Kossan Rubber Industries Bhd
(July 23, RM4.09)
Maintain buy with a higher target price of RM5.16: Generally, the current operating environment of the glove industry is less tense now. To recap, there was intense competition that started at the end of 2018 and continued into early-2019. As a result, the average selling price suffered its steepest drop in the first quarter of 2019 (1Q19) before recovering slightly in 2Q19. The competition originated in Thailand’s Sri Trang which marked down natural rubber (NR) glove prices to gain market share. Positively, Kossan Rubber Industries Bhd was not affected significantly, especially its production of NR gloves for industrial usage. A testament to this was Kossan’s profit before tax (PBT) margin growth (+1.3% quarter-on-quarter [q-o-q]; +2.4% year-on-year [y-o-y]) in the first quarter of calendar year 2019, while it peers all recorded declines in PBT margins, such as Hartalega Holdings Bhd (-4.1% q-o-q; -5.3% y-o-y), Top Glove Corp Bhd (-0.4% q-o-q; -2.2% y-o-y) and Supermax Corp Bhd (-0.4% q-o-q; -0.2% y-o-y).

The management has reiterated that global glove demand will continue to grow by 8% to 12% over the next three years due to: i) more stringent healthcare regulations; ii) incremental demand from emerging markets where gloves per capita are still very low; and iii) increases in populations. The group is expected to operate at full capacity with lead times of 45 to 60 days. More importantly, the group would still be able to pass on any cost increase (such as the 5.3% hike in the natural gas tariff), albeit with a time lag of two months.

Kossan’s current capacity stands at about 26.5 billion gloves per annum. Plant 18 (2.5 billion gloves per annum), which has already started two out of eight lines, is expected to fully ramp up its production by October 2019. Plant 19 (three billion gloves per annum) is on track to be fully commissioned by 4Q19. Kossan’s annual capacity is expected to have increased by 20.8% to 32 billion gloves by then.

Future capacity growth will come from its 824-acre (333.46ha) land in Bidor, Perak earmarked for integrated and modernised glove manufacturing facilities. The ongoing land-clearing process in Bidor is expected to take about nine months to complete before construction works commence in June 2020. According to the management, we can expect Bidor to start contributing to the group’s profit from the second half of 2021. Note that the Bidor expansion can provide additional output of up to 45 billion gloves per annum when the plant is fully commissioned.

While Kossan is focusing on its expansion in Bidor, it is also looking to sell 56 acres of land in Bestari Jaya and 98 acres in Kuala Langat, acquired for an aggregate sum of RM130 million in 2013 and 2017 respectively. The disposal is expected to fetch approximately RM200 million, which will be utilised as working capital and capital expenditure.

The management is aiming to increase its profit margins via: i) cost rationalisation; ii) stringent quality control to minimise glove rejection rates; and iii) an increase in automation. Speaking of production automation, the group is aiming to reduce its reliance on workers to 1.3 workers per million pieces of gloves (currently about 2.5 workers per million pieces of gloves) once its automated packing process is in place by the end of 2019. Kossan is scheduled to release its performance for the second quarter of financial year 2019 (2QFY19) on Aug 22. We expect the quarterly profit to fall in between RM55 million and RM65 million, about 38.2% higher than 2QFY18 earnings, underpinned by volume growth at Plants 16 and 17.

Looking forward, we are confident that Kossan will be able to achieve double-digit earnings growth of 22.6% and 12.1% for FY19 and FY20 respectively, driven by higher volumes at Plants 18 and 19. — TA Securities, July 23