Kossan Rubber on the growth path

Kossan Rubber Industries Bhd

(April 15, RM3.66)

Maintain buy at RM3.68 with a target price of RM4.12: Kossan aims to gradually increase its production capacity by 67% to 25 billion pieces per year in the next four to five years, with production lines catering to a production mix of natural rubber, nitrile and surgical gloves.

Kossan is the third largest domestic rubber glove producer (after Top Glove Corp Bhd and Supermax Corp Bhd) by installed production capacity of about 15 billion gloves per year, Kossan’s nine new production lines of nitrile gloves with a total capacity of 1.25 billion pieces per year, which were installed in 2012, were commercialised in the first quarter of 2013 financial year (1QFY13). In addition, we will also see additional capacity of 300 million pairs of surgical gloves per year kicking in in 2013.

We expect to see an earnings growth of 15.5% year-on-year (y-o-y) in 2013 alongside the additional 13.3% capacity coming onstream, benefiting from the growing global demand for nitrile gloves. The higher-margin surgical gloves could modestly lift Kossan’s margin in the glove manufacturing segment.

Recall its 23ha freehold industrial land acquisition in Batang Berjuntai, Selangor, in February this year for RM35.4 million. Kossan intends to increase its existing landbank to house more glove manufacturing production lines beyond 2013, in line with its strategy to grow organically. We understand that Kossan targets to build six or seven plants, which could house 60 to 70 production lines.

This could translate into an additional 14.4 billion pieces of gloves per year upon completion.

The stellar performance achieved in 2012 with a notable 62% y-o-y growth and a five percentage point y-o-y margin expansion at the pre-tax level reinforces our positivism on Kossan’s technical rubber products (TRP) division’s expansion plan into Indonesia. We understand the investment was made with the aim of having the company cater to the growing Indonesian automotive sector by offering a wide array of rubber products for automotive applications such as automotive hoses, parts, seals and profiles.

Global demand for natural rubber and nitrile gloves is still growing healthily. Based on channel checks, we gather that most industry players are in oversold positions as intermediaries continue to move back to their normal buying patterns given the current stable raw material prices compared with the high and volatile latex prices in 2010/11. At the same time, we understand Kossan is in an oversold position of about two months at the moment.

Kossan has wrapped up its 2012 earnings with rising margins for three consecutive quarters for both the rubber gloves and TRP divisions, largely due to lower raw material prices and increased production efficiency. Moving forward, we expect Kossan’s margins to remain stable, at 10% to 11% profit before tax margin for 2013, on the back of higher production efficiency and raw material costs.