INVESTMENT HIGHLIGHTS

• 1QFY19 earnings came in at RM58.7m in-line with our and consensus expectations

• Higher production capacity contributed to increase in sales volume by +18.8%yoy

• This resulted in earnings growth of +31.9%yoy despite a weaker average selling price

• Plant 18 and plant 19 is expected to commission in August and December 2019 respectively

• Maintain BUY with a revised TP of RM4.53

Within expectations. Kossan’s 1QFY19 earnings came in at RM58.7m which is within our and consensus’ full-year earnings expectation at 24.1% and 24.9% of full year forecasts respectively. Comparing to 1QFY18, revenue and earnings rose strongly by +16.0%yoy and +31.9%yoy respectively driven by increase in gloves sales volume resulting from the commencement of Plant 16 (August 2018) and Plant 17 (November 2018).

Higher earnings contribution across business segments. The solid increase in quarterly earnings year-over-year was mainly attributable to the: (i) increase in gloves sales volume (+18.8%yoy) as well as; (ii) higher earnings contribution across its business segments. During the quarter, its biggest segment i.e. gloves division recorded a PBT increase of +43.2%yoy. Meanwhile, its Technical Rubber Products as well as Cleanroom division also recorded a +35.1% and +38.2% increase in earnings respectively vs 1QFY18. In addition, efficient manufacturing processes and increased automation were among the factors contributing to the higher earnings. These mitigated the downward pressure in average selling prices (ASP) for its gloves which dropped between -3.0%yoy to -5%yoy to US$22.0 to US$24.0 per 1000 pieces due to the: (i) lower raw material prices and; (ii) heightening competition.

Expanding manufacturing capacity. Kossan's Plant 18 is expected to be fully commissioned by 3QFY19 (August 2019) from the early guidance in the 2QFY19 while Plant 19 is expected to be commissioned by 4QFY19 (December 2019). These two plants will add additional 5.5b pieces of new production capacity in FY19. This will increase its existing capacity from 26.5b pieces to 32.0b pieces (+20.8%). Hence, we believe that these plants will contribute strongly to Kossan's earnings going forward.

Earnings forecast. We are revising our FY19F and FY20F by -2.2% and -1.9% as we take into account the slight push back on commencement of the new plants. Key risks to our earnings would be: (i) slowdown in demand for glove product; (ii) sudden jump in raw materials prices i.e. nitrile and latex and; (ii) delay in expansion plans.

Target Price. We are revising our target price to RM4.53 per share (previously RM4.62). The target price is derived via pegging our FY20F EPS of 20.6sen to PER of 22.0x which is its two-year historical average.

Maintain BUY. We believe that earnings growth for Kossan will be supported by high demands for glove and its ability to keep with these demands as seen in its expansion plan. Moreover, we opine that utilisation rate will not be significantly impacted due to the aggressive expansion going forward as new capacity will be fully taken up within a quarter. With the newer plants, the group is targeting to further improve the efficiency level to 1.8 workers per million gloves by 2HFY19 (from the current level of 3.0 workers per million gloves). We opine that this will further improve profit margins despite the downward pressure in ASP. All things considered, we are maintaining our BUY recommendation on Kossan.

Source: MIDF Research - 27 May 2019