KEY INVESTMENT HIGHLIGHTS

• 3QFY19 earnings came in at RM49.2m (-10.8%yoy) which lagged our and consensus’ expectation

• Earnings was dragged by lower production volume in view of labour shortage

• Expect a better performance in 4QFY19 as labour shortage has now been resolved

• New plant 18 has fully commenced in November 2019

• Maintain BUY with an unchanged TP of RM4.64

Below expectations. Kossan’s 3QFY19 earnings came in at RM49.2m which brings its cumulative 9MFY19 earnings to RM163.8m (+14.5%yoy). This lagged our and consensus’ full-year earnings expectation at 68.0% and 68.7% of full year forecasts respectively. Comparing to the previous corresponding quarter, 3QFY19 revenue and earnings declined by -7.4%yoy and -10.8%yoy respectively mainly due to lower production volume.

A delay in the full commissioning of Plant 18. Kossan's Plant 18 was initially expected to be fully commissioned by October 2019. However, there was a temporary labour shortage during the quarter which resulted in the delay of its full commencement. Consequently, production output was flat as compared to 3QFY18. Coupled with the decline in average selling price (ASP) by about -7.0%yoy, revenue from glove division dropped by -5.7%yoy. Nonetheless, 3QFY19 profit margin remains stable at 9.3% (vs 3QFY18: 9.6%) as Nitrile Butadiene Rubber (NBR) costs dropped by about -16.0%yoy which was mitigated by the increase in natural gas costs.

Expecting a rebound 4QFY19 performance. We understand that the labour shortage at Plant 18 has been resolved and all eight lines are already fully commissioned in November 2019. This plant adds additional 2.5b pieces of new production capacity (+9.4). In addition, the increase in natural gas costs will only be passed on to customers in 4QFY19. Hence, we expect improve earnings in the forthcoming quarter.

Earnings forecast. We are fine-tuning our FY19F estimates by -4.0% as we take into account the delay in full commence of Plant 18. Key risks to our earnings would be: (i) further delay in expansion plans; (ii) sudden jump in raw materials prices i.e. NBR and natural rubber and; (iii) slowdown in demand for glove product.

Target Price. We maintain our target price at RM4.64 per share. 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. Its two new plants will add additional 5.5b pieces of new production capacity which will increase existing capacity from 26.5b pieces to 32.0b pieces (+20.8%). 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 (from the current level of 3.0 workers per million gloves produced). 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 - 22 Nov 2019