INVESTMENT HIGHLIGHTS

• 2QFY19 earnings came in at RM55.9m (+28.6%yoy) in-line with our and consensus expectations

• Production volume was lower during the quarter due to scheduled upgrading works

• However, this was partially mitigated by the higher average selling price

• Maintain BUY with a revised TP of RM4.64

Within expectations. Kossan’s 2QFY19 earnings came in at RM55.9m which brings its cumulative 1HFY19 earnings to RM114.6m (+30.3%yoy). This is within our and consensus’ full-year earnings expectation at 48.1% and 48.2% of full year forecasts respectively. Comparing to 1QFY19, revenue and earnings declined by -1.9%qoq and -4.8%qoq mainly as a result of lower production volume during the quarter.

Production volume was lower due to upgrading works.Scheduled revamp and upgrading works were carried out across the group’s plants for approximately five days during the quarter. Consequently, production output was lowered by about -6.0%qoq. Furthermore, profit margin was eroded due to the abrupt upward movement in the natural rubber latex price by more than +20.0%qoq to about RM5.00/kg during the quarter. However, this was partially mitigated by the increase in average selling price (ASP) by about +4.0%qoq to US$24.0 per 1000 pieces.

Capacity expansion on track. Kossan's Plant 18 is expected to commission four lines in August 2019 (all eight lines are targeted to be fully commission by October 2019) while Plant 19 is expected to begin commissioning by 4QFY19 (December 2019). These two plants will add additional 5.5b pieces of new production capacity which 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.

Prospect. We expect a higher production volume in the 2HFY19 due to the: (i) improve plant’s operating efficiency attributable to the upgrading works and; (ii) contribution from the commissioning of new plants especially Plant 18. Moreover, natural rubber price has eased by -12.0%qoq to about RM4.40/kg in August 2019. This will lower the group’s cost of production given that about 30.0% of its product portfolio is natural rubber glove.

Earnings forecast. We are fine-tuning our FY19F and FY20F earnings estimates by +1.1% and +2.7% as we take into account a lower cost of production arising from the decline in cost of raw materials. 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 RM4.64 per share (previously RM4.53). The target price is derived via pegging our FY20F EPS of 21.1sen 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 the higher production volumes as seen in its expansion plan. Moreover, we opine that utilisation rate will not be significantly impacted going forward as new capacity to 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 caused by the heightening competition. All things considered, we are maintaining our BUY recommendation on Kossan.

Source: MIDF Research - 23 Aug 2019