Kossan Rubber (KRI MK) 1Q21: Within Expectations;
Kossan Rubber Peak Quarterly Earnings On The Horizon 1Q21 earnings were within our expectations but above consensus forecast.
Volume output has recovered since its downtime following the COVID-19 outbreak in its labour workforce. Despite the recently reignited interest in the glove sector, sector dynamics and ASP visibility remain unchanged. Kossan still offers value amid peak quarterly earnings which are expected to normalise gradually from 2H21 onwards.
Maintain BUY and target price of RM5.00.
Within our expectations but above consensus. Kossan Rubber’s (Kossan) 1Q21 core profit surged 112% qoq and 1,508% yoy to RM1,092m, coming in at 35% and 43% of our and consensus’ full-year estimates respectively. Going into 2Q21, quarterly core earnings may peak alongside raised ASPs as Kossan Rubber narrows its pricing to its peers’.
Kossan declared an interim DPS of 12 sen, representing a payout of 30%. This is a deviation from past practices, whereby no dividends were declared for the quarter.
Twin boost kicks in with production being restored. Glove sales grew 73% qoq and 282% yoy in 1Q21, against ASP growth of >50-60% and a recovery in volume output following the resumption of production after downtime brought about by an outbreak of COVID-19 in its labour workforce that weighed on 4Q20’s output.
Meanwhile, utilisation rates recovered from 89% in 4Q20. The greenback was slightly unfavourable vs the ringgit, down 1.1% qoq. Its other segments like cleanroom gloves saw commendable growth of 23.6%. In contrast, technical rubber products’ growth contracted 22.0% qoq, but it is not usual for the segment to experience seasonal softness in 1Q.
• Blockbuster ASPs kick in but slightly tempered by higher costs. Despite significantly higher ASPs and economies of scale, glove PBT margins improved marginally by 4.7ppt to 67.1% on a qoq basis. Margins were tempered by higher NBR costs, which could uptrend further but at a diminished rate. The qoq margin gain was further magnified by RM50m remediation payments to its foreign workforce in 4Q20.
Similarly, 1Q21 saw a RM50m COVID-19 contribution to the government. Overall 1Q21 core margins improved by 12.2ppt to 49.8% qoq as the effective tax rate normalised to 24% (4Q20: 29%). STOCK IMPACT
• ASP continues uptrend for now. Going forward, ASP for Apr 21 remains on an uptrend on a mom basis, but ASPs for May 21 have yet to be priced. Although we expect Kossan’s ASPs to uptrend as it still trails its peers, the diminished visibility suggests demand has seen a slight pullback.
Overall, demand-supply dynamics remain highly favourable for glove producers, with the Malaysian Rubber Glove Manufacturing Association estimating 2021 global glove production to increase 22% to 420b pieces p.a. This includes capacity arising from new entrants that is estimated to be in the range of up to 10b pieces p.a.
• Planned expansion of 33% over the next two years. Against this backdrop, Kossan’s expansion plan trails the industry. Its planned capacity expansion includes: a) plant 20 located between plants 18 and 19, equipped with a capacity of 1.5b pieces p.a., with an expected commissioning in 1H21; b) phase 1 of Meru is slated to produce 2b pieces p.a., commencing in 2H21; c) phase 2 of Meru is earmarked for a production capacity of 3b pieces p.a., commencing in 1H22; and d) Bidor with 4b pieces capacity with a commissioning timeline in 2H22.
Upon completion, these expansions will boost Kossan’s production capacity to 42.4b from 32b, or +33% over the next two years. EARNINGS REVISION/RISKS
• No changes to earnings.
• Key downside risks include: a) softer-than-expected ASP revisions, b) delays in expansion plans, c) the US dollar depreciating markedly against the ringgit, and d) sudden spike in costs. VALUATION/RECOMMENDATION
• Maintain BUY with an unchanged SOTP-based target price of RM5.00. Our target price is derived from the present value of: a) expected dividends over 2021-23, and b) 2023 earnings pegged to the company’s respective mean of its five-year PE as a reflection of normalised earnings.
We think diminishing sentiment has far outpaced the extent of normalising ASPs, and Kossan’s valuations remain compelling. Furthermore, Kossan’s pre-COVID-19 five-year mean PE (25x) trades at a deep discount to the industry bellwether, Hartalega (42x), leaving it upside for a re-rating over the medium term.
-by UOB Kay Hian Research