Investment Highlights

• We reiterate BUY on Kossan Rubber Industries (Kossan) with an unchanged fair value (FV) of RM2.26/share, based on target FY25F PE of 22x (0.25x SD above its 10-year average of 17x to reflect the potential boost from trade diversions from China to Malaysia). No ESG-related FV adjustments based on an unchanged 3-star rating.

• Kossan’s FY23 core net profit of RM34mil came in way below expectations, 33% below our forecast and 31% street’s. Our core net profit was calculated after the adjustment of RM4mil PPE write-off incurred in 2QFY23 and RM35mil PPE impairment loss from decommissioning activities in 4QFY23.

• We believe the deviation was mainly due to lower-than- expected sales volume as a result of Red Sea-related shipment delays, as earlier reported by Hartalega Holdings (Hartalega), as well as lower-than-expected average selling prices (ASP) in both glove and cleanroom segments.

• Hence, we trimmed FY24F EPS by 11% to reflect lower sales volume assumption due to continued Red Sea crisis and longer time to scale up production in 1QFY24F. However, we maintain FY25F earnings and introduce FY26F core net profit with a growth of 35%, supported by higher ASP, sales volumes and profit margin as a result of regaining pricing power.

• For 1QFY24F, we expect Kossan’s QoQ earnings to be stronger, supported by higher ASP, sales volume and better profit margin from economies of scales.

• No interim dividend has been declared in 4QFY23, which is below our earlier expectation of 1 sen/share. In tandem with lower FY24F earnings, we trim FY24F DPS to 3 sen from 3.5 sen previously. We maintain FY25F DPS and introduce 6 sen/share for FY26F.

• On a QoQ basis, Kossan registered a 37% fall in 4QFY23 core net profit to RM29mil from RM46mil despite a flattish revenue growth. This was primarily attributed to the rubber glove and cleanroom divisions, which was possibly impacted by lower ASP amid higher raw material prices.

• We estimate that Kossan’s 4QFY23 ASP registered a 7% decline to US$18-20/1K pcs (vs US$20-21/1K pcs in 3QFY23), which is comparable to the declines observed by Hartalega and Top Glove Corporation. We believe that this has been contributed by continued pricing pressure from Chinese players despite higher raw material prices.

• We gather that Chinese peers have been selling 3.0-3.5g nitrile medical gloves at US$14-15/1K pcs since late 2022, which implies a discount of US$2/1K pcs compared to Malaysia's US$16-17/1K pcs currently.

• Going into 1QFY24, we believe Kossan will be able to increase ASP to fully pass on higher operating costs such as raw materials and natural gas. However, we believe that the group has no intention of increasing ASP for the sole purpose of expanding currently depressed margin.

• Separately, we estimate that Kossan’s 4QFY23 sales volume experienced a QoQ improvement of 8%-9%. Going forward, we anticipate a higher QoQ sales volume in 1QFY24F without a need to lower ASP (assuming raw material prices do not decrease) as customers with depleting inventories are expected to begin meaningful replenishment against the backdrop of major Chinese competitors operating at maximum production capacity for 3 consecutive quarters (2Q-4QCY23) without any material capacity expansions in 4QCY23. Our expectation on the improvement of sales volume in 1QFY24F is consistent with other Malaysian glove manufacturers, based on our channel checks.

• Kossan has ample financial resources with a substantive 4QFY23 net cash of RM2bil (RM0.81/share), which translates to 40% of current market cap. Hence, the group can expand capacity without resorting to any additional borrowings or opt to distribute a special dividend to investors.

• For now, the stock is trading at an attractive ex-cash FY25F PE of 16x, at a 20% discount to its pre-pandemic 20x.

Source: AmInvest Research - 23 Feb 2024