Kossan Rubber Industries Berhad Maintain BUY

Earnings impacted by ongoing revamp works Revised Target Price (TP): RM7.85 (Previously RM8.60)

INVESTMENT HIGHLIGHTS

• 3Q16 earnings below expectations

• Earnings dragged by ongoing revamp of production lines

• Costs rationalisation efforts to continue

• FY16 and FY17 earnings forecasts revised down by -22% and -8.6% respectively

• Maintain BUY with a revised TP of RM7.85

Below expectations. Kossan’s 3Q16 earnings came in at RM34.7m. This brings its 9M16 earnings to RM128.9m, which is below our and consensus’ earnings expectations, accounting for 57.3% and 59.6% of full year FY16 earnings forecasts respectively. Revenue declined by - 6.3%yoy, whilst earning was lower by -38.3%yoy. On quarter-overquarter basis, revenue increased marginally by +2.5%, whereas earnings dipped by -17%. A first interim dividend of 5.0sen was declared during the quarter under review.

Earnings impacted by ongoing production lines revamp. The decline in revenue year-over-year was mainly attributable to lower quantity of gloves sold by -3.8%. This is due to the revamp of its old production lines which led to a temporary loss of production output. However, on sequential quarterly basis, the quantity sold was marginally higher by +3.0%. As per last quarter, Kossan’s utilisation rate for the quarter has not hit its optimum level which is above 80% due to the aforementioned reason. Additionally, earnings was also impacted by: (i) industry wide selling price pressures; (ii) escalated production costs stemming from hikes in minimum wage and natural gas prices; and (iii) additional labour cost arising from shortage of labour supply.

Costs rationalisation efforts to continue. Management disclosed that Kossan is still in the midst of a scheduled revamp to increase automation in its glove production lines. This is taking place at its old plants where the workflows are mostly manually driven. The revamp involves upgrading 12 of its older production lines. It is also currently undergoing upgrading works on two of its production plants which include replacing its biomass energy system to natural gas. We understand that the efforts in revamping its plants and lines are to cater for the increase in energy cost as well as to upgrade its older lines to higher output capacity lines

Source: MIDF Research - 23 Nov 2016