Kossan Rubber Industries Bhd

(April 27, RM5.74)

Maintain buy with target price of RM6.75: All three of Kossan’s new plants have entered full commercial production. Plant 1, Plant 2 and Plant 3 were fully operational in October 2014, March 2015 and April 2015 respectively.

To recap, these new plants will boost capacity by six billion gloves per annum to 22 billion gloves. Capacity will mainly be used for the production of nitrile gloves. The mix between nitrile and natural rubber gloves now stands at 70:30. Easing prior concerns, the capacity for all three of its new factories is fully utilised. On average, the group’s utilisation rate remains high at between 85% and 90%. Demand for new capacity is attributed to both natural growth in the industry, as well as certain consolidation exercises conducted by its customers. It also continues to garner positive feedback in relation to its 3g nitrile gloves. At present, excess orders are estimated at 135 million gloves per month (1.6 billion gloves per year).

Given the timeline above, we expect results to pick up from the second quarter, driven by contributions from the full commercial production at Plant 2 and Plant 3. This should be accompanied by higher margins underpinned by the higher proportion of nitrile gloves produced.

Margins for nitrile gloves can range from 18% to 20% versus natural rubber gloves from 6% to 7%. Incorporating future expansion plans, prospects appear solid with an expected three-year earnings compound annual growth rate (CAGR) of 24%.

We increase our target price for Kossan to RM6.75 per share (from RM6.30 per share). This is premised on a higher price-earnings ratio (PER) of 19.5 times and calendar year 2016 earnings per share of 34.5 sen. The increase PER reflects our increased confidence in underlying operations. Demand appears to be more resilient than initially anticipated. Other supporting arguments include the industry’s high three-year earnings CAGR (24%) and return on equity (22%). Maintain our “buy” recommendation on the stock. — TA Securities, April 27

This article first appeared in The Edge Financial Daily, on April 28, 2015.