Review

• Kossan’s FY16 net profit of RM170.9mn (-15.9% YoY) was within ours and below consensus expectations at 98.1% and 93.8% respectively. No dividends were declared.

• YoY, revenue increased by 2.0% to RM1.7bn on a 2.3% growth in sales volume. PBT however, declined by 20.5% YoY to RM213.4mn. The weak performance was on the back of price competition in the gloves segment, cost pressures from the minimum wage and natural gas hike, and loss of productivity and operational efficiency due to production line upgrading and fuel conversion (from biomass to natural gas) works at 2 glove plants across 2QFY16 to 3QFY16.

• QoQ, performance improved with PBT and PBT margins respectively having increased by 27.7% to RM54.4mn and 2.1%-points to 12.4%. This was attributable to the strengthening of the USD against the Ringgit as well as higher productivity and operational efficiency as a result of completion of production line upgrading and fuel conversion works (from biomass to natural gas) at 2 glove plants. Plant utilization rates in 4QFY16 was gradually recovering to almost 80% and the product mix as at 31 December 2016 remained unchanged from FY15 at 70% nitrile gloves and 30% natural rubber gloves.

Impact

• We cut our FY17/FY18 estimates by 8.2%/16.4% to RM229.0mn/RM258.8mn upon effecting the following changes: 1) incorporating FYE16 figures into our model, 2) fine-tuning our utilization rates and 3) imputing delays to expansion at Bestari Jaya. We also introduce FY19 estimates of RM295.4mn.

Outlook

• Notwithstanding expectations for improved operating efficiency from the recent completion of upgrading works of 2 plants, we view that downside risk is present from the steep climb in key inputs (natural rubber and nitrile butadiene rubber) since 4QCY16 which could offset upside risk from the strengthening of the USD against the Ringgit. Nevertheless, we expect it to be transitory with the pass through of the increased costs supported by improving supply and demand dynamics.

• Supportive of the group’s earnings growth prospects, construction of the upcoming plant in Jalan Meru which commenced in May 2016 with 3.0bn gloves/annum is expected to be completed in July 2017. However as for its next phase of expansion in Bestari Jaya whereby the first phase with 4.5bn gloves/annum was initially scheduled to commence construction at end- 2016, it has been delayed to the end of 2017 owing to building plan and water supply constraints.

Valuation

• Our TP is reduced to RM6.80/share (previously RM7.40/share) based on an unchanged PER of 19.0x against CY17 EPS of 35.8sen. In view of the limited upside potential from the stock we downgrade the stock to Hold.

Source: TA Research - 24 Feb 2017