We came back from a company visit feeling optimistic that the company’s new capacity expansion plans for FY15 are on track. The stage is set for Kossan Rubber to be further re-rated upwards, underpinned by: (i) new in-coming production capacity, gradually starting in 4QCY2014 which will kick-start subsequent quarterly earnings growth and (ii) potential margin expansion from new capacity due to its revised gloves production scheduling. All in, we are raising our FY15E earnings forecast by 8% by taking into account the potential margin expansion from Kossan and introducing our FY16E numbers. Correspondingly, our target price is also raised by 8% from RM4.86 to RM5.23 based on 16x FY15E revised EPS. We maintain our OUTPERFORM rating.

Potential margins expansion from new gloves production lines due to revised production scheduling. We believe Kossan’s new gloves production lines could potentially lead to higher margins due to improved productivity and efficiency as the lines are designed to focus on larger orders with fewer clients (compared to previous production scheduling model) for a single product type and specification, thus reducing idle downtime from frequent machinery setting adjustments to accommodate diverse specifications. This could lead to an output of 35,000 pieces of gloves per hour, which is higher than its existing average production line speed of 29,000 gloves per hour; a robust 20% enhancement. Its current production style comprises shorter production lines catering to a large customer base with diverse products, which reduces reliance risk on few larger clients. However, such an arrangement limits margin expansion due to more downtime on frequent machinery setting adjustment.

Slight delay but FY15 full-steam ahead. Three plants with a total of 17 production lines producing 6bn pieces of gloves will be completed in various stages. Plant (1) with 5 lines was completed in June with commercial production in August 2014. The remaining Plant (2) and (3) with a total of 12 lines are expected to be operational in September and November; and scheduled for full commercial production in Nov 2014 and Jan 2015, respectively. These three plants, when fully operational by end 2015, will enlarge installed capacity by 38% from the existing 16b to 22b pieces of gloves per annum. Plans are in also place to add two new plants with c.5b pieces capacity in FY15 which would boost FY16E earnings. With these planned capacities, Kossan’s NBR:NR mix is targeted to shift from the current 57:43 to 80:20 by FY16. We have already factored in the FY14 delay into our earnings model.

Raising our FY15E net profit by 8%, introducing FY16E numbers. We are raising our FY15E earnings forecast by 8% taking into account margin expansion (EBITDA margin raised from 17.8% to 19.5%) emanating from the new plant’s production scheduling strategy and introducing our FY16E numbers. Correspondingly, our target price is raised by 8% from RM4.86 to RM5.23 based on unchanged 16x FY15E revised EPS. We maintain our OUTPERFORM rating.

We like Kossan because: (i) of its superior net profit growth of 16% and 28% in FY14E and FY15E, compared to peers average of 10-12%, respectively, the unprecedented earnings growth over the next two years underpinned by rapid capacity expansion, and (iii) the fact that Kossan is not just a rubber glove play but also a bet on its TRP division, which has     grown steadily over the past few quarters.

Key risks. Delay in commissioning of production lines.

Source: Kenanga