Kossan is rock solid and still a jewel

by **Cals** Mon 20 Jan 2014, 18:51

Business & Markets 2014

Written by Affin IB Research

Monday, 20 January 2014 10:04

Kossan Rubber Industries Bhd
(Jan 16, RM4.09)
Maintain buy at RM4.19 with a revised target price of RM5.08 (from RM4.30): We raise our target price (TP) for Kossan from RM4.30 to RM5.08 (this is our fourth upgrade since February last year) based on a higher target price-earnings ratio (PER) of 18 times 2014 earnings per share (EPS: 15 times previously). The higher target PER (10% discount to Hartalega Holdings Bhd’s target PER, 3% premium to Top Glove Corp Bhd’s target PER of 17.5 times) in our view, is justified given: (i) Kossan’s strong fundamentals (healthy balance sheet with low gearing, improved earnings quality from the sale and production of higher quality gloves); (ii) still decent valuations underpinned by strong EPS annual growth of 30% for financial year 2014 ending December (FY14); (iii) improved trading liquidity following its sixth round of bonus issue since its listing in 1996; and (iv) Kossan’s most balanced product mix among its peers which enables it to ride stronger demand from both developed and developing countries.

We remain upbeat on Kossan’s prospects and we favour its current position — all its production lines are highly versatile and interchangeable. This means minimal downtime in switching from natural rubber (NR) to nitrile gloves and vice versa depending on customer need. We are also positive on Kossan’s strategic capacity expansion and diversification to technical rubber product (TRP), surgical and cleanroom gloves that enables the glovemaker to widen its customer base.

To cater for the increasing demand for its TRP products, we understand the group is aggressively looking to expand its TRP production facilities. Given the rising cost of production in Malaysia, we believe there is also a high likelihood Kossan will expand production abroad, in Vietnam possibly. Assuming a 15-line plant, we believe FY15 net profit should be boosted by around RM15 million to RM230 million. Note that profit before tax from Kossan’s TRP division has grown by 15% year-on-year for the first nine months of FY13 to RM15 million.

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Kossan’s highly interchangeable production lines also provide some flexibility for the manufacturer in adjusting its average selling prices (ASPs) when the cost of production increases. Following the 16% increase in electricity tariff, management is likely to raise ASPs by around 1% to compensate for the tariff hike. We believe this is highly possible for Kossan, judging from its track record in raising ASPs similar to the minimum wage hike in January last year. In contrast, we believe Top Glove (“add”; TP RM6.48) will likely absorb the increase in electricity tariff as we expect the group to strategically maintain its low ASPs, in particular its NR-based glove products in order to remain competitive. Apart from the declining latex cost that has adversely impacted Top Glove’s ASPs, the continuous shift in demand to nitrile gloves has further exerted pressure on its selling prices.

Overall, we reiterate our “buy” call and continue to like Kossan’s solid fundamentals. Our strong EPS annual growth of 30% for FY14 is underpinned by: (i) resilient sales in higher niche gloves; and (ii) favourable latex costs (pencilled into our earnings forecast is an average latex cost assumption of RM6 per kg for FY13 to FY15). — Affin IB Research, Jan 16

This article first appeared in The Edge Financial Daily, on January 20, 2014.