Kossan Rubber Industries Bhd
(Feb 5, RM5.18)
Maintain outperform with a target price (TP) of RM5.90: We hosted the management of Kossan Rubber Industries recently for an update with our clients and received positive response despite the weaker market sentiment. The group has seen an upward surge in its price performance, outperforming our previous TP of RM5.12 largely driven by the strengthening of the US dollar perception coupled with the defensive nature of the sector.

We commend Kossan for its cost-efficiency initiatives which have been recognised by the market and thus continue to maintain our “outperform” call, with a revised TP upwards to RM5.90.

Our TP is derived by our dividend discount model approach implying a financial year 2016 (FY16) price-earnings ratio of 16.6 times. Albeit richer in valuation, the continuous production efficiency and diversified product mix, strengthened further by the materialisation of improving contributions from the technical rubber products and clean-room division will continue to support Kossan’s growth.

Glove players are all operating on the same platform, however their individual capabilities and competitive strengths have been reflected in the respective performances. For Kossan, its product mix and efficiency enhancements have been the key to its steady uptrend performance. The group’s average production speed is 45,000 pieces per hour for lightweight synthetic rubber (SR) with an average utilisation of 80%. Its current composition is natural rubber: SR with 40:60, with its target to further increase its SR production to 80% of its total capacity by 2016.

Strategies are continuous research and development to improve efficiency, well-managed product mix, interchangeable lines to promote flexibility to production with minimal downtime, ongoing revamp of old production lines to increase overall efficiency and minimise wastage of materials, and rejection of gloves through automation.

As the group will be buoyed by calculated capacity expansion plans of its three new SR plants, which will fully contribute by the second quarter of FY15 coupled with improving efficiencies. Kossan has a minimum dividend policy of 30%, with plans to increase its payout ratio to 40% to 50% in the next three years.

Kossan’s current 3gm SR gloves are favourable among its customers due to their unique light weight, coupled with low chemical residue which minimises dermatitis allergies.

Some of the new plants’ capacities have therefore been dedicated to producing this product, ordered by certain reputable long-term customers. By running the same type of product, Kossan will be able to reduce its downtime and cost per unit, translating into higher overall margins for the product with larger volumes.

Kossan’s next phase of growth includes diversifying into this segment, with an expected double-digit earnings growth yearly. Latest targets are hospitals, automotive parts and infrastructure. The division is expected to contribute double-digit earnings growth, although starting at a low base, but would see stable recurring income. — Public Bank Investment Bank, Feb 5

This article first appeared in The Edge Financial Daily, on February 6, 2015.