savings to customers. Moreover, we gathered the industry expect volatile quarterly sales order as distributors or buyers sees no urgency to place sizeable orders or hold substantial stocks as supply is plentiful and readily available.

We expect the operating environment to remain challenging in subsequent quarters, plagued by massive oversupply. Nevertheless, we expect the oversupply situation to be less acute and gradually improve following signs of players culling production capacity via decommissioning of selective plants. 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. 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 12 months. We project the demand for gloves to rise by 15% in 2023, which is consistent with MARGMA’s forecast. This will result in an excess capacity of 112b pieces (instead which is similar to CY22. Despite the improvement, the overcapacity still persists which means low prices and depressed plant utilisation will continue to plague the industry in 2023.

Forecasts. We now project a net profit of RM44m in FY23 (previously net loss of RM76m) as we assume a higher EBITDA margin of 11% (previously 1%) due to lower-than-expected input raw material and natural gas prices. We raise our FY24F net profit by 3x as we lift our EBITDA margin assumption to 14% (from 9%).

We raise our TP by 5% to RM1.34 (previously RM1.28) due to a higher FY24FBVPS projection. Our valuation basis remains unchanged at 0.9x FY24F BVPS, at 60% discount to the sector’s average of 1.7x charted during previous downturns in 2008−2011 and 2014−2015. Our TP reflects a 5% discount to account for a 2-star ESG rating as appraised by us (see Page 4).

At 42-87x forward PER and forward ROE of only 1-2%, its valuations are lofty despite the improved outlook. Its valuations may become even more mind boggling assuming a knee-jerk reaction to the upside following this set of encouraging results. Downgrade to UNDERPERFORM from MARKET PERFORM.

Key risks to our recommendation are: (i) Certain Chinese glove giants stop predatory pricing practices (i.e. selling below cost over an extended period of time to eliminate competitors), leading to a strong earnings rebound for the sector, (ii) stronger-thanexpected growth in demand for gloves driven by rising hygiene standards and health awareness globally, (iii) industry consolidation reducing competition among players, and (iv) epidemic and pandemic occurrences.

Source: Kenanga Research - 16 Nov 2023