Review

• Kossan’s 9MFY16 net profit of RM126.3mn (-14.7% YoY) was below ours and consensus expectations at 59.7% and 59.6% respectively. The deviation was mainly due to pricing pressures and lower-than-expected operating efficiency from scheduled plant revamp and upgrading works.

• YoY, 9MFY16’s weak performance was mainly due to the glove division facing pricing pressures, higher production costs from the minimum wage and natural gas hike, and lower operating efficiency on the back of the scheduled revamp and upgrading works of 2 older plants (12 production lines) since 2QFY16. Accordingly, PBT margins declined by 3.0%-points to 12.9%. In spite of pricing pressures, demand was healthy with a 2.1% increase in sales volume.

• QoQ, 3QFY16’s revenue grew by 2.5% to RM414.0mn on a 3.0% increase in sales volume. PBT however declined by 16.0% to RM42.6mn mainly due to the onset of the 11.1% minimum wage and 6.0% natural gas hike in July 2016. Representing a consecutive decline since 1QFY16, PBT margins slid further by 2.3%-points to 10.3%.

• Separately, an interim dividend of 5.0sen was declared, lower than the 5.5sen declared in the previous corresponding period.

Impact

• Our FY16/FY17/FY18 earnings are revised by -17.7%/+0.7%/+0.3% after trimming FY16’s ASPs and margins to respectively reflect stiff pricing pressures and the weaker operating efficiency - as well as aligning FY16/FY17/FY18’s USD/RM assumptions from RM4.05 to our in-house forecasts of RM4.10/RM4.13/RM4.10.

Outlook

• Overall operating efficiency is expected to improve upon completion of the revamp and upgrading works being conducted at the 2 older plants. In view of this, management is optimistic on achieving improvents in 4QFY16.

• Meanwhile, while pricing pressures persists, we expect it to gradually abate as the sector’s supply-demand dynamics normalize. At this juncture, of particular concern is the extent of volatility in the USD against the Ringgit and raw material prices.

Valuation

• Our TP is raised slightly to RM7.30/share (from RM7.25/share) based on an unchanged PER of 19.0x against CY17 EPS of 38.4sen. Against CY17, it is currently trading at a PER of 18.0x. Considering the limited upside potential we downgrade Kossan to Hold.

Source: TA Research - 23 Nov 2016