Kossan Rubber Industries Bhd
(Nov 3, RM4.69)
Maintain buy with target price of RM5: Though orders for its medical glove are stable, Kossan has seen a jump in the orders for its high-risk gloves (less than 5% of total sales volume). The high-risk gloves provide superior protection given their extra thickness and extended cuff length.

We understand that the increased orders came from the United States and Europe as they prepare for the potential spread of Ebola.

Additionally, Kossan recently secured a major client, which is taking up 9% of its existing 16 billion pieces in annual capacity.

We believe the high-risk gloves command better margins (vs medical gloves) as they are three times more expensive while the rubber input is just two times more with a weight of 8g per piece (vs 3g to 5g for medical gloves).

However, as the high-risk gloves account for only a small fraction of Kossan’s sales, impact on the group is minimal at this juncture.

Kossan will be releasing its third quarter of financial year 2014 (3QFY14) results on Nov 19 and we expect slightly better quarter-on-quarter (q-o-q) earnings (second quarter of 2014 [2Q14]: RM35 million net profit; first half of 2014 [1H14]: (RM71 million) as the new capacity from Plant 1 only kicked in progressively from August 2014 and sales volume increase in 3Q is expected to be less than 5% q-o-q.

Moreover, margins could also be flattish as Kossan passes on the lower rubber prices to customers.

Upon the full commercialisation of its three new plants in mid-2015, Kossan’s capacity will rise to 22 billion pieces per annum. Additionally, these new plants are of higher efficiency and could lead to overall margin enhancement.

We maintain our earnings forecasts, assuming a moderate take-up for its new capacity and a slight margin decline in light of the nitrile competition.

Key input costs of Kossan are benign, with latex and nitrile butadiene rubber (NBR) prices having fallen 22% and 10% year-to-date (YTD).

Going forward, we expect rubber prices to stabilise at current levels, as this is reportedly the breakeven levels for rubber planters in Thailand and Indonesia. Given that NBR is a close substitute to natural rubber, NBR price tends to track that of natural rubber rather than crude oil, in spite of it being a by-product of crude oil.

In view of the strong demand for nitrile gloves and its high plant utilisation of 82%, Kossan is expanding its capacity. It (i) just commercialised Plant 1 progressively from August 2014 onwards, with an annual capacity of 1.5 billion pcs; (ii) will commercialise Plants 2 and 3 in November 2014 and January 2015 respectively with a total annual capacity of 3.7 billion pieces. Plant 1-3 will be the key drivers of Kossan’s earnings in FY15.

Annual capacity should be boosted by 38% to 22 billion pieces by mid-2015, upon the full operation of the three plants. It is also looking to add another five billion pieces per annum capacity in 2016, boosting capacity by another 23% to 27 billion pieces. Its nitrile/latex product mix is expected to reach 80:20 in FY16, from 60:40 now.

We are conservative in our assumptions due to the nitrile competition. We have only imputed for capacity growth of 18% and 15% in FY15 to FY16 respectively and sales volume growth of 17% and 14% in FY15 to FY16 respectively.

Management is, however, confident of the execution of its capacity expansion plan and take-up of its new capacity, potentially from its existing customers. — Maybank IB Research, Nov 3

This article first appeared in The Edge Financial Daily, on November 4, 2014.