Kossan’s 1HFY14 results came in slightly below expectations but its profit  margin  continued  to  improve  y-o-y.  Lower  ASP  and  production downtime due to revamp works and water rationing led to lower sales. Its  earnings  margin  improved  on  more  effective  cost  control  and  a better  product  mix.  We  revise  our  earnings  forecasts  on  lower  ASP. Maintain BUY with a new MYR5.12 FV, based on a 17x FY15F P/E. 
 
Sales  volume  declines  on  production  downtime.  Kossan  Rubber Industries’ (Kossan)  1HFY14  net  earnings  of  MYR71.4m  (+7.2%  y-o-y) came  in  slightly  weaker  than  our  and  consensus  expectations,  at  39% and  41%  of  the  respective  full-year  forecasts.  This  was  attributed  to  its lower-than-expected  revenue,  given  lower  average  selling  price  (ASP) and  softer  sales  volume  (down  6.3%  YTD),  caused  by  downtime  at  its production lines due to revamp works and the water rationing incident in April.  ASP  declined  9%  y-o-y  and  3.5%  q-o-q  in  2QFY14,  partly  due  to lower raw material prices.  

Margins improve further. Despite lower sales volume, Kossan’s overall EBITDA  and  PBT  margin  in  1HFY14  inched  higher  to  19.8%  (1HFY13: 17.8%) and 15.1% (1HFY13: 13.6%) respectively, thanks to a favourable product  mix  (higher  number  of  nitrile  gloves  sold)  and  its  continued efforts to improve cost efficiency. This resulted in a 7.2% YTD growth in 1HFY14 earnings.   

Brighter 2H outlook. We expect Kossan to report a seasonally stronger 2H  on  the  back  of  higher  demand  and  an  increase  in  production capacity.  We  estimate  that  margins  should  inch  higher  barring  any unscheduled production downtime it experienced in 1H.  

Maintain  BUY.  We  lower  our  FY14/15F  earnings  forecasts  by  8%/9% after factoring in lower ASP. Despite our downward earnings revision, we still  like  Kossan  for  its  clear  earnings  visibility  in  FY14-16F  and consistent improvements in its profit margins. We maintain our BUY call with a slightly higher MYR5.12 FV (from MYR5.10), after rolling over our earnings  horizon  to  FY15.  Our  FV  is  premised  on  a  lower  FY15  P/E  of 17x  (from  18x),  at  a  10%  discount  to  Hartalega  Holdings’  (HART  MK, NEUTRAL,  FV:  MYR6.95)  19x.  However,  we  think  this  is  justifiable noting  that  Hartalega  fetches  a  better  net  profit  margin  of  20%  vs Kossan’s 11-12%  given  its  superior  operating  efficiency  and  greater emphasis on nitrile glove production.

Financial Exhibits

- Capacity expansion of Plant 1 was completed and operation has started in Aug 2014. Plant 2 and 3 are expected to commence operations in Nov 2014 and Feb 2015 respectively. Completion of these three plants is expected to bring Kossan’s total production capacity to 22bn pieces per annum in FY15, from 16bn pieces per annum in FY13

- ASPs for FY14-16 are expected to be around USD25-28  

- We estimate utilisation rates at around 82-85% for FY14-16

- We expect no drastic surge in raw material prices in FY14-16

Financial Exhibits

SWOT Analysis

Company Profile

Kossan Rubber Industries’ principal activities are in the manufacturing of examination rubber gloves and technical rubber products. 

Recommendation Chart

Source: RHB