INVESTMENT HIGHLIGHTS

• 1QFY18 earnings below expectations at RM44.5m

• Higher revenue contribution across business segments

• New capacity expansion timeline

• FY18-19F earnings forecasts revised down by -12.1% and - 20% respectively

• Maintain NEUTRAL with a revised TP of RM7.55 per share

Within expectations. Kossan’s 1QFY18 earnings came in at RM44.5m which is below our and consensus’ full-year earnings expectation at 19.0% and 20% of full year forecasts respectively. Against last year, revenue and earnings were down marginally by -3.2% and -4.3% respectively. However, on a quarterly sequential basis, it recorded a marginal increase in revenue by +1.3% and -3.0% in earnings respectively. No dividend was declared for the quarter under review.

Higher revenue contribution across business segments. In 1QFY18, the lower revenue year-over-year was mainly attributable to the lag effect in transferring the +23% increase in natural gas tariff earlier this year. Due to this, its gloves division recorded a marginal decline in revenue by -3.2%yoy. Meanwhile, its technical rubber products (TRP) as well as Cleanroom division recorded a -9.4% and +28.7% in revenue respectively vs 1QFY17. That said, efficient manufacturing processes, increased automation as well as higher sales deliveries were among the factors contributing to the higher revenue quarter-over-quarter. Volume sold also increased by +2.7%yoy and +3.4%qoq due to the continued strong demand for gloves.

New capacity expansion timeline. Management disclosed that Kossan’s Plant 16 that will contribute +3.0b new capacity has been fully-commissioned last December 2017. However, due to an issue involving the plant’s glove formers; production has been halted and no contribution came from this plant in 1QFY18. Plant 16 will only begin to fully contribute to Kossan’s revenue in 2HFY18. Meanwhile, the other two plants to be built along Jalan Meru (Plant 17 and 18) are now currently under construction. Plant 17 and 18 are expected to be completed in 3QFY18 and 1QFY19 respectively and will start contributing to Kossan’s revenue thereafter. These two new plants will add +4.5b of new production capacity going forward.

Earnings forecast. Post earnings announcement, we are revising our FY18-19F earnings forecasts down by -12.1% and -20% as we adjust our capacity expansion assumption due to the delay of Plant 16 and recognising that Plant 17’s contribution to come in only later in the year. Key risks to our earnings would most likely be: (i) sudden jump in raw materials prices i.e latex and nitrile and; (ii) delay in expansion plans.

Maintain NEUTRAL with a revised Target Price (TP) of RM7.55. Post earnings announcement and adjustment, we are maintaining our NEUTRAL recommendation on Kossan with a revised TP of RM7.55 per share after we roll forward our valuation base period to FY19. Our TP is derived via pegging our FY19F EPS of 34.4sen to a revised PER19 of 22x, representing the average PER across five years. We believe that despite the high demand for gloves, earnings growth for this year will continue to be constrained as currently Kossan is already operating at full capacity with its latest Plant 16’s capacity being held back due to the issue with its gloves formers and new capacity of +4.5b will only be contributing next year.

Source: MIDF Research - 25 May 2018