• U/G to NEUTRAL from Buy, with higher MYR1.08 TP (DCF) from MYR0.91, 5% downside. 2022 core earnings were below our and Street’s expectations. During 4Q22, ASP moderated by 10-15% QoQ while volumes sold were down 1-3% QoQ. Management remains cautious on 2023, given the oversupply situation as well as high energy prices and labour costs. We expect the industry’s ongoing prudent capacity expansion plans, coupled with Kossan Rubber’s balance sheet strength, should help the company sail through the near-term challenges.

• Results overview. Kossan delivered its maiden loss since listing of MYR3.1m (-101% YoY), bringing 2022 core earnings to MYR154m (-95% YoY), ie 93% and 92% of our and Street’s estimates. The weaker-than- expected result was mainly attributed to the 58-63% YoY decline in ASPs in 2022. Kossan expects its near-term outlook to remain choppy, given the persisting industry oversupply situation, and elevated energy prices and labour costs, which may continue to cast doubt on 2023’s outlook. The group declared a final dividend of 2.5 sen.

• Volume and costs. 4Q22 sales volumes declined 1-3% QoQ, ie better than the 3Q22’s 14-18% QoQ decline. Nitrile butadiene rubber or NBR sales eased 27-32% QoQ while natural rubber or NR was down 19-12% QoQ.

• Outlook. We gathered that cost pass-throughs remain challenging in the near term, as the industry’s recent new orders received were rather erratic while clients still refused to place bulk orders. In the near term, glove distributor inventory level still stood at 4-6 months (largely unchanged) vs the previous guidance – likely on the slower-than-expected destocking pace at the exam/single use and life science segments. We think the industry could be poised for a demand recovery by 2H23 following a more disciplined approach in scaling back new capacity plans. Lastly, we also expect the recent correction in natural gas prices (YTD: -43%) could help offset against elevated electricity and labour costs in in 2H23 – taking into consideration the 6-month time lag from the Brent crude correction in late 2022.

• Earnings adjustment. We cut our FY23F-24F earnings by 65% and 34% after lowering our effective capacity assumption as well as factoring in weaker USD and lower plant utilisation assumptions.

• U/G to NEUTRAL with a higher MYR1.08 TP after tweaking our DCF assumptions. Our TP implies 0.7x 2024F P/BV vs 3x of the pre-COVID-19 4-year historical mean. We incorporate an 8% ESG discount to our intrinsic value to derive our TP, as the ESG score is below our country median.

• Key upside/downside risks: Higher/lower than-expected sales volumes, stronger-/weaker-than-expected USD against the MYR, and lower-/higher- than-expected raw material prices.

Source: RHB Research - 20 Feb 2023