Review

• Kossan’s 9MFY19 net profit of RM163.8mn (+15.3%) came in below our and consensus full-year earnings estimates at 66.9% and 68.7% respectively. We attribute the miss to the temporary labour shortage in 3Q19 which resulted in the new Plant 18 and other plants not able to run at the intended capacity.

• QoQ, PBT and revenue declined by 10.3% to RM62.8mn and 3.5% to RM531.3mn respectively. The weaker performance was due to: i) increase in natural gas cost of 5.4%, ii) temporary labour shortage and iii) lower volumes of circa-2%.

• 9MFY19, PBT increased by 16.8% to RM207.8mn, ahead of revenue growth of 5.7% to RM1.6bn. This was driven by the glove division which achieved higher sales volumes of 9.2% and higher operating efficiency. As such, PBT margin improved by 1.2p.p to 12.6% despite the tough operating environment where peers like Hartalega and Top Glove recorded margin contraction.

Impact

• We adjust our FY19/FY20/FY21 earnings estimates lower by 7.7%/4.5%/2.7% after lowering our sales volume assumptions by circa-5% to account for the slight delay in the full commissioning of Plant 18 and Plant 19.

Outlook

• We understand that the temporary labour shortage in 3Q19 has been resolved. As such, Plant 18 (2.5bn gloves/annum) have fully commissioned in Nov-19. Thereafter, Plant 19 (3.0bn gloves/annum) will now begin commissioning in Jan-20 (previously 4Q19). The additional capacity from Plant 19 will increased Kossan’s annual capacity by 10.3% to 32.0bn gloves in 2020.

• Moving into 4Q19, management guided that they are able to pass on the increase in natural gas cost which will result in margin improvement with stable ASP. We expect 4Q19 earnings to come in the range of RM58mn- 62mn (which is an increase of 17.9%-26.0% QoQ) as Plant 18 is expected to deliver its maiden contribution. For 2020, we remain confident the group will be able to deliver a double-digit earnings growth of 16.1%.

Valuation

• Upon the earnings revision, we trim Kossan’s target price to RM4.93/share (RM5.16/share previously), based on an unchanged PE multiple of 24.0x CY20 EPS. The stock is currently trading at an unwarranted discount of 27.1% to Top Glove, given its better earnings growth, margins and balance sheet. Maintain Buy.

Source: TA Research - 22 Nov 2019