This article first appeared in The Edge Malaysia Weekly on July 20, 2020 - July 26, 2020

IN the ongoing rally in the glove sector, Kossan Rubber Industries Bhd — one of the big four — has been trading at a discount to its peers.

Its forward 12-month price-earnings ratio (PER) of 32.9 times is lower than that of Top Glove Corp Bhd (43.4 times), Hartalega Holdings Bhd (50.7 times) and Supermax Corp Bhd (62.3 times).

“We do increase production and make money, but [the share price movement] depends on market forces. Looking at the PER, yes [it is undervalued],” Kossan founder Tan Sri Lim Kuang Sia tells The Edge in an interview.

In a July 13 note, CGS-CIMB Research points out that Kossan remains attractive as it is a laggard play in the glove sector, trading at a 34.2% discount to the Malaysian glove sector average CY2021 PER of 28.3 times.

“This is despite the stock set to also benefit from the sector’s favourable supply-demand dynamics owing to Covid-19,” it notes.

The research house has raised Kossan’s FY2021-22 earnings per share by 4.1%-7.2%, mainly to account for additional capacity from the expected commissioning of its new Meru plant. Accordingly, the target price has also been raised to RM15.

Lim sees the company’s earnings peaking in 3Q and 4Q this year in view of higher production capacity and average selling prices (ASPs).

“The pandemic could be over by the middle of next year, then [demand will be] back to normal… [However, demand] would still be good in the first half of next year. If you look at China, its glove consumption is still very high despite the flattening of coronavirus cases,” he says, noting that the company’s gloves are booked till mid-2021.

The company expects to see an increase of over 20% quarter on quarter in ASPs from July this year.

Kossan’s net profit rose 10.35% to a record high of RM64.8 million in its first quarter ended March 31, 2020 (1QFY2020). For FY2019, its net earnings grew 13.41% to RM224.78 million from RM198.21 million in the preceding year.

Its shareholders can expect a bumper dividend payout this year as the company is committed to paying at least 30% of its profit, according to Lim. Last year, it paid a dividend of six sen per share, equivalent to a dividend payout ratio of 34.2%.

The company’s total annual production capacity is forecast at 32 billion pieces for 2020, an increase of 10.3% against 29 billion pieces in 2019. Nitrile gloves make up of about 80% of the company’s production, with the remainder being natural rubber gloves.

Kossan recently announced that it plans to acquire an industrial property measuring 4.05ha in Meru, Selangor, for RM40 million cash to expand its production facilities. Including the land purchase, the total capital expenditure for the project is RM200 million. The facility will add production capacity of 6.4 billion pieces from 21 production lines and will be fully operational in the second half of 2022.

The US is the biggest export market for Kossan, accounting for 50% of total sales. Other major markets are Europe and Japan.

It is worth noting that Lim has been disposing of the company’s shares since the glove stock rally, paring his indirect stake, held through Kossan Holdings (M) Sdn Bhd, to 48% from 51.37% as at end-December 2019. His direct shareholding remains at 0.12%.

“It’s just normal profit-taking given the current high share price,” he says, when asked of the stake sale.

Based on last Friday’s closing price of RM13.50, Lim’s net worth stood at RM8.31 billion, a 213.6% jump against RM2.65 billion as at end-December 2019. Year to date, the stock has risen 224.5%.

Last Thursday, the market was caught off guard by news that the US Customs and Border Protection has served a detention order on disposal gloves manufactured by two subsidiaries of Top Glove — Top Glove Sdn Bhd and TG Medical Sdn Bhd — possibly linked to foreign labour issues.

Lim says as far as Kossan is concerned, the company has done its best to comply with the requirements in relation to the foreign labour issue.

“We are working very closely and communicating with the activist groups, and we are also getting advice from the consultants. We must get things right.”

Kossan employs close to 7,000 staff, of which 4,000 are foreigners. In a bid to reduce reliance on foreign labour, it has been gearing up its level of automation.

While the glove industry has attracted many new players, Lim cautions that venturing into the sector may not be easy as it involves high investment cost and stringent compliance.

“First, you need to think of infrastructure and utilities. Then you will require a minimum of 15 to 18 months for the installation of 10 production lines. You also need to get ISO and certification before you can sell the products. So, at least two-and-a-half years will be spent before you can start operating.”

“By the time you get ready, the pandemic is over and the vaccine is found. When demand is back to normal, how are you going to compete?” he questions.

According to Bloomberg, analysts’ median target price for Kossan is RM12.74, translating into a possible downside of 5.6% from its Friday close of RM13.50.

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