TA Kossan Aug 2013 Initiate Coverage

I n i t i a t i o n C o v e r a g e

Monday, August 12, 2013

FBM KLCI: 1,779.32

Sector: Manufacturing

MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048

Page 1 of 15

TA SecuritiesA Member of the TA Group

Kossan Rubber Industries Berhad

TP: RM6.80 (+12.6%) Affordable Exposure to Glove Manufacturing Last traded: RM6.04

THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY*

BUY

TA Research Team Coverage +603-2072-1277 ext: 1612 [email protected] www.taonline.com.my

Investment Thesis and Key Assumptions

We initiate coverage on Kossan with a target price of RM6.80/share. We like

Kossan for its aggressive expansion plan to double production capacity to

32bn pieces of gloves/annum by 2018. Signaling their commitment, more

than 70 acres of industrial land with natural gas supply has been secured for

expansion. Production lines will be highly versatile and interchangeable with

minimum downtime. The new plants are envisaged to improve profit margins

through lower production cost per glove and higher production efficiency.

We are also positive on the shift of focus towards higher margin gloves.

Specifically, this relates to gloves with lower levels of competition such as

special purpose, nitrile and latex powdered-free gloves. In tandem with their

goals, Kossan aspires to become the world’s largest manufacturer of surgical

gloves. In operation since February, they currently have a surgical gloves

factory producing approximately 650mn surgical gloves/annum.

Growth will be mainly underpinned by the increase in total installed capacity.

Supported by strong demand for gloves, we are expecting earnings growth of

29.7% and 17.1% in FY13 and FY14. That said, as capacity from rival glove

manufacturers starts to kick in, we anticipate a lower utilization rate in FY15.

Hence, our predicted earnings growth for FY15 will decrease to 13.6%.

All in all, we like Kossan for its affordable exposure to the glove

manufacturing industry. Kossan’s FY14 PER of 12.4x is undemanding vs. the

industry’s average of 14.7x. Our target price implies a total potential upside of

16.2% from the stock’s last closing price. Therefore, we initiate coverage on

Kossan with a BUY rating. Key re-rating catalyst include: 1) Stronger than

expected demand for gloves; 2) Maintenance of margin despite increased

competition; 3) Better than anticipated returns from expansion into TRP.

Downside risks include 1) Onset of competition from local glove manufacturers

who are continually increasing total installed capacity; 2) Expected rise in

natural gas prices from RM16.07/mmbtu to RM40.00/mmbtu.

Earnings Summary (RM mn)

FYE Dec 31 2011 2012 2013f 2014f 2015f

Revenue 1,090.0 1,234.0 1,272.3 1,536.0 1,731.1

Other income 10.4 4.4 4.6 4.9 5.1

Tota l Cost (980.0) (1,093.6) (1,097.5) (1,331.2) (1,497.5)

PBT 112.9 138.5 171.9 202.8 232.6

Taxation (21.8) (33.7) (36.0) (43.7) (51.8)

Net profi t 89.7 102.2 132.5 155.2 176.3

EPS (s en) 28.0 32.0 41.5 48.5 55.1

EPS Growth (%) (20.9) 13.9 29.7 17.1 13.6

DPS (s en) 7.0 12.0 18.7 21.8 24.8

Div Yield (%) 1.1 2.0 3.1 3.6 4.1

PER (x) 21.7 19.1 14.7 12.6 11.1

Q Share Information

Bloomberg Code KRI MK

Stock Code 7153

Listing Main Market

Share Cap (mn) 318.6

Market Cap (RMmn) 1924.5

Par Value 0.50

52-wk Hi/Lo (RM) 6.12/2.97

12-mth Avg Daily Vol ('000 shrs) 495.1

Estimated Free Float (%) 37.4

Beta 0.8

Major Shareholders (%)

Kossan Holdings Sdn Bhd - 51.24

EPF -5.03

Invesco Ltd - 5.03

Forecast Revision

FY13 FY14

n.a. n.a.

132.5 155.2

Consensus 127.5 149.5

103.9 103.8

Financial Indicators

FY13 FY14

Net gearing (x) 0.1 0.1

CFPS (RM) 0.4 0.2

P/CFPS (x) 13.8 26.7

ROA (%) 13.0 14.1

ROE (%) 20.7 21.5

NTA/Share (RM) 2.1 2.4

Price/ NTA (x) 2.9 2.5

Share Performance (%)

Price Change KRI FBM KLCI

1 mth 4.1 0.4

3 mth 39.2 0.6

6 mth 80.8 8.7

12 mth 85.8 8.1

Kumpulan Wang Persaraan - 5.60

Forecast Revision (%)

Net profit (RMm)

TA's / Consensus (%)

Previous Rating n.a.

(12-Mth) Share Price relative to the FBM KLCI

Source: Bloomberg

12-Aug-13

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1.0 Background

Established in 1979, Kossan Rubber Industries Bhd was one of the first

companies in Malaysia to venture into glove manufacturing. From the

introduction of its first glove production line in August 1988, Kossan is now one

of the largest glove manufacturers in the world with an estimated total installed

capacity of approximately 16bn gloves/annum by the end of FY13.

Furthermore, Kossan is also Malaysia’s largest manufacturer for Technical

Rubber Products (TRPs) with approximately 9,000mt of rubber compound

produced. Kossan employs more than 5,200 workers in 15 plants located

throughout the Klang Valley.

Figure 1: Products offered

Disposable Gloves Technical Rubber Products

Source: Companies, TA Securities

2.0 Business Operations

Table 1: Revenue Distribution (RM mn)

FY08 FY09 FY10 FY11 FY12

Total Revenue 897.2 842.1 1046.9 1090.0 1234.0

Revenue - Gloves 788.9 754.8 936.5 936.5 1074.7

Revenue - TRP 108.3 87.4 110.4 153.4 159.3

Proportion - Gloves 87.9% 89.6% 89.5% 85.9% 87.1%

Proportion - TRP 12.1% 10.4% 10.5% 14.1% 12.9%


2.1 Technical Rubber Products (TRPs)

Apart from gloves, Kossan also undertakes the production of TRPs which

contributes approximately 10% to total revenue. The bulk of TRPs supplied by

Kossan are to the automotive industry, marine industry, construction & civil

engineering and aerospace. For the automotive industry, products are mainly

supplied to the US, Germany and Australia. Currently, Kossan produces

approximately 9,000 mt of rubber compound per year. Unlike rubber gloves,

technical rubber products require longer production times [lead times of four

to six months]. This increases their exposure to fluctuations in the exchange

rate and material prices. Hence, margins for TRP products can vary from 5% to

40%, with customizable products carrying higher margins. In terms of

prospects, Kossan will construct a technical rubber manufacturing facility in

Indonesia, specializing in the production of seismic bearings. The plant which

will begin construction within the year is expected to contribute to earnings in

the 1HFY14. Also, the company is on the lookout for overseas based rubberized

automobile parts manufacturer-distributors. Potential benefits from the

acquisition include knowledge transfer and a pathway into the overseas market

through leverage of a local brand.

12-Aug-13

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2.2 Gloves

Kossan derives the bulk of its revenue from the production of gloves, which

makes up 90% of its total revenue. Key products produced in its glove division

include examination gloves (powder-free latex and nitrile), surgical gloves,

cleanroom gloves and facemask. As of FY13, Kossan has a total installed glove

capacity of 16bn gloves/annum. Compared to the other glove manufacturers

under our coverage, this places Kossan as the third largest manufacturer,

trailing behind Top Glove and Supermax. In terms of geographic distribution

(see Figure 2), Kossan exports a combined 80% of its gloves to USA, Canada and

Europe. Customers in these regions tend to place higher emphasis on quality

rather than price.

Figure 2: Geographic Distribution


As a percentage of total products (see Figure 3), 55% of gloves manufactured

are made from latex and 45% from nitrile. This translates to a projected FY13

year end capacity of 8.8bn latex gloves/annum and 7.2bn nitrile gloves/annum.

Similar to Supermax, this provides Kossan with a diverse mix of products,

making them less susceptible to changes in consumer tastes. To recap, demand

for nitrile gloves remains resilient as consumers have been switching from the

usage of latex gloves to nitrile gloves. Cited reasons for the change in

preference include thinner nitrile gloves and prevalence of protein allergies in

latex gloves.

Figure 3: Product mix


USA & Canada,

50%Europe, 30%

Asia

Pacific,

12%

Latin

America, 8%

Nitrile

45%

Latex

55%

12-Aug-13

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Of the produced gloves, 95% is supplied to the medical industry such as

examination and surgical gloves. The remaining 5% is supplied to the non-

medical industry in sectors such as food service, automotive and household.

Thickness and characteristics of gloves will vary according to the targeted

market segment.

In terms of customer diversity, Kossan markets its gloves to 200 active

customers, spread across 150 countries. Its biggest and top five customers

contribute approximately 11% and 35% of total sales. Over the near term, this

dependency will be mitigated by strong continued demand for gloves. However,

as rival glove manufacturers continue to add to existing capacities, we do not

discount the possibility of future price reductions to maintain existing

customers.

The proportion of gloves manufactured under original equipment

manufacturer (OEM) and original brand manufacturer (OBM) are 80% and

20% respectively. While this may result in lower margins, it reduces the

possibility of conflicts arising from competition with existing customers.

3.0 Expansion Plans – Gloves

Figure 4: Estimated Capacity


More than 70 acres of industrial land with natural gas supply located in the

Klang Valley has been secured for expansion. By 2018, management targets to

increase the production capacity to 32bn pieces of gloves/annum. Currently,

three plants are already under construction with expectations of commercial

running in between 4QFY13 to 1QFY14. Together, these plants will add

approximately 5.0bn pieces of gloves/annum constituting mainly of nitrile

products. In addition to current installed capacity of 16bn pieces of

gloves/annum, total installed capacity by FY14 should rise to 21.0bn pieces of

gloves/annum. Incoming capacity will be skewed towards the production of

nitrile gloves.

Production lines will be highly versatile and interchangeable with minimum

downtime. Taking the latest lines as a benchmark, each of Kossan’s double

former line has the capability of producing approximately 30k to 35k pieces of

gloves/hour. While this lags Hartalega’s 45k pieces of gloves/hour, it is above

the industrial average of 18k to 22k pieces of gloves/hour. Progressing through

the phases of expansion, incremental improvements to production efficiency

will be expected. The new plants are envisaged to improve profit margins

through lower production cost per glove and higher production efficiency.

Production efficiency can be expanded to include items such as higher output,

less rejects, less downtime and light weight products. These cost cutting

measures will aid Kossan in maintaining their margins in anticipation of

potential long run margin compression of nitrile gloves.

12-Aug-13

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4.0 Business Strategy - Gloves

4.1 Business Positioning and Market Segment

Figure 5: Targeted Market Segment


Looking ahead, Kossan will focus resources on the production of special

purpose, nitrile and latex powdered-free gloves. These products are expected to

fetch higher profit margins due to lower levels of competition. In tandem with

their goals, Kossan aspires to become the world’s largest manufacturer of

surgical gloves. In operation since February, they currently have a surgical

gloves factory producing approximately 650mn surgical gloves/annum. This

places them among the largest surgical glove manufacturers in the world.

In comparison, less emphasis will be placed on latex powdered gloves and

gloves made from materials such as PVC, PU and Vinyl. It is noted that gloves in

this segment run a higher risk of overcapacity due to the low barriers to entry.

Given this, prices of these types of gloves are more elastic with a heightened

risk of price war initiated by smaller manufacturers.

Overall, we view this move as positive. This is consistent with the current

market trend as consumers have been shifting from the usage of latex gloves to

nitrile gloves (see Figure 6). Supporting the trend, margin compression of latex

gloves have also been recorded in Top Glove’s [largest manufacturer of latex

gloves] latest quarter results. We are particularly excited about Kossan’s

aspirations to be the largest manufacturer of surgical gloves. We opine that this

will provide Kossan with future earnings stability pending the eventual

commoditization of nitrile gloves in the long run.

12-Aug-13

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Figure 6: Examination gloves export from Malaysia


5.0 Financials

5.1 Revenue

Figure 7: Revenue (RMmn)


Since FY06, Kossan has shown consistent growth with revenue increasing by

116% or CAGR of 13.7% (see Figure 7). The main drivers of revenue growth are

total installed capacity, demand for gloves, average selling prices (ASP) and the

USD/MYR rate. Total installed capacity determines the quantity of gloves

produced and ultimately sold. However, this relationship only holds true if

additional capacity is met by increasing demand. Believing demand will remain

strong and continue to grow, Kossan targets to double total installed capacity to

32bn pieces of gloves/annum by 2018.

Furthermore, revenue will also be determined by ASPs. ASPs differ according to

the type of glove being sold. Products such as special purpose, nitrile and

powder-free latex gloves fetch higher and more stable ASPs compared to

powdered latex, PVC, PU and vinyl gloves. In an effort to increase profit

margins, new lines will be skewed towards the production of nitrile gloves.

Kossan has also signaled its intent to becoming the world’s largest

manufacturer of surgical gloves. Lastly, fluctuations in the USD/MYR rate will

also play an impact on revenue. As most sales are conducted in USD, a higher

(lower) USD/MYR rate will result in higher (lower) revenue.

83

77

69

56 53

17

23

31

44 47

0

10

20

30

40

50

60

70

80

90

2008 2009 2010 2011 2012

NR

SR

571.3

702.6

897.2842.1

1,046.91,090.0

1,234.0

49.8%

23.0%

27.7%

-6.1%

24.3%

4.1%

13.2%

-10%

0%

10%

20%

30%

40%

50%

60%

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12

% ChangeRMmn

12-Aug-13

Page 7 of 15


5.2 Costs

Figure 8: Cost breakdown


Similar to other glove manufacturers, Kossan’s main cost component is material

expenses. Material expenses make up 55% of total cost and consist of latex and

nitrile used during the production of gloves. Purchased in USD, this creates a

natural hedge against fluctuations in the USD/MYR rate. Also, given that nitrile

gloves are on average thinner than latex gloves, we note that less material is

required for the production of nitrile gloves. We note that the average weight of

latex and nitrile gloves is 5.5g and 3.4g respectively. Taking the average price of

latex and nitrile in FY12 and assuming no wastage is made, 3.6sen of latex and

2.1sen of nitrile is required for the production of one latex and nitrile glove

respectively. Hence, apart from the respective price of latex/kg and nitrile/kg,

material cost will also depend on the composition of latex to nitrile gloves

produced.

Another major cost component for glove manufacturers is labour cost.

Currently, Kossan employs approximately 5,200 workers. For Kossan, labour

cost formulates 10% of total cost. This is due to the labour intensive attributes

of glove manufacturing. The two most labour intensive process in glove

manufacturing is stripping and packaging. To mitigate this impact, efforts on

automation such as the introduction of robotics are being implemented. Apart

from reducing labour cost, this will also ensure consistent quality and reduce

human errors which will decrease output cost. Labour cost will be impacted by

events such as a change in the minimum wage policy and shortage of labour

supply.

Kossan is also reliant on energy costs, which is mainly used for the heating of

gloves. Of the 9% attributed to energy costs, 6% is composed of natural gas and

3% for electricity. Natural gas availability represents one of the main

considerations during land acquisitions. In the absence of natural gas,

manufacturers will then look towards biomass for energy needs. For Kossan,

energy cost will mainly be determined by the prices of natural gas, which in

turn will be affected by the continuance of subsidies and supply of natural gas.

Material

55%

Others

9%

Packaging

8%

Labour

10%

Energy

9%

Chemical

9%

12-Aug-13

Page 8 of 15


Combined, the above factors represent close to 75% of total cost. In an effort to

provide earnings stability, Kossan employs a cost pass through mechanism in

respect to changes in cost. Any increase/decrease in cost will be consequently

met with an increase/decrease in ASP. As a result, a change in cost is unlikely to

play a major impact on earnings in the long run. However, due to a one month

time lag in passing on cost to consumers, we do not discount that earnings will

ultimately be impacted during that period.

5.3 Balance Sheet and Cash Flow

Kossan has a healthy balance sheet with a low net gearing ratio of 10%,

implying that it isn’t highly levered (see Table 2). Of total debt, long term debt

is low at 20% as the bulk of interest bearing borrowings are short term. The

duration of long term borrowing vary from three to six years, used mainly for

the purchase of land, machineries and equipments. In comparison, short term

borrowings such as banker’s acceptance and revolving credit are used for

working capital purposes. Also, to prevent earnings dilution, Kossan’s balance

sheet is free from convertible instruments and hybrid borrowings.

Table 2: Net gearing

FY08 FY09 FY10 FY11 FY12 1QFY13

Long Term Debt (%) 16 23 16 12 18 20

Short Term Debt (%) 84 77 84 88 82 80

Net Gearing (%) 63 51 24 18 16 10 Source: Companies, TA Securities

Net operating cash flow for FY12 stood strong at RM93mn. In line with profit

growth from strong demand and increased capacity, we believe future

operating cash flow will be sufficient to support planned capital expenditure

(CAPEX) and an increase in the dividend payout ratio (from 35% to 50% in the

next two years). Expected CAPEX over the next five years will range between

RM70mn to RM80mn. This will mainly be used for the purchase of plant and

equipment, in support of Kossan’s expansion activities.

6.0 Peer Comparison

In reference to Figure 11, of the glove manufacturers under our coverage,

Kossan is the third largest glove manufacturer (see Figure 9). With an expected

installed capacity of 16bn gloves/annum by the end of the year, Kossan trails

Supermax’s installed capacity of 17.8bn gloves/annum albeit leading

Hartalega’s total installed capacity of 14bn. From a diversity perspective,

Kossan is one of the more balanced manufacturers with a close to equal mix of

nitrile and latex gloves. Compared to Hartalega and Top Glove, their more

diversified exposure will provide them with earnings stability in situations of

changes in consumer demand between nitrile and latex gloves.

12-Aug-13

Page 9 of 15


Figure 9: Nitrile and latex capacity (mn gloves/annum) as at July 2013


In terms of margins, Kossan enjoys industry average margins ranking between

Supermax and Top Glove with a PBT margin of 11.2% (see Figure 10). Given

their relative similar product composition, we opine that Supermax may have

better margins due to their higher composition of OBM products. Also, Kossan’s

margins may be pulled back by the variance in margins of TRP products which

ranges between 5% and 40%. That said, we anticipate margins to improve as

Kossan expands capacity in lucrative segments such as specialty purpose gloves

and nitrile gloves. We are predicting PBT margins of 13.5% and 13.2% for FY13

and FY14 respectively.

Figure 10: PBT Margin (%) FY12/FY13*


Taking average profit per worker as a benchmark for efficiency, we can see that

Kossan is the third most efficient glove manufacturer (see Figure 11). Their

average profit per worker of RM19,647 is slightly above Top Glove but trails

Supermax and Hartalega. That said, coupled with automation efforts and

expansion into higher margin products, we opine that average profit per

worker will increase in the future.

7.2

7.1

7.1

12.6

8.8

10.7

31.0

1.4

16.0

17.8

41.9

14.0

0.0 10.0 20.0 30.0 40.0 50.0

Kossan

Supermax

Top Glove

Hartalega

Total Capacity Latex Capacity Nitrile Capacity

11.2

10.4

29.64

13.8

0 5 10 15 20 25 30 35

Kossan

Top Glove

Hartalega*

Supermax

12-Aug-13

Page 10 of 15


Figure 11: Average profit per worker (FY12/FY13*)


7.0 Risks

Akin to other glove manufacturers, Kossan’s earnings will be influenced by

material prices, exchange rate, energy cost and labour cost. Before proceeding,

we would like to reiterate that the sensitivity analysis conducted below is based

on the assumption that prices remain unchanged in respect to increases or

decreases in cost.

7.1 Material prices

As discussed earlier, material price is the largest component of cost, making up

55% of total cost. With this, fluctuations in material prices, specifically the price

of latex and nitrile plays an important role in the determination of earnings.

Keeping everything else constant, a 10 sen (1.7%) increase in the price of latex

decreases earnings by 3.0%. For nitrile, a 10 sen (1.8%) increase in the price of

nitrile will decrease earnings by 2.9%.

With near record stock levels and continued global uncertainties, we expect

material prices to remain soft for the foreseeable future. We are currently

predicting latex and nitrile prices of RM6.00/kg and RM5.60/kg respectively.

The main determinants of latex and nitrile prices include the demand for

automotive vehicles and the respective supply of latex and nitrile.

Figure 12: Price of Crude Oil, Natural Rubber and Synthetic Latex

Source: WTI, MRB, Companies, TA Securities

Kossan Top Glove Hartalega* Supermax

No. of workers 5,200 11,000 3,700 3,500

Avg. profit per worker (RM) 19,647 18,430 63,412 34,777

Avg. rev per worker (RM) 237,308 210,405 278,928 284,964

0

50,000

100,000

150,000

200,000

250,000

300,000

0

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160

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

RM/KGUSD/bbl

Crude Oil Latex Nitrile

12-Aug-13

Page 11 of 15


Figure 13: Sensitivity Analysis on Latex price

\


Figure 14: Sensitivity Analysis on Nitrile price

\


7.2 Exchange rate

Secondly, most sales conducted by Kossan are denominated in USD. As a result,

fluctuations in the USD/MYR rate will have an impact on earnings. That being

said, this impact is minimized by the purchase of materials and chemicals in

USD. Incorporating this, we note that a 10 sen appreciation/depreciation

(3.2%) in the USD/MYR rate will increase/decrease earnings by 2.2%, ceteris

paribus. We are currently predicting a year end USD/MYR rate of between

RM3.05 to RM3.11.

Figure 15: USD/MYR Rate

Source: Bloomberg, TA Securities

12.1

9.1

6.0

3.0

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-5.0

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-0.40 -0.30 -0.20 -0.10 Base

Price

+0.10 +0.20 +0.30 +0.40

RM/kg

% Change in Earnings

11.6

8.7

5.8

2.9

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-8.7

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Price

+0.10 +0.20 +0.30 +0.40

RM/kg

%Change in Earnings% Change in Earnings

2.7

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3.1

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y-1

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12-Aug-13

Page 12 of 15


Figure 16: Sensitivity Analysis on USD/MYR Rate

\


7.3 Energy cost

Meanwhile, energy cost used mainly for the heating of gloves makes up 9% of

Kossan’s total cost. Of this, 6% is derived from natural gas and 3% from

electricity. With the potential removal of government subsidies, natural gas

prices are expected to rise from the current average of RM16.07/mmbtu to

within RM40.00/mmbtu in the near future. Based on our back of the envelope

calculations, a RM5.00/mmbtu (31.1%) increase in natural gas price will

decrease earnings by 18.0%. In preparation, glove manufacturers including

Kossan have been looking towards biomass as a potential substitute for natural

gas. However, as the price of biomass increase in tandem with demand growth,

energy costs will ultimately rise as a result of the reduced subsidies.

Figure 17: Sensitivity Analysis on Natural Gas Price

\


7.4 Labour cost

Being a labour intensive industry, labour cost makes up 9% of total cost. Hence,

fluctuation in cost will be influenced by changes to wages such as the recent

implementation of the minimum wage policy. Based on the current no. of

workers, every RM100 increase in monthly wages will increase cost by

RM6.24mn.

-8.6

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Rate

+0.10 +0.20 +0.30 +0.40

RM

% Change in Earnings

73.2

54.9

36.6

18.3

-18.3

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-54.9

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-RM20 -RM15 -RM10 -RM5 Base

Price

+RM5 +RM10 +RM15 +RM20

RM/mmbtu

%Change in Earnings

12-Aug-13

Page 13 of 15


Earnings forecast and Assumptions

Table 3: Assumptions

Drivers Assumption FY13 FY14 FY15

Capacity (bn) 15.6 19.7 22.8

Utisation rate (%) 85.0 85.0 83.0

Average ASP 27 27 27 Source: Companies, TA Securities

Our broad based assumptions for FY13 to FY15 include the commissioning of

plants as scheduled. This assumption ignores the potential of delays and trusts

that plants will be fully commissioned within its expected time frame. In other

words, our assumed capacity for FY13/FY14/FY15 is 15.6bn/19.7bn/22.8bn

pieces of gloves/annum. FY14 capacity will be boosted by the expected

completion of three plants between 4QFY13 and 1QFY14.

Secondly, we expect the average price of latex and nitrile to remain stable at

RM6.00/kg and RM5.60/kg, Prices are expected to be kept down by maturing

plantations in Thailand, Cambodia and Vietnam. Further catalyst includes the

slowdown in China’s car market arising from the tapering of economic

activities, which would impose less pressure on latex price escalation.

We assume average ASPs to remain stable at USD27/thousand gloves. Here, we

expect offsetting impacts from Kossan’s venture into higher margin gloves and

potential competition. There will be a positive impact on ASPs as Kossan

increase production of the higher priced specialty gloves. However, as rival

glove manufacturers continue to increase installed capacities, we do not

discount the possibility of reduced ASPs due to increased competition.

Lastly, we expect the capacity utilization rate to remain stable at 85% over the

next two years and decrease to 83% in FY15. Over the next two years, the

utilization rate will be supported by the strong continued demand for nitrile

gloves. However, in FY15, as capacities from rival glove manufacturers begin to

come aboard, we expect a decrease in the utilization rate to 83%.

Based on the above assumptions, we derive our FY13/FY14/FY15 earnings

estimates of RM132.5mn/RM155.2mn/RM176.3mn. This translates to an

earnings growth of 29.7%/17.1%/13.6% in FY13/FY14/FY15.

Valuation and Recommendations

Using our target industry PE multiple of 14x, we fairly value Kossan at

RM6.80/share. Taking into account proceeds from capital gains and dividend

yield, this translates into a total return of 16.2%. We also like Kossan for its

affordable exposure to the glove manufacturing industry. Kossan’s FY14 PER of

12.4x is undemanding vs. the industry’s average of 14.7x (see Table 5). With

that, we initiate coverage on Kossan with a BUY recommendation. Key

opportunities and threats include: 1) Plan to double total installed capacity to

32bn pieces of gloves/annum by 2018; 2) Shifting focus towards higher margin

gloves such as special purpose and nitrile gloves; 3) Expansion of TRP facilities

with potential of high margins for customized products; 4) Onset of

competition from local glove manufacturers who are continually increasing

total installed capacity; 5) Expected rise in natural gas prices from

RM16.07/mmbtu to RM40.00/mmbtu.

12-Aug-13

Page 14 of 15


Table 4: Earnings Summary Profit & Loss (RMmn)

FYE Dec 31 2011 2012 2013f 2014f 2015f

Revenue 1,090.0 1,234.0 1,272.3 1,536.0 1,731.1

Other income 10.4 4.4 4.6 4.9 5.1

Total Cost (980.0) (1,093.6) (1,097.5) (1,331.2) (1,497.5)

PBT 112.9 138.5 171.9 202.8 232.6

Taxation (21.8) (33.7) (36.0) (43.7) (51.8)

Net profit 89.7 102.2 132.5 155.2 176.3

EPS (sen) 28.0 32.0 41.5 48.5 55.1

EPS Growth (%) (20.9) 13.9 29.7 17.1 13.6

DPS (sen) 7.0 12.0 18.7 21.8 24.8

Div Yield (%) 1.1 2.0 3.1 3.6 4.1

PER (x) 21.7 19.1 14.7 12.6 11.1

Balance Sheet (RMmn)

FYE Dec 31 2011 2012 2013f 2014f 2015f

PPE 433.0 514.4 547.5 578.3 606.1

Others 5.1 5.1 5.1 5.1 5.1

Fixed Asset 438.0 519.4 552.5 583.4 611.2

Cash 51.6 99.8 140.0 114.2 134.4

Others 322.8 370.7 364.4 451.7 507.9

Current Asset 374.4 470.5 504.4 565.9 642.2

Total assets 812.4 989.9 1,056.9 1,149.3 1,253.4

ST debt 134.0 160.7 144.5 129.8 116.7

Other l iabil ities 112.0 123.7 134.5 155.7 174.7

Current Liability 245.9 284.4 279.0 285.5 291.3

Shareholders' funds & MI 506.3 617.4 693.7 783.0 884.5

LT borrowings 26.0 38.3 34.4 30.9 27.8

Others 34.2 49.8 49.8 49.8 49.8

LT liabilities 60.2 88.1 84.2 80.7 77.6

Total Liabilities + equity 812.4 989.9 1,056.9 1,149.3 1,253.4

Cash Flow (RMmn)

FYE Dec 31 2011 2012 2013f 2014f 2015f

PBT 112.9 138.5 171.9 202.8 232.6

Adjustments (56.4) (55.0) (95.6) (113.5) (131.1)

Dep. & amortisation 40.3 45.1 46.9 49.1 52.2

Changes in WC (50.9) (35.7) 17.1 (66.1) (37.3)

Operational cash flow 45.9 92.9 140.3 72.4 116.4

Capex (39.8) (82.8) (80.0) (80.0) (80.0)

Others (7.6) 2.5 0.0 0.0 0.0

Investment cash flow (47.4) (80.4) (80.0) (80.0) (80.0)

Debt raised/(repaid) (11.8) 43.1 (20.2) (18.1) (16.3)

Equity raised(repaid) (0.4) 0.0 0.0 0.0 0.0

Others (19.2) (9.7) 0.0 0.0 0.0

Financial cash flow (31.5) 33.4 (20.2) (18.1) (16.3)

Net cash flow (32.9) 45.9 40.1 (25.7) 20.1

Opening cash 80.7 47.7 93.7 133.8 108.1

Forex 0.0 0.0 0.0 0.0 0.0

Closing cash & cash equivalents 47.7 93.7 133.8 108.1 128.2

12-Aug-13

Page 15 of 15


Ratios

FYE Dec 31 2011 2012 2013f 2014f 2015f

Profitability ratios

ROE (%) 19.1 18.6 20.7 21.5 21.7

ROA (%) 11.3 11.3 13.0 14.1 14.7

PBT Margins (%) 10.4 11.2 13.5 13.2 13.4

Liquidity ratios

Current ratio (x) 1.5 1.7 1.8 2.0 2.2

Quick ratio (x) 0.9 1.1 1.2 1.3 1.4

Leverage ratios

Total liabilities / equity(x) 0.6 0.6 0.5 0.5 0.4

Net debt / Equity (x) 0.2 0.2 0.1 0.1 0.0

Growth ratios

Sales (%) 4.1 13.2 3.1 20.7 12.7

Pretax (%) (19.7) 22.6 24.2 18.0 14.7

Total assets (%) 4.5 21.8 6.8 8.7 9.1

Table 5: Peers Comparison

Price TP Mkt Cap FY13 FY14 FY13 FY14 FY13 FY14

(RM) (RM) RM mn (sen) (sen) (%) (%) (x) (x)

Top Glove 6.08 7.10 BUY 3,769.0 33.6 38.8 2.7 15.4 18.1 15.7

Supermax 2.30 2.70 BUY 1,562.2 19.0 24.2 6.4 27.3 12.1 9.5

Hartalega 6.85 7.40 HOLD 5,027.9 32.0 36.4 (42.0) 13.8 21.4 18.8

Kossan 6.04 6.80 BUY 1,924.3 41.5 48.5 29.7 17.1 14.6 12.4

Simple average 3,453.0 28.2 33.2 (11.0) 18.8 17.2 14.7

EPS EPS Growth PER

FY13 FY14 FY13 FY14 FY13 FY14 FY13 FY14 FY13 FY14

(x) (x) (x) (x) (%) (%) (sen) (sen) (%) (%)

Top Glove 2.2 2.4 2.8 2.5 15.6 16.6 17.2 19.8 2.8 3.3

Supermax 1.3 1.5 1.7 1.5 14.7 16.8 5.7 7.3 2.5 3.2

Hartalega 1.0 1.2 6.6 5.5 33.8 31.8 14.5 16.4 2.1 2.4

Kossan 2.1 2.4 2.9 2.5 20.7 21.5 18.7 21.8 3.1 3.6

Simple average 1.5 1.7 3.7 3.2 21.4 21.7 12.5 14.5 2.5 2.9

NTA/Share Div yieldP/NTA ROE DPS

Disclaimer

The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may

have an interest in the securities and/or companies mentioned herein.

for TA SECURITIES HOLDINGS BERHAD(14948-M)

MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048

(A Participating Organisation of Bursa Malaysia Securities Berhad)

Kaladher Govindan – Head of Research

Documents

TA Kossan Aug 2013 Initiate Coverage