This article first appeared in The Edge Financial Daily on April 11, 2018
Kossan Rubber Industries Bhd
(April 10, RM7.60)
Downgrade to hold with a target price (TP) of RM8.10: We recently spoke to Kossan Rubber Industries Bhd about the progress of its new F16 plant (three billion pieces per annum [pa]). As at March 18, all eight lines in the plant had already been installed but yet to begin full commercial production, mainly due to teething issues during the trial runs, leading to a longer-than-expected period required for line tests. Hence, we revise our expectations of full commercial production of the plant to only begin by mid-second quarter of 2018 (2Q18), from our earlier projection of 1Q18.
Kossan is now taking a more conservative stance on the delivery of its other two new plants, F17 and F18 (4.5 billion pieces pa). Currently, construction works are ongoing and will only be completed by end-2018. We now expect gradual commercial production to begin by 2Q19, a four-month delay from our earlier forecast. Note that both plants will increase Kossan’s total production capacity by 18.9% to 29.5 billion pieces pa and will be producing nitrile butadiene (NBR) gloves, bringing its total product mix to its target of 80 NBR:20 natural rubber.
Full commissioning of Plant 16 is key to financial year 2018 forecast (FY18F) earnings growth. Given that Kossan has not added any new capacity since Dec 15, 2017, it has not been able to benefit from the recent surge in demand for gloves (due to a lower supply of vinyl gloves from China). As a result, the group’s FY17 volume growth of 6% year-on-year has been weaker than its peers (Top Glove Corp Bhd and Hartalega Holdings Bhd) given that production growth mainly stemmed from refurbishment works on its older lines. Hence, we believe the commencement of full commercial production of Plant 16 is essential to drive earnings growth in FY18F.
For the upcoming 1QFY18 results, we expect Kossan to record a flattish net profit on a quarter-on-quarter basis. Our view is based on a minimal increase in its production volumes in 1QFY18F, while the recent weakness in the US dollar against the ringgit should be mitigated by a decline in natural latex prices. Nevertheless, we lower our FY18 to FY20 earnings per share (EPS) estimates by 1.9% to 6% to take into account delays in its expansion plans. Note that any further delay in the ramp-up of its new plants will act as a downside risk to our forecasts.
In tandem with our EPS cut, we downgrade the stock to a “hold” from an “add”, with a lower 12-month TP of RM8.10. We also lower our target price-earnings ratio (PER) multiple to 19.6 times calendar year 2019 PER (in line with its five-year average) from 22.4 times previously, mainly due to our concerns over continuous delays in its capacity expansion plans and weaker three-year compound annual growth rate of 18.3% versus its peers’ average of 25.8%. An upside risk is faster-than-expected commissioning of its new lines, while a downside risk is sharp weakening of the US dollar against the ringgit. — CGSCIMB Research, April 9