Kossan Rubber - Sales volume growth to gain momentum

BUY

Fair Value RM4.54

Investment Highlights 

• Kossan Rubber Industries’s (KRI) net profit for 1HFY12 accounted for 42% of our full year forecast and 40% of consensus. We consider results to be broadly in line to expectations given a stronger 2H on back of rising sales volume. 
• KRI posted sequentially higher net profit for 2QFY12, up 8% on back of turnover which rose 5%. Its improved performance was mainly attributed to:- 1) Higher glove sales volume which surged 5% QoQ (YoY: 27%) as led by re-stocking activities; 2) the strengthening greenback and; 3) a lower input cost base. 
• KRI’s non-core technical rubber products division (TRP) which constitutes 14% of group pre-tax continues to perform with 2Q earnings up 29% QoQ due to delivery of contracted project. We expect robust demand to underpin TRP’s stable earnings growth, in tandem with the cyclical recovery of the construction/infrastructure industry. This division could also see a potential earnings boost should management’s plan for a TRP plant in Indonesia materialises. 
• Moving forward, a modest margin expansion (YoY: +1 to +1.5ppts) appears to be on track given easing latex price. As an indication, average YTD SMR20 grade bulk latex price of RM7.00/kg has slumped 11% MoM, and a steeper 27% as compared to the corresponding period in the previous year. 
• We maintain our latex price assumption at RM6.00-6.50/kg, underpinned by our long-term view of disequilibrium in global latex demand & supply situation. We reckon the latest move by the International Tripartite Council (Thailand, Indonesia & Malaysia) to cut rubber exports by 300,000 tons (~ 2.6% of 2012’s estimated global output) may provide short term relief to rubber prices. However, this is unlikely to result in a reversal of its long-term downward trajectory due to the absence of a real recovery in global automobile industry. 
• We re-iterate our BUY recommendation on KRI with a slightly higher fair value of RM4.54/share (from RM4.31/share previously) as we roll forward our valuation base year from FY12F to FY13F. 
• Our target PER of 12.5x is close to the stock’s 10-year mean of 11x, but at a steep 35% discount to industry leader Top Glove Corp’s (TOPG Mk Equity, Buy) target PE of 19x. We continue to like the group for its less susceptible earnings profile as underpinned by its more balanced product mix.

Source: AmeSecurities