Kossan Rubber - Lower margin, but earnings in line Buy

- Kossan Rubber Industries (KRI) kicked off 1QFY12 on a softer note with a net profit of RM22mil. Annualised net profit accounted for 80% of our forecast and 76% of consensus estimates. Though on the low end of our forecast, we deem results to be broadly in line with expectations.

- 1Q group turnover increased 3% QoQ, attributable mainly to a better performance of its bread-and-butter gloves division which recorded a 4% rise in segmental revenue.  - Despite this, net profit declined 8% on a sequential basis, as benefits of topline growth was more than offset by a lower EBITDA margin (QoQ: -0.9ppt to 14%) largely as a result of a RM0.3mil EBIT loss in clean-room production due to new product development costs. 

- On a YoY basis, net profit fell 4% despite higher turnover which was up 13%. The decline in earnings was mainly attributable to higher average selling prices which were more than offset by volatile latex prices and a higher effective tax rate (YoY: +5.4ppts to 22%).

- Looking ahead, KRI’s capacity expansion is on track. Management is pressing ahead with the commissioning of 9 new production lines with a capacity of 1.25 billion pieces by July this year. This constitutes part of the group’s plans to boost installed capacity by another 3.25 billion pieces to a total of 17 billion pieces by end-FY13F.   

- Additionally, management is planning to increase production of non-natural rubber gloves, especially better margin nitrile variants from 33% currently to 44% by year-end. This fits into its strategy to move into higher-valued gloves to mitigate its earnings risks over the long run.

- No change to our earnings forecasts at this juncture. We maintain our BUY recommendation on KRI with an unchanged fair value of RM4.31/share, based on a target PE of 12.5x FY12F earnings. We continue to like the group for its less susceptible earnings portfolio as underpinned by its more balanced product mix. Our valuation is near the stock’s 10-year mean of 11x, but at a 35% discount to industry leader Top Glove Corp’s (TOPG Mk Equity, Buy) target PE of 19x.   

Source: AmeSecurities