INVESTMENT HIGHLIGHTS

• 1Q17 earnings within expectations

• Revenue boosted by increase in volume sold by +7.5%yoy and +5.5%qoq

• Earnings to improved post-revamp on production lines and new capacity

• FY17-18F earnings forecasts revised down by -6.6% and - 6.5%

• Maintain BUY with a revised TP of RM7.57

Within expectations. Kossan’s 1QFY17 earnings contracted by - 9.3%yoy to RM46.5m. 3MFY17 earnings is broadly within our and consensus expectations, accounting for 21.3% of full year earnings forecasts respectively. Compared with 1QFY16, revenue climbed by +21.3% but earnings was down by -9.3% respectively. On a quarterly sequential basis, Kossan recorded an increase in revenue and earnings by +14.3% and +4.3% respectively.

Revenue boosted by increase in volume sold. In 1QFY17, the increase in revenue year-over-year was mainly attributable to increase in sales volume and all its business division as well as stronger USD. During the quarter, its gloves division recorded an increase of +7.5%yoy and +5.5%qoq in quantity sold. However, Kossan’s PBT declined by -14.2%yoy mainly due to surge in raw materials prices during the quarter by >80%yoy. That said, management shared that revenue and earnings during the quarter were cushioned by the increment in average selling prices (ASP) for its gloves which grew by an average of +3-7% and +9.5%yoy respectively. Note that the increase in ASP however is <10%yoy which is less than the >80%yoy increase in raw materials price which caused a drag to earnings.

Earnings to improve post-revamp on production lines and new capacity. Management disclosed that post-completion of its revamp works on 12 its older production lines back in September 2016, quantity sold has increased by +5.5%qoq. In addition, Kossan is expecting +3.0b new capacity to come in this July 2017. The plant which began its construction back in May 2016 is slated to focus on the production of Kossan’s patented Low Derma gloves. Meanwhile the other two plants to be built along Jalan Meru are now on the final planning stage. Construction is expected to begin in the 1H17 and is expected to be operational in 2QFY18 and 4QFY18 respectively. These two new plants will add +4.5b pieces of new capacity to Kossan going forward.

Earnings forecast. Despite meeting our earnings expectation, we are revising down our FY17-FY18F earnings forecasts by -6.6% and -6.5% respectively after we made adjustments to our expected utilisation rate from 83 to 80% in FY17 and from 85% to 83% in FY18 as we expect the incoming +3.0b and +4.5b in capacity this year and next year to dilute the utilisation of the lines coupled with slower increase in ASP. 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 RM7.57. Post earnings announcement, we are reiterating our BUY recommendation on Kossan with a revised TP of RM7.57 per share after we roll forward our valuation base year to FY18. Our TP is derived via pegging our FY18F EPS of 34.4sen 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 - 26 May 2017