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KENANGA RESEARCH

20 May 2013

Company Update

Kossan Rubber Industries


Expect a solid 1QFY13
We came back from a company visit feeling optimistic that the companys new capacity expansion plans for FY14 are on track. Elsewhere, we expect Kossan Rubber Industries (Kossan) 1QFY13 results due out by end of the month to register a solid 1QFY13 net profit of RM33m (+50% YoY/ +10% QoQ) equivalent to 27%-28% of ours and market consensus full-year net profit forecasts due to a higher-than-expected utilization rate from its new capacity expansion, which came on-stream in 4QFY12. We are raising our FY13 and FY14 net profits by 6% and 5% respectively taking into account its better-than-expected utilisation rate. In tandem, our target price has also been raised by 15% from RM4.23 to RM4.88. Apart from the higher earnings, the upgrade in our target price also reflected a slightly higher 1year forward PER rating of 11x assigned (at +0.5 standard deviation above the 6-year forward average PER) from 10x previously. The revised target PER of 11x is still well below the recent M&A PERs for Adventa and Latexx Partner at between 13.0x and 16.0x despite Kossans bigger market capitalisation and earnings base. We maintain our OUTPERFORM rating. 1QFY13 results preview. We expect Kossan 1QFY13 results due out by end of the month to register a solid 1QFY13 net profit of RM33m (+50% YoY/ +10% QoQ) equivalent to 27%-28% of ours and market consensus full-year net profit forecasts due to a higher-than-expected utilization rate from its new capacity expansion, which came on-stream in 4QFY12. Its FY13 earnings growth is expected to come from: i) its nine-lines production plant, producing 1.3b nitrile gloves p.a., which had been commercially ready in 4Q2012 and ii) the completion of the production lines for the remaining balance of the 700m surgical gloves in Feb 2013. Kossan has managed to secure buyers for more than 80% of the new capacity. Building new lines once capacity hit 80% instead of 90%. Going forward, Kossan is building new lines once its capacity utilisation hit 80% instead of 90% in the past. This strategy will allow Kossan to have spare capacity in order to capitalise on potential new enquiries as well as specific requirement needs from its clients. Plans to build two new plants are on track targeting nitrile gloves, which are expected to boost its capacity by an additional 2.2b to 2.4b pieces of gloves or 16%, bringing its total installed capacity to 17.2b pieces p.a. The first and second plants are expected to be completed by 1HFY2014 and 3Q2014 respectively. We have factored in RM60m in capex p.a. over the next two years into our earnings model. For illustrative purposes, assuming net profit margin and utilisation rate of 8% and 80%, respectively, this new capacity will fetch a total net profit of RM13.7m or 9.8% of our FY14 forecast. We have factored in the contribution from this capacity expansion into our earnings forecast. Major expansion beyond FY14. The solid volume growth and potential uptick in demand for rubber gloves is a timely boost for Kossan as it is looking to expand its production capacity. Recall that in a recent announcement to Bursa Malaysia, Kossan had said that it was buying a piece of freehold industrial land measuring approximately 56 acres located in Batang Berjuntai, Kuala Selangor for RM35.4m or RM14.50 per sq feet, the purchase of which is expected to be completed by 1QFY2014. This acquisition is in line with Kossans strategy to replenish its land bank to build more gloves production lines as the companys production is presently running at full capacity. With the strong demand for nitrile gloves, the land is highly likely to be used to house production plants. Note that Kossans recent new nitrile capacity of 1.3b pieces of gloves has been mostly taken up by confirmed buyers. The RM35.4m acquisition will not have a material impact on Kossans net debt and net gearing of RM89m and 0.1x respectively as at 31 Dec 2012. Based on our estimate, the size of the land can cater to between six and seven plants or 60 to 70 lines with a production capacity of 9.0m pieces per line per month. Conservatively, this means a production capacity of between 6.5b to 7.6b pieces of gloves or 43-51% of its current capacity. We like Kossan because (1) its valuations are undemanding with the stock trading at just 9.2x its CY14 EPS or at a 38% discount to its larger peers (like Top Gloves 14.5x and Hartalegas 14.2x for CY14), (2) it is gradually raising its dividend payout ratio (Kossan recently declared a final seven sen tax-exempt dividend. This brings its total full-year FY12 DPS to 12.5 sen, implying a 38% payout ratio well ahead of its <20% payout ratios in the past three years) and (3) the fact that Kossan is not just a rubber glove play but a bet on its TRP division, which is growing strongly at a rate of >20% QoQ at the pre-tax profit level over the past few quarters.
4.20 4.00 3.80 3.60 3.40 3.20 3.00

OUTPERFORM
Price: Target Price:
Share Price Performance

RM4.10 RM4.88

2.80 May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

KLCI YTD KLCI chg YTD stock price chg Stock Information Bloomberg Ticker Market Cap (RM m) Issued shares 52-week range (H) 52-week range (L) 3-mth avg daily vol: Free Float Beta Major Shareholders KOSSAN HOLDINGS S/B KWAP INVESCO HK LTD Summary Earnings Table FYE Dec (RMm) 2012A Turnover 1235.5 EBIT 147.2 PBT 140.8 Net Profit (NP) 104.5 Consensus (NP) NM Earnings Revision EPS (sen) 32.7 EPS growth (%) 16.3 NDPS (sen) 5.5 BVPS (RM) 1.93 PER 12.5 PBV (x) 2.1 Net Gearing (%) 14.4 Net Div. Yield (%) 3.0

1,769.16 4.7% 22.0%

KRI MK Equity 1,306.3 318.6 4.12 2.97 723,883 38% 0.8

51.2% 5.6% 5.1%

2013E 1371.5 165.8 158.3 123.6 120.6 +6.3 38.7 18.4 12.5 2.19 10.6 1.9 13.9 3.0

2014E 1541.6 188.2 181.6 141.9 136.9 +5.2 44.4 14.8 12.5 2.51 9.2 1.6 9.5 3.0

The Research Team research@kenanga.com.my +603 2713 2292

PP7004/02/2013(031762)

KENANGA RESEARCH

Kossan Rubber Industries


Income Statement FY Dec (RM m) Revenue EBITDA Depreciation Operating Profit Other Income Interest Exp Associate Exceptional Items PBT Taxation Minority Interest Net Profit Core Net Profit Balance Sheet FY Dec (RM m) Fixed Assets Intangible Assets Other FA Inventories Receivables Other CA Cash Total Assets Payables ST Borrowings Other ST Liability LT Borrowings Other LT Liability Minorities Int. Net Assets Share Capital Reserves Equity 2010A 409.5 0.9 0.3 123.7 150.5 1.0 91.5 777.3 113.1 150.1 9.5 27.7 32.3 2.0 442.6 159.9 282.7 442.6 2011A 433.0 4.9 0.1 163.8 157.6 1.4 51.6 812.4 103.5 134.0 8.5 26.0 34.2 9.5 496.8 159.9 337.0 496.8 2012A 518.8 4.9 0.2 152.2 206.2 16.7 98.4 997.3 118.4 153.1 22.1 33.9 41.3 12.2 616.4 159.9 455.6 615.4 2013E 549.2 4.9 0.1 206.1 228.9 18.5 67.3 1,075.1 142.5 130.0 12.0 33.9 42.4 15.2 699.1 159.9 539.2 699.1 2014E 595.4 4.9 0.1 231.6 257.3 20.8 87.4 1,197.6 159.7 130.0 12.1 33.9 42.4 18.5 801.0 159.9 641.2 801.0 Valuations EPS (sen) NDPS (sen) NTA (RM) PER (x) Net Div. Yield (%) P/NTA (x) EV/EBITDA (x) 35.5 10.0 1.4 11.6 2.4 3.0 7.7 28.1 7.0 1.6 14.6 1.7 2.6 8.8 Leverage Debt/Asset (x) Debt/Equity (x) Net Cash/(Debt) Net Debt/Equity (x) 0.2 0.4 -86.2 0.2 0.2 0.3 -108.3 0.2 DuPont Analysis Net Margin (%) Assets Turnover (x) Leverage Factor (x) ROE (%) 10.8% 0.7 1.8 25.6% 8.2% 0.7 1.6 18.1% 2010A 1046.9 181.7 -34.2 147.5 1.1 -8.0 0.0 0.0 140.7 -26.9 -0.4 113.4 113.4 2011A 1090.0 159.1 -40.3 118.8 1.6 -7.5 0.0 0.0 112.9 -21.8 -1.4 89.7 89.7 2012A 1235.5 190.5 -44.4 146.1 1.1 -6.3 0.0 0.0 140.9 -33.7 -2.7 104.5 104.5 2013E 1371.5 215.3 -49.5 165.8 1.0 -8.5 0.0 0.0 158.3 -31.7 -3.0 123.6 123.6 2014E 1541.6 242.0 -53.8 188.2 1.3 -7.9 0.0 0.0 181.6 -36.3 -3.4 141.9 141.9 Profitability (%) EBITDA Margin Operating Margin PBT Margin Core Net Margin Effective Tax Rate ROA ROE 17.4% 14.1% 13.4% 10.8% 19.1% 14.6% 25.6% 14.6% 10.9% 10.4% 8.2% 19.3% 11.0% 18.1% Financial Data & Ratios FY Dec (RM m) Growth Turnover (%) EBITDA (%) Operating Profit (%) PBT (%) Core Net Profit (%) 24.3% 41.3% 55.3% 63.9% 70.0% 4.1% -12.5% -19.5% -19.7% -20.9% 2010A 2011A

20 May 2013

2012A 13.4% 19.8% 23.0% 24.7% 16.5%

2013E 11.0% 13.0% 13.4% 12.4% 18.4%

2014E 12.4% 12.4% 13.5% 14.7% 14.8%

15.4% 11.8% 11.4% 8.5% 20.0% 10.5% 17.0%

15.7% 12.1% 11.5% 9.0% 20.0% 11.5% 17.7%

15.7% 12.2% 11.8% 9.2% 20.0% 11.8% 17.7%

8.5% 0.8 1.6 17.0%

9.0% 0.8 1.5 17.7%

9.2% 0.8 1.5 17.7%

0.2 0.3 -88.6 0.1

0.2 0.2 -96.6 0.1

0.1 0.2 -76.5 0.1

32.7 12.5 1.9 12.5 3.0 2.1 7.3

38.7 12.5 2.2 10.6 3.0 1.9 6.5

44.4 12.5 2.5 9.2 3.0 1.6 5.7

Cashflow Statement FY Dec (RM m) Operating CF Investing CF Financing CF Change In Cash Free CF 2010A 137.8 (39.4) (35.2) 63.2 52.7 2011A 45.9 (47.4) (31.5) (32.9) 6.1 2012A 126.6 (85.7) 3.7 44.5 40.5 2013E 111.4 (60.0) (76.3) (24.9) 51.4 2014E 160.1 (60.0) (80.0) 20.1 100.1

Source: Kenanga Research


Fwd PER Band
5 PRICE (RM) PER 4.9 x PER 6.7 x PER 8.4 x PER 10.2 x PER 12.0 x 4.5

Fwd PBV Band


7 PRICE (RM) PBV 0.9 x PBV 1.3 x PBV 1.8 x PBV 2.2 x PBV 2.6 x

6
4

5
3.5

4
3

2.5

1.5

1
1

0
Fe b09 M ay -0 9 A ug -0 9 Fe b10 M ay -1 0 A ug -1 0 Fe b13 M ay -1 3 ov -1 0 Fe b11 M ay -1 1 A ug -1 1 N ov -1 1 Fe b12 M ay -1 2 A ug -1 2 N ov -1 2 M ay -0 8 A ug -0 8 ov -0 9 ov -0 8

Source: Kenanga Research

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ug -0 8 N ov -0 8 Fe b09 M ay -0 9 A ug -0 9 N ov -0 9 Fe b10 M ay -1 0 A ug -1 0 N ov -1 0 Fe b11 M ay -1 1 A ug -1 1 N ov -1 1 Fe b12 M ay -1 2 A ug -1 2 N ov -1 2 Fe b13 M ay -1 3

ay -0 8

0.5

KENANGA RESEARCH

Stock Ratings are defined as follows: Stock Recommendations OUTPERFORM : A particular stocks Expected Total Return is MORE than 10% (An approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%) MARKET PERFORM : A particular stocks Expected Total Return is WITHIN the range of 3% to 10% UNDERPERFORM : A particular stocks Expected Total Return is LESS than 3% (An approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate)

Sector Recommendations*** OVERWEIGHT NEUTRAL UNDERWEIGHT : A particular sectors Expected Total Return is MORE than 10% (An approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%) : A particular sectors Expected Total Return is WITHIN the range of 3% to 10% : A particular sectors Expected Total Return is LESS than 3% (An approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate)

***Sector recommendations are defined based on market capitalisation weighted average expected total return for stocks under our coverage.

This document has been prepared for general circulation based on information obtained from sources believed to be reliable but we do not make any representations as to its accuracy or completeness. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may read this document. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees. Kenanga Investment Bank Berhad accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or any solicitations of an offer to buy or sell any securities. Kenanga Investment Bank Berhad and its associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein from time to time in the open market or otherwise, and may receive brokerage fees or act as principal or agent in dealings with respect to these companies. Published and printed by: KENANGA INVESTMENT BANK BERHAD (15678-H) 8th Floor, Kenanga International, Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Telephone: (603) 2166 6822 Facsimile: (603) 2166 6823 Website: www.kenangaresearch.com Chan Ken Yew Head of Research

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KENANGA RESEARCH