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Wednesday, April 15, 2020

Kossan Rubber Industries - Potential Game Changing Strategy

The stage is now set for a solid FY20 after three quarters of anaemic quarterly earnings growth. Looking ahead, forward earnings growth will be amplified by re-stocking activities ramp-up due to the current COVID-19 pandemic and further boosted by better margins from higher ASP. TP raised from RM5.90 to RM6.30 based on 28.5x FY21E EPS (at +1.5SD above 5-year historical forward mean). We roll forward our valuation from FY20E to FY21E. Reiterate OP.

Higher volume sales and ASP; longer delivery lead times. Longer delivery lead times are indicating that demand will outstrip supply at least over the medium-term. The Malaysian Rubber Glove Manufacturers Association has forecast a 20% demand growth to 230b pieces in 2020. We believe Kossan will benefit from robust demand which has led to industry longer delivery lead times (the moment order was placed to delivery) which has risen to an average of between 80 to 100 days as compared to 40 to 50 days normally. Signs of demand outstripping supply could potentially lead to higher ASPs. Looking at the stable raw material prices, ceteris paribus, hikes in ASPs are expected to lead to margins expansion. We understand that Kossan has raised prices by 3- 5% in anticipation of higher demand and we also noted the industry current high >90% utilisation rate for nitrile-centric players which is a stark contrast compared to the lacklustre demand in 2019.

Expect a solid 1QFY20. Signs of pent-up demand for nitrile gloves, potentially on re-stocking activities are pointing towards a better 1QFY20. We expect its 1QFY20 PATAMI, which is due to be released by end-May, to be higher QoQ and YoY due to new capacity expansion from plant 18, 19 and better margins due to higher operating efficiencies from new plants. For illustration purposes, with full-quarter commencement of Plant 18, and partial commencement of Plant 19, net margin of 10%, and ASP of 9.5 sen/piece; 1QFY20 PATAMI could come in at RM66-68m (+8% to +11% QoQ; +12% to +16% YoY), fitting within our/consensus full-year forecasts, at 25%/24%.

Game changer, potential PER re-rating. Anecdotal evidence could potentially suggest a potential PER re-rating as Kossan is embarking on an aggressive capacity expansion as opposed to their past historical conservative expansion stance. Recall, beyond plant 19, land clearing is underway in the Bidor plant, and the first plant is expected to start commercial operation sometime in 2021, earlier than the previously targeted 2022.

Plant 17,18 and 19 to boost earnings over next two years. We understand that Plant 18 (2.5b pieces) was fully commissioned in Nov 2019. Plant 19 (3.0b pieces) currently has two to three lines commissioned and another two expected to be commissioned soon and on track for full operations by 1H 2020. Upon completion, these three new plants will bring the group’s total installed capacity to 32b (+28%) pieces of gloves per annum.

Trading at unwarranted 38% PER discount valuation to bigger peers. The stock has risen 28% YTD. We continue to remain bullish and expect the stock to trade close to +2.0SD in anticipation of a ramp up in demand from restocking activities; hence, expectation of peak earnings growth in subsequent quarters. We roll forward our valuation from FY20E to FY21E. TP is raised from RM5.90 to RM6.30 based on 28.5x FY21E EPS (at +1.5SD above 5-year historical forward mean). We expect valuation gap to narrow considering that KRI’s net profit growth is 17% vs industry average of 13%. Reiterate Outperform. Key risk to our call is slower-than-expected commissioning of the new plants.

Source: Kenanga Research - 15 Apr 2020

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