• 4QFY16 earnings within expectations

• Revenue weakened by technical rubber products and cleanroom divisions

• Earnings improved post-revamp on production lines

• FY17F earnings forecasts revised down by -4.2%

• Maintain BUY with a revised TP of RM7.52 per share

Within expectations. Kossan posted 4QFY16 earnings of RM44.6m. This brings its FY16 earnings to RM170.9m, which came in within our estimates but below consensus expectation, accounting for 99% and 93% of full year earnings estimates respectively. Against last year, revenue declined nominally by -0.2% while earnings was down by - 19.2% respectively. On a quarterly sequential basis, it recorded an increase in both revenue and earnings by +5.8% and +31.2% respectively.

Revenue weakened by technical rubber products and cleanroom divisions. In 4QFY16, the decline in revenue year-overyear was mainly attributable to lower revenue recorded by both technical rubber products by -16.5% and -9.5% respectively. Meanwhile, the gloves division recorded a marginal increase of +1.3% year-over-year. However, on the PBT basis, the gloves division recorded a -39.7% decline against last year due to pricing pressures. That said, management shared that revenue during the quarter was supported by the marginal increment in quantity sold by +2.3%yoy as well as increase in average selling prices (ASP) for NR and NBR gloves which grew by an average of +3-7% and +2%yoy respectively.

Earnings improved post-revamp on production lines. Management disclosed that Kossan has completed the upgrading works on its 12 aged production lines as at end-September 2016. In addition, it has also completed its conversions of biomass energy to natural gas as well as fully commissioning its Combined Heat and Power Cogeneration Natural Gas Generator Set (COGEN) at two factory locations. These completions supported the earnings growth during the quarter via increasing production output and lowering the cost of production to 87% of revenue (from 89% in 3QFY16). In addition, despite the lower revenue and earnings recorded against last year, Kossan recorded improvements in margin. PBT margin grew from 16.4% in FY15 to 17.3% while PATANCI margin grew to 13.9% in FY16 (from 12.4% in FY15).

Earnings forecast. Despite meeting our earnings expectation, we are revising down our FY17F earnings forecasts by - 4.2% to RM218.6m (from RM228.2m previously) after we made adjustments to our expected utilisation rate from 85% to 83% as we expect the incoming 3.5b capacity this year to dilute the utilisation rate of the lines. Additionally, we are also introducing our FY18F numbers in this report. Key risks to our earnings would most likely be: (i) increasing competition which may squeeze margins and ASP; (ii) sudden jump in raw materials prices i.e latex and nitrile and; (iii) demand and supply mismatch.

Maintain BUY with revised Target Price (TP) of RM7.52. Post earnings announcement; we are reiterating our BUY recommendation on Kossan with a revised TP of RM7.52 per share. Our TP is derived via pegging our FY17F EPS of 34.2sen to an unchanged PER of 22x, which is its 3-year average PER. We continue to like Kossan for its: (i) earnings visibility and; (ii) prudent management.

Source: MIDF Research - 24 Feb 2017