This article first appeared in The Edge Financial Daily on July 12, 2017

Kossan Rubber Industries Bhd 
(July 11, RM6.86)
Maintain add with a higher target price (TP) of RM7.55: We recently hosted a meeting with Kossan Rubber Industries Bhd’s management. The group was represented by Edward Yip (general manager, corporate planning and investor relations) and Benjamin Lim (assistant manager, investor relations).

The meeting was well received, with 25 fund managers and buy-side analysts in attendance. The bulk of the discussion was about its future, with the group revealing its expansion plans to drive earnings.

Financial year 2016 (FY16) was a blip; the first quarter of FY17 (1QFY17) was a sign of better things to come. The decline in FY16 net profit to RM170.9 million (-15.6% year-on-year) was due to a combination of external and internal factors. In addition to stronger-than-expected pricing competition, Kossan suffered capacity loss (about 10% to 12% of total capacity) from two factories that faced revamp works from 2QFY16 up to early 4QFY16.

Also, margins were hit by hikes in natural gas prices and minimum wages. 

In 1QFY17, Kossan recorded a sequentially stronger performance (1QFY17 net profit: +4.3% quarter-on-quarter) as total capacity reverted to normal.

We expect Kossan to record a stronger performance in FY17, supported by a better second half of FY17 (2HFY17), with a new three billion pieces per annum (pa) plant beginning operations by July. This is the first new plant to be added since Dec 15, upping its total capacity to 25 billion pieces pa (+13.6%).

This timeline is ahead of our estimates as we had earlier projected for the new plant to only begin production in 4QFY17. This leads to an earnings upside to our FY17 estimates. 

Also, Kossan will add two new plants in FY18 with a total capacity of 4.5 billion pieces pa.

The first plant is slated for completion by 1QFY18, while the second plant will begin operations in 3QFY18. Total capacity will rise to 29.5 billion pieces pa by 3QFY18.

We gather that all of its new plants have been earmarked to manufacture its patented accelerator-free nitrile gloves, with the latest automation to be installed along with high-speed dipping manufacturing lines. 

Kossan will carry on conducting revamp works on its existing facilities to increase overall operating efficiencies. However, this will be conducted on a gradual basis to ensure that production is not disrupted.

Revamp works include plans to utilise more automation in its production flow in a bid to increase cost savings and production output.

With its new capacity coming on stream earlier than expected, our FY17 to FY19 earnings per share forecasts are adjusted higher by 2.2% to 4.6%. Accordingly, our TP is raised to RM7.55 based on an unchanged 19 times FY18 price-earnings ratio (+1 standard deviation from its five-year mean).

Kossan is our top pick in the glove sector, with valuations below its peers (Hartalega Holdings Bhd and Top Glove Corp Bhd). We expect its share price to move higher in tandem with stronger earnings delivery, especially in 2HFY17. Downside risks include delays in expansion plans and stronger pricing competition. — CIMB Research, July 10