• Keep NEUTRAL with a higher DCF-derived TP of MYR1.27 from MYR1.24, c.7% downside. In 2Q23, Kossan Rubber reported a narrower core due to a favourable cost structure. 1H23 core loss of MYR36.4m was below our and Street’s 2023 full year target as ASP and sales volume were lower 30-35% and 15-20% YoY respectively. Management’s commentary was relatively cautious for the rest of 2023, on the back of excessive supply capacity in the market and disruptive pricing pressures from overseas competitors.

• Results overview. Kossan’s core loss narrowed to MYR8.3m in 2Q23 from MYR28m in 1Q23 which was in line with our view that a better cost structure could gradually lead to improved margins. ASP was flattish QoQ. We believe the company was conservative in raising the ASP at the expense of a lower sales volume moving forward. Kossan embarked on a capacity rationalisation exercise through the decommissioning of two older plants with total annual capacity of 3bn pieces. This would bring the group total annual capacity to 30.5bn pieces. Kossan did not declare any dividend during the quarter.

• Volume and cost. Sales volume contracted 3-5% QoQ in 2Q23 vs a 14-18% QoQ decline in 1Q23. Raw material prices ie Nitrile butadiene rubber (NBR) decreased 1-2% QoQ, natural rubber increased slightly by 3-6% QoQ, whereas the cost of natural latex (NL) was higher 3-6% QoQ. NBR and NL costs were -16% and +0.3% YTD, 21% and 8% below pre-COVID mean level.

• Outlook. We expect the favourable cost outlook and decommissioning exercise to provide some headroom for margins expansion in the coming quarters. We also forecast the demand for gloves to pick up gradually in the coming quarters, as client inventory levels continue to deplete, on top of the fact that their glove inventories (stockpiled since 2020) are approaching their expiry dates (typical shelf life for gloves is 3-5 years). We expect glove makers’ profitability to recover YoY by 2024 with our base case global glove demand assumption to pick up by 6% YoY in 2024 from -5% in 2023. This should be underpinned by the resumption of customers order as the industry excess capacity continues to be phased out resulting in demand-supply equilibrium.

• Earnings adjustment. We cut our 2023 and 2024 earnings by 41% and 13%, after we factored in lower annual capacity assumptions. We also expect the pace of ASP hike will not be apparent as this could lead to customer pushback amid a lower cost environment. Every 5% strengthening of USD is expected to have c.6% positive impact to our earnings estimatse.

• Keep NEUTRAL, with a higher TP of MYR1.27 after we lower our WACC to 7.5% from 8.4% (in view of a more balanced risk-reward outlook). Our TP implies 0.8x 2024F P/BV, vs 3.6x of its pre-COVID-19 historical mean. We incorporate an 8% ESG discount to our intrinsic value to derive the TP. Kossan net cash remains robust (at 58% of its market cap, higher than peers’ but below Supermax’) which allows Kossan to weather through near term challenges.

Source: RHB Research - 28 Jul 2023