We like Kossan for its proven track record in maintaining operating margins despite an increase in costs, as observed in the past three years. Maintain BUY with a revised DCF-based TP of MYR7.53 (from MYR8.27, 21% upside). Further, we welcome Kossan’s announcement to consider its first share buyback in five years, as a sign of confidence in the fundamental value of the stock.

Building up to 2017. Kossan Rubber Industries (Kossan) has unveiled its aggressive capacity expansion plans to add 20bn glove capacity over four phases to bring total annual capacity to 44bn glove pieces by 2020. Although no new capacity is likely to be added in 2016, management expects to lay the foundation during the year for an additional 7.5bn gloves capacity in 2H17. We forecast a 3-year EPS CAGR of 15%, which would stand out amidst the subdued Malaysian GDP growth expectations this year.

Operational challenges. We believe that the increasing industry competition, particularly in the nitrile segment, would complicate the cost pass-through mechanics as manufacturers compete on price to maintain/take market share. As such, we believe margins could be pressured by the removal of government subsidies (ie gas tariff increase) and labour cost increase (ie minimum wage, as well as foreign labour levy hike). We also expect earnings to be affected by the recent strength of MYR. RHB has revised its 2016 USD forex assumption to MYR4.18 (from MYR4.34).

Earnings and risks. We lower our FY16F-18F earnings by 2% to 4% after updating our assumptions. The upside risks to our forecast include the re-rating of the sector, driven by liquidity and buoyed by market risk aversion; the key downside risk would be higher prices for raw materials such as latex and nitrile. Maintain BUY. We like Kossan for its proven track record in maintaining operating margins despite an increase in costs, as observed in 2013 during the nationwide minimum wage hike as well as the two rounds of gas tariff hikes in 2014. We also welcome founder/CEO Dato’ Lim Kuang Sia’s readiness to consider Kossan’s first share buyback in five years as a sign of confidence in the fundamental value of the stock. Our revised DCF-based TP of MYR7.53 (CoE: 8%, TG: 2%) implies 21.4x FY16F P/E. Kossan is currently trading at FY16F P/E of 17.7x (below its historical +1SD trading band of 19.1x), whereas the stock has traded above this valuation level for the past 12 months.

SWOT Analysis

Source: RHB Research - 22 Mar 2016