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Thursday, August 9, 2012

Kossan eyes upstream move

KUALA LUMPUR: KOSSAN RUBBER INDUSTRIES BHD,the country’s fourth largest rubber glove maker, will prioritise upstream expansion into rubber PLANTATION to manage the risk of fluctuating latex prices.
Managing director Datuk Lim Kuang Sia told The Edge Financial Daily upstream expansion has been given a high priority within the group. It is looking for approximately 10,000ha of greenfield land to plant rubber, either in Indonesia or Myanmar.
“We have been steadily expanding our capacity, and now that we are big we need to look into risk management and raw material supply management.
Diversifying upstream into rubber plantations will give us a natural hedge against the volatility of rubber prices and ensure we have sufficient supply in the event of a shortage,” said Lim.
This follows in the footsteps of the world’s largest glovemaker, Top Glove Corp Bhd, which acquired 30,000ha of greenfield rubber plantation land in Indonesia last month.Low Soo Fang, an analyst with AmBank, said the move upstream would be a positive one for Kossan.
“Kossan will not be forced to use financial derivatives to hedge against rubber prices instead of a physical hedge. Such a move may discourage some funds from investing in the stock due to the risks associated with such financial derivatives. Moving upstream is different as it involves real physical assets,” said Low.
“Of course, it will still depend on whether they can find a suitable location to plant at good price,” he added, noting that Kossan should have no trouble financing the land acquisition due to its low gearing. As at March 31 this year Kossan’s net borrowings were RM79.23 million and net gearing was approximately 23%.
“We have to make sure that on the one hand we pay out enough dividends to shareholders. On the other hand, we have to make sure we invest the excess cash wisely to ensure that our profit can grow sustainably,” said Kossan’s Lim.
Notably, a greenfield rubber plantation would take about seven years for the trees to mature, in which time Kossan would not see much return on its investment while bearing a burden on its cash flow.
However, Lim said the group has a healthy cash flow and even after dividends there are sufficient funds left to sustain rubber planting until maturity. Lim said the group is exploring the potential of expanding its technical rubber products (TRP) division in Indonesia, which could cost roughly RM12 million to set up including the purchase of land.
The TRP division contributes 12% to the group’s revenue and is currently the largest in the country. TRP deals in engineering and manufacturing rubber products for industrial applications, for example, infrastructure rubber products like seismic bearings for buildings and sealants.
“One area of interest to us is the booming automotive sector in Indonesia, which will have a high demand for TRP for engine parts. They are going to be the largest car manufacturers in the world.
There are existing TRP players in Indonesia, but they are still very small. And we have years of experience and expertise,” said Lim.Kossan would not need a local partner for a pure manufacturing subsidiary in Indonesia, he said, but would need one for a plantation-related business.
Another reason to expand TRP operations to Indonesia is the availability of cheap labour, said Lim.
“Right now, one of the biggest challenges in the industry is the increasing cost of labour in the country, and it is going to continue going up. We want to stay ahead of the game.
Unlike rubber gloves, TRP cannot automate ... which results in higher labour costs,” said Lim, noting that labour accounts for 15% to 16% of TRP production costs and 8% to 9% for rubber gloves.
Lim said Kossan is planning to invest RM10 million by 2014 to automate its rubber glove arm and reduce its dependency on foreign workers following the minimum wage policy which has increased labour costs. “Right now we have about 5,000 employees, of which 70% are foreign workers.
In one year, we aim to reduce this to about 50% and by 2014, this could be as low as 30%,” said Lim noting that the next challenge for the industry would be finding sufficient technicians and engineers to operate the highly automated plants.
Kossan is close to completing the current round of capacity expansion. The group has just finished a nine-line production plant worth RM38 million that will add up to 1.25 billion or 9% to its annual rubber glove capacity to 14.5 billion by the end of the year.
At the same time, the group has upgraded its existing factory lines which will boost existing production capacity by some 5% or 500 million gloves. By October, the group will also complete and begin operating a RM45 million plant which will add 700 million to the group’s surgical glove capacity, said Lim.
The surgical glove segment makes up about 3% of the group’s rubber glove capacity. The group will continue to focus on this segment in line with its focus on higher value-added products, said Lim.
“While basic rubber gloves still make up the bulk of our revenue, the pricing is vulnerable to overcapacity or sudden increases in raw materials prices,” said Lim.
On that note, the group recently acquired a 51% stake in a Chinese-based clean room TECHNOLOGY company for US$3 million (RM9.33 million). Lim said Kossan will manufacture clean room gloves, masks and wipes for computer chips.
Looking ahead, Lim said Kossan will spend approximately RM50 million to continue building up its capacity and pointed out that the group has an additional 4.45ha of industrial land in Meru, Selangor, for it to expand.
Low notes that Kossan has traditionally been very conservative with expansion, ensuring that it has a high utilisation rate of its existing capacity before expanding.
Kossan is also the cheapest of the four big glovemakers with a forward price earnings ratio of 9.15 times compared with Top Glove’s 17.94 times, HARTALEGA HOLDINGS BHD’s 14.42 times and Supermax Corp Bhd’s 11.13 times.
“Historically, Kossan has traded at a discount to Top Glove mainly due to lower trading liquidity. Fundamentally however, there shouldn’t be such a big discount,” said Low.
But Low said Top Glove and Kossan differ in that Top Glove is a dividend-yielding stock while Kossan is seen as a growth play. Top Glove pays out about 40% of its earnings compared to Kossan’s 24%. But their dividend yields are close, with Top Glove at 2.41% and Kossan at 2.56%.
This article appeared in The Edge Financial Daily on August 8, 2012.

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