Better days ahead for Kossan

by **Cals** Tue 16 Jul 2013, 10:16

Better days ahead for Kossan
Business & Markets 2013
Written by AmResearch
Tuesday, 16 July 2013 09:37

KOSSAN RUBBER INDUSTRIES BHD []
(July 15, RM5.67)
Maintain buy at RM5.68 with a revised fair value of RM6.30: We maintain our “buy" recommendation on Kossan with a higher fair value of RM6.30 to reflect our upwards earnings revision for 2013 financial year (FY13F) to FY15F of 14% to 22% and the rolling forward of our base year to FY14F.

We continue to peg Kossan to a price-earnings ratio (PER) of 12.5 times.

Our bullish view on Kossan is underpinned by: (i) its growing production capacity (FY13F: +20%; FY14F: +30%) amid robust global rubber glove demand (FY13F: +10% to 15%, first quarter of 2013 [1Q13] sales volume: +29% year-on-year [y-o-y]); (ii) its focus on differentiation and its move up the value chain through product innovations; (iii) upbeat prospects for its technical rubber products (TRP) division; and (iv) lower production costs.

The group's FY13F earnings will be bolstered by the March 2013 commissioning of its nine surgical glove lines (+700 million pieces) and spillover capacity from end-FY12 commercialisation of nine nitrile glove lines (+1.5 billion pieces).

We understand plans are afoot for the CONSTRUCTION [] of three nitrile glove plants by May next year which will collectively expand Kossan's installed capacity by about five billion pieces (or 30%). This potentially translates into additional revenue of about RM400 million. We gather Kossan has sold forward the bulk of its new capacities.

In the medium term, Kossan's capacity growth will be centred on its recently acquired 56-acre (23ha) plot in Batang Berjuntai, where it plans to build six to eight high productivity plants to achieve an installed capacity of 32 billion pieces per annum by 2018 (five-year compound annual growth rate of 15%).

We are also encouraged to learn that management is planning to accelerate growth of its TRP business (which contributes to about 12% of revenue), backed by a strong foreign demand for infrastructure rubber products and automotive component parts. The construction of its plant in Jakarta, Indonesia, is slated to begin in the next one to two months.

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Factoring in lower production costs due to a lower latex price assumption (RM6 per kg from RM6.50 per kg), increased plant efficiency as well as greater contribution from higher margined products (clean room and surgical gloves, for example), we expect Kossan's earnings before interest, tax, depreciation and amortisation margin to expand by one to two percentage points to about 17% for FY13F to FY14F.
All in, we have incorporated capital expenditure of RM75 million which we believe can be internally funded given Kossan's sound operating cash flows and manageable net gearing (1Q13: 0.1 times).

Our revised gross dividend per share forecasts of 16 sen for FY13F and 19 sen for FY14F are premised on a 38% to 40% payout ratio. Although yields have declined following its strong share price performance (year-to-date: +49% versus FBM KLCI's +5%), its three-year average of 3.5% is the highest among its peers.

Nonetheless, we believe the stock still has legs on the upside given the group's solid fundamentals, improving liquidity (including possibility of bonus and warrants in FY13F) and still conducive operating environment. — AmResearch, July 15

This article first appeared in The Edge Financial Daily, on July 16, 2013.