Kossan Rubber Industries Bhd
(May 22, RM6.30)
Maintain “outperform” with a higher target price (TP) of RM7.06 from RM6.68: Kossan Rubber Industries Bhd’s (Kossan) first quarter of financial year 2015 (1QFY15) net profit of RM45.5 million (an increase of 23% year-on-year [y-o-y]); an increase of 20% quarter-on- quarter (q-o-q), came in within expectations of our and consensus’ full-year forecasts at 22% and 23%, respectively.

No dividend was declared for the quarter.

Sequentially, 1QFY15 revenue rose 2% to RM369 million due to higher sales of gloves (an increase of 4.5%) which more than offset lower average selling prices (ASP).

The higher revenue was mainly attributed to the revamp of two old plants that brought about higher output from the more efficient and technologically advanced production facilities, as well as small capacity added from Plant 2 which commenced its trial run in March this year.

The higher contribution from gloves more than offset weaker performance in Technical Rubber Products (TRP) with revenue and profit before taxes reduced by 25.1% and 67.8%, respectively due to weaker demand for industrial and automotive parts.

Overall, profit before tax (PBT) margin improved 2.4 points from 16% in 1QFY15 compared with 13.6% in 4QFY14 due to production efficiency and better sales-mix.

Y-o-y, 1QFY15 revenue rose 20% due largely to contribution from its glove division, which accounted for more than 88% of total revenue.

Specifically, glove revenue rose 24% due to higher volume growth (an increase of 30%) on the back of 85% utilisation rate which more than offset lower ASP (a decrease of 10%).

Net profit came in at RM45.5 million (an increase of 23% y-o-y) which grew faster than the turnover growth due to margin expansion driven by efficiency improvement from automation, economies of scale from capacity expansion, and product mix skewed towards higher-margin nitrile gloves.

Looking ahead, growth in subsequent quarters will be driven by Plant 2 and Plant 3 with four billion gloves capacity per year. The plants are expected to be running at full capacity from June.

We understand that buyers have been found. This brings the three new plants’ capacity to 22 billion from 16 billion gloves per year.

We understand that another phase of expansion is expected sometime in FY15 due to overwhelming demand for various glove products.

Recall at end-December 2014, Kossan acquired a piece of 13.3 acres (5.38ha) of freehold industrial land in Kapar, Klang for a cash consideration of RM39 million.

We understand the land is earmarked for two glove plants and a warehouse, targeted for completion in FY16.

No changes to our FY15 estimates (FY15E) and FY16E numbers.

Maintain “outperform”. Despite the stock having already gained 38% year to date (YTD), we continue to  like Kossan.

We expect strong results for subsequent quarters and potential margin expansion to attract market attention.

Consequently, we upgrade our TP from RM6.68 to RM7.06 based on 19 times FY16 earnings per share (at an increase of two standard deviation above its historical forward average).

We like Kossan for its superior net profit growth of 43% and 15% in FY15E and FY16E respectively; and the unprecedented earnings growth over the next two years underpinned by rapid capacity expansion.

Risk to our call is delay in commissioning of new production lines. — Kenanga Investment Bank Bhd, May 22

This article first appeared in The Edge Financial Daily, on May 25, 2015.