TA Securities

A Member of the TA Group

MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048

Initiation Coverage
Monday, August 12, 2013
FBM KLCI: 1,779.32 Sector: Manufacturing

Kossan Rubber Industries Berhad

Affordable Exposure to Glove Manufacturing
THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY*

TP: RM6.80 (+12.6%)

Last traded: RM6.04

BUY
TA Research Team Coverage +603-2072-1277 ext: 1612 paulyap@ta.com.my www.taonline.com.my

Investment Thesis and Key Assumptions We initiate coverage on Kossan with a target price of RM6.80/share. We like Kossan for its aggressive expansion plan to double production capacity to 32bn pieces of gloves/annum by 2018. Signaling their commitment, more than 70 acres of industrial land with natural gas supply has been secured for expansion. Production lines will be highly versatile and interchangeable with minimum downtime. The new plants are envisaged to improve profit margins through lower production cost per glove and higher production efficiency. We are also positive on the shift of focus towards higher margin gloves. Specifically, this relates to gloves with lower levels of competition such as special purpose, nitrile and latex powdered-free gloves. In tandem with their goals, Kossan aspires to become the worlds largest manufacturer of surgical gloves. In operation since February, they currently have a surgical gloves factory producing approximately 650mn surgical gloves/annum. Growth will be mainly underpinned by the increase in total installed capacity. Supported by strong demand for gloves, we are expecting earnings growth of 29.7% and 17.1% in FY13 and FY14. That said, as capacity from rival glove manufacturers starts to kick in, we anticipate a lower utilization rate in FY15. Hence, our predicted earnings growth for FY15 will decrease to 13.6%. All in all, we like Kossan for its affordable exposure to the glove manufacturing industry. Kossans FY14 PER of 12.4x is undemanding vs. the industrys average of 14.7x. Our target price implies a total potential upside of 16.2% from the stocks last closing price. Therefore, we initiate coverage on Kossan with a BUY rating. Key re-rating catalyst include: 1) Stronger than expected demand for gloves; 2) Maintenance of margin despite increased competition; 3) Better than anticipated returns from expansion into TRP. Downside risks include 1) Onset of competition from local glove manufacturers who are continually increasing total installed capacity; 2) Expected rise in natural gas prices from RM16.07/mmbtu to RM40.00/mmbtu.

Share Information Bloomberg Code Stock Code Listing Share Cap (mn) Market Cap (RMmn) Par Value 52-wk Hi/Lo (RM) 12-mth Avg Daily Vol ('000 shrs) Estimated Free Float (%) Beta Major Shareholders (%) Kossan Holdings Sdn Bhd - 51.24 Kumpulan Wang Persaraan - 5.60 EPF -5.03 Invesco Ltd - 5.03 Forecast Revision FY13 Forecast Revision (%) Net profit (RMm) Consensus TA's / Consensus (%) Previous Rating Financial Indicators FY13 Net gearing (x) CFPS (RM) P/CFPS (x) ROA (%) ROE (%) NTA/Share (RM) Pri ce/ NTA (x) Share Performance (%) Price Change 1 mth 3 mth 6 mth KRI 4.1 39.2 80.8 85.8 FBM KLCI 0.4 0.6 8.7 8.1 0.1 0.4 13.8 13.0 20.7 2.1 2.9 FY14 0.1 0.2 26.7 14.1 21.5 2.4 2.5 n.a. 132.5 127.5 103.9 n.a. FY14 n.a. 155.2 149.5 103.8 KRI MK 7153 Main Market 318.6 1924.5 0.50 6.12/2.97 495.1 37.4 0.8

Earnings Summary (RM mn)

FYE Dec 31 Revenue Other i ncome Tota l Cos t PBT Ta xa ti on Net profi t EPS (s en) EPS Growth (%) DPS (s en) Di v Yi el d (%) PER (x) 2011 1,090.0 10.4 (980.0) 112.9 (21.8) 89.7 28.0 (20.9) 7.0 1.1 21.7 2012 2013f 2014f 2015f 1,234.0 1,272.3 1,536.0 1,731.1 4.4 4.6 4.9 5.1 (1,093.6) (1,097.5) (1,331.2) (1,497.5) 138.5 171.9 202.8 232.6 (33.7) (36.0) (43.7) (51.8) 102.2 132.5 155.2 176.3 32.0 41.5 48.5 55.1 13.9 29.7 17.1 13.6 12.0 18.7 21.8 24.8 2.0 3.1 3.6 4.1 19.1 14.7 12.6 11.1

12 mth

(12-Mth) Share Price relative to the FBM KLCI

Source: Bloomberg Page 1 of 15

TA Securities
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12-Aug-13

1.0 Background Established in 1979, Kossan Rubber Industries Bhd was one of the first companies in Malaysia to venture into glove manufacturing. From the introduction of its first glove production line in August 1988, Kossan is now one of the largest glove manufacturers in the world with an estimated total installed capacity of approximately 16bn gloves/annum by the end of FY13. Furthermore, Kossan is also Malaysias largest manufacturer for Technical Rubber Products (TRPs) with approximately 9,000mt of rubber compound produced. Kossan employs more than 5,200 workers in 15 plants located throughout the Klang Valley. Figure 1: Products offered
Disposable Gloves Technical Rubber Products

Source: Companies, TA Securities

2.0 Business Operations

Table 1: Revenue Distribution (RM mn) FY08 Total Revenue 897.2 Revenue - Gloves 788.9 Revenue - TRP 108.3 Proportion - Gloves 87.9% Proportion - TRP 12.1%
Source: Companies, TA Securities

FY09 842.1 754.8 87.4 89.6% 10.4%

FY10 1046.9 936.5 110.4 89.5% 10.5%

FY11 1090.0 936.5 153.4 85.9% 14.1%

FY12 1234.0 1074.7 159.3 87.1% 12.9%

2.1 Technical Rubber Products (TRPs) Apart from gloves, Kossan also undertakes the production of TRPs which contributes approximately 10% to total revenue. The bulk of TRPs supplied by Kossan are to the automotive industry, marine industry, construction & civil engineering and aerospace. For the automotive industry, products are mainly supplied to the US, Germany and Australia. Currently, Kossan produces approximately 9,000 mt of rubber compound per year. Unlike rubber gloves, technical rubber products require longer production times [lead times of four to six months]. This increases their exposure to fluctuations in the exchange rate and material prices. Hence, margins for TRP products can vary from 5% to 40%, with customizable products carrying higher margins. In terms of prospects, Kossan will construct a technical rubber manufacturing facility in Indonesia, specializing in the production of seismic bearings. The plant which will begin construction within the year is expected to contribute to earnings in the 1HFY14. Also, the company is on the lookout for overseas based rubberized automobile parts manufacturer-distributors. Potential benefits from the acquisition include knowledge transfer and a pathway into the overseas market through leverage of a local brand.

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2.2 Gloves Kossan derives the bulk of its revenue from the production of gloves, which makes up 90% of its total revenue. Key products produced in its glove division include examination gloves (powder-free latex and nitrile), surgical gloves, cleanroom gloves and facemask. As of FY13, Kossan has a total installed glove capacity of 16bn gloves/annum. Compared to the other glove manufacturers under our coverage, this places Kossan as the third largest manufacturer, trailing behind Top Glove and Supermax. In terms of geographic distribution (see Figure 2), Kossan exports a combined 80% of its gloves to USA, Canada and Europe. Customers in these regions tend to place higher emphasis on quality rather than price.
Figure 2: Geographic Distribution
Latin America, 8%

Asia Pacific, 12% USA & Canada, 50% Europe, 30%

Source: Companies, TA Securities

As a percentage of total products (see Figure 3), 55% of gloves manufactured are made from latex and 45% from nitrile. This translates to a projected FY13 year end capacity of 8.8bn latex gloves/annum and 7.2bn nitrile gloves/annum. Similar to Supermax, this provides Kossan with a diverse mix of products, making them less susceptible to changes in consumer tastes. To recap, demand for nitrile gloves remains resilient as consumers have been switching from the usage of latex gloves to nitrile gloves. Cited reasons for the change in preference include thinner nitrile gloves and prevalence of protein allergies in latex gloves.
Figure 3: Product mix

Nitrile 45% Latex 55%

Source: Companies, TA Securities

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Of the produced gloves, 95% is supplied to the medical industry such as examination and surgical gloves. The remaining 5% is supplied to the nonmedical industry in sectors such as food service, automotive and household. Thickness and characteristics of gloves will vary according to the targeted market segment. In terms of customer diversity, Kossan markets its gloves to 200 active customers, spread across 150 countries. Its biggest and top five customers contribute approximately 11% and 35% of total sales. Over the near term, this dependency will be mitigated by strong continued demand for gloves. However, as rival glove manufacturers continue to add to existing capacities, we do not discount the possibility of future price reductions to maintain existing customers. The proportion of gloves manufactured under original equipment manufacturer (OEM) and original brand manufacturer (OBM) are 80% and 20% respectively. While this may result in lower margins, it reduces the possibility of conflicts arising from competition with existing customers. 3.0 Expansion Plans Gloves
Figure 4: Estimated Capacity

Source: Companies, TA Securities

More than 70 acres of industrial land with natural gas supply located in the Klang Valley has been secured for expansion. By 2018, management targets to increase the production capacity to 32bn pieces of gloves/annum. Currently, three plants are already under construction with expectations of commercial running in between 4QFY13 to 1QFY14. Together, these plants will add approximately 5.0bn pieces of gloves/annum constituting mainly of nitrile products. In addition to current installed capacity of 16bn pieces of gloves/annum, total installed capacity by FY14 should rise to 21.0bn pieces of gloves/annum. Incoming capacity will be skewed towards the production of nitrile gloves. Production lines will be highly versatile and interchangeable with minimum downtime. Taking the latest lines as a benchmark, each of Kossans double former line has the capability of producing approximately 30k to 35k pieces of gloves/hour. While this lags Hartalegas 45k pieces of gloves/hour, it is above the industrial average of 18k to 22k pieces of gloves/hour. Progressing through the phases of expansion, incremental improvements to production efficiency will be expected. The new plants are envisaged to improve profit margins through lower production cost per glove and higher production efficiency. Production efficiency can be expanded to include items such as higher output, less rejects, less downtime and light weight products. These cost cutting measures will aid Kossan in maintaining their margins in anticipation of potential long run margin compression of nitrile gloves.
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4.0 Business Strategy - Gloves 4.1 Business Positioning and Market Segment
Figure 5: Targeted Market Segment

Source: Companies, TA Securities

Looking ahead, Kossan will focus resources on the production of special purpose, nitrile and latex powdered-free gloves. These products are expected to fetch higher profit margins due to lower levels of competition. In tandem with their goals, Kossan aspires to become the worlds largest manufacturer of surgical gloves. In operation since February, they currently have a surgical gloves factory producing approximately 650mn surgical gloves/annum. This places them among the largest surgical glove manufacturers in the world. In comparison, less emphasis will be placed on latex powdered gloves and gloves made from materials such as PVC, PU and Vinyl. It is noted that gloves in this segment run a higher risk of overcapacity due to the low barriers to entry. Given this, prices of these types of gloves are more elastic with a heightened risk of price war initiated by smaller manufacturers. Overall, we view this move as positive. This is consistent with the current market trend as consumers have been shifting from the usage of latex gloves to nitrile gloves (see Figure 6). Supporting the trend, margin compression of latex gloves have also been recorded in Top Gloves [largest manufacturer of latex gloves] latest quarter results. We are particularly excited about Kossans aspirations to be the largest manufacturer of surgical gloves. We opine that this will provide Kossan with future earnings stability pending the eventual commoditization of nitrile gloves in the long run.

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Figure 6: Examination gloves export from Malaysia

90 80 70 60 50 40 30 20 10 0 2008 2009 2010 2011 2012
Source: Companies, TA Securities

83 77 69 56 44 31 23 17 NR 53 47 SR

5.0 Financials 5.1 Revenue

Figure 7: Revenue (RMmn)
RMmn 1,400.0 1,200.0 1,000.0 800.0 600.0 400.0 4.1% 200.0 -6.1% 0.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Source: Companies, TA Securities

49.8% 897.2 702.6 571.3 23.0%

1,046.9 842.1

% Change 60% 1,234.0 50% 1,090.0 40% 30%

27.7%

24.3% 20% 13.2% 10% 0% -10%

Since FY06, Kossan has shown consistent growth with revenue increasing by 116% or CAGR of 13.7% (see Figure 7). The main drivers of revenue growth are total installed capacity, demand for gloves, average selling prices (ASP) and the USD/MYR rate. Total installed capacity determines the quantity of gloves produced and ultimately sold. However, this relationship only holds true if additional capacity is met by increasing demand. Believing demand will remain strong and continue to grow, Kossan targets to double total installed capacity to 32bn pieces of gloves/annum by 2018. Furthermore, revenue will also be determined by ASPs. ASPs differ according to the type of glove being sold. Products such as special purpose, nitrile and powder-free latex gloves fetch higher and more stable ASPs compared to powdered latex, PVC, PU and vinyl gloves. In an effort to increase profit margins, new lines will be skewed towards the production of nitrile gloves. Kossan has also signaled its intent to becoming the worlds largest manufacturer of surgical gloves. Lastly, fluctuations in the USD/MYR rate will also play an impact on revenue. As most sales are conducted in USD, a higher (lower) USD/MYR rate will result in higher (lower) revenue.
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5.2 Costs
Figure 8: Cost breakdown

Chemical 9% Energy 9% Labour 10% Packaging 8% Others 9% Material 55%

Source: Companies, TA Securities

Similar to other glove manufacturers, Kossans main cost component is material expenses. Material expenses make up 55% of total cost and consist of latex and nitrile used during the production of gloves. Purchased in USD, this creates a natural hedge against fluctuations in the USD/MYR rate. Also, given that nitrile gloves are on average thinner than latex gloves, we note that less material is required for the production of nitrile gloves. We note that the average weight of latex and nitrile gloves is 5.5g and 3.4g respectively. Taking the average price of latex and nitrile in FY12 and assuming no wastage is made, 3.6sen of latex and 2.1sen of nitrile is required for the production of one latex and nitrile glove respectively. Hence, apart from the respective price of latex/kg and nitrile/kg, material cost will also depend on the composition of latex to nitrile gloves produced. Another major cost component for glove manufacturers is labour cost. Currently, Kossan employs approximately 5,200 workers. For Kossan, labour cost formulates 10% of total cost. This is due to the labour intensive attributes of glove manufacturing. The two most labour intensive process in glove manufacturing is stripping and packaging. To mitigate this impact, efforts on automation such as the introduction of robotics are being implemented. Apart from reducing labour cost, this will also ensure consistent quality and reduce human errors which will decrease output cost. Labour cost will be impacted by events such as a change in the minimum wage policy and shortage of labour supply. Kossan is also reliant on energy costs, which is mainly used for the heating of gloves. Of the 9% attributed to energy costs, 6% is composed of natural gas and 3% for electricity. Natural gas availability represents one of the main considerations during land acquisitions. In the absence of natural gas, manufacturers will then look towards biomass for energy needs. For Kossan, energy cost will mainly be determined by the prices of natural gas, which in turn will be affected by the continuance of subsidies and supply of natural gas.

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Combined, the above factors represent close to 75% of total cost. In an effort to provide earnings stability, Kossan employs a cost pass through mechanism in respect to changes in cost. Any increase/decrease in cost will be consequently met with an increase/decrease in ASP. As a result, a change in cost is unlikely to play a major impact on earnings in the long run. However, due to a one month time lag in passing on cost to consumers, we do not discount that earnings will ultimately be impacted during that period. 5.3 Balance Sheet and Cash Flow Kossan has a healthy balance sheet with a low net gearing ratio of 10%, implying that it isnt highly levered (see Table 2). Of total debt, long term debt is low at 20% as the bulk of interest bearing borrowings are short term. The duration of long term borrowing vary from three to six years, used mainly for the purchase of land, machineries and equipments. In comparison, short term borrowings such as bankers acceptance and revolving credit are used for working capital purposes. Also, to prevent earnings dilution, Kossans balance sheet is free from convertible instruments and hybrid borrowings.
Table 2: Net gearing

Long Term Debt (%) Short Term Debt (%) Net Gearing (%)
Source: Companies, TA Securities

FY08 16 84 63

FY09 23 77 51

FY10 16 84 24

FY11 12 88 18

FY12 18 82 16

1QFY13 20 80 10

Net operating cash flow for FY12 stood strong at RM93mn. In line with profit growth from strong demand and increased capacity, we believe future operating cash flow will be sufficient to support planned capital expenditure (CAPEX) and an increase in the dividend payout ratio (from 35% to 50% in the next two years). Expected CAPEX over the next five years will range between RM70mn to RM80mn. This will mainly be used for the purchase of plant and equipment, in support of Kossans expansion activities.

6.0 Peer Comparison In reference to Figure 11, of the glove manufacturers under our coverage, Kossan is the third largest glove manufacturer (see Figure 9). With an expected installed capacity of 16bn gloves/annum by the end of the year, Kossan trails Supermaxs installed capacity of 17.8bn gloves/annum albeit leading Hartalegas total installed capacity of 14bn. From a diversity perspective, Kossan is one of the more balanced manufacturers with a close to equal mix of nitrile and latex gloves. Compared to Hartalega and Top Glove, their more diversified exposure will provide them with earnings stability in situations of changes in consumer demand between nitrile and latex gloves.

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Figure 9: Nitrile and latex capacity (mn gloves/annum) as at July 2013

14.0 Hartalega 1.4 12.6 41.9 Top Glove 7.1 17.8 Supermax 7.1 16.0 Kossan 8.8 7.2 0.0 10.0 Total Capacity
Source: Companies, TA Securities

31.0

10.7

20.0 Latex Capacity

30.0

40.0

50.0

Nitrile Capacity

In terms of margins, Kossan enjoys industry average margins ranking between Supermax and Top Glove with a PBT margin of 11.2% (see Figure 10). Given their relative similar product composition, we opine that Supermax may have better margins due to their higher composition of OBM products. Also, Kossans margins may be pulled back by the variance in margins of TRP products which ranges between 5% and 40%. That said, we anticipate margins to improve as Kossan expands capacity in lucrative segments such as specialty purpose gloves and nitrile gloves. We are predicting PBT margins of 13.5% and 13.2% for FY13 and FY14 respectively.
Figure 10: PBT Margin (%) FY12/FY13*

Supermax

13.8

Hartalega*

29.64

Top Glove

10.4

Kossan

11.2

10

15

20

25

30

35

Source: Companies, TA Securities

Taking average profit per worker as a benchmark for efficiency, we can see that Kossan is the third most efficient glove manufacturer (see Figure 11). Their average profit per worker of RM19,647 is slightly above Top Glove but trails Supermax and Hartalega. That said, coupled with automation efforts and expansion into higher margin products, we opine that average profit per worker will increase in the future.

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Figure 11: Average profit per worker (FY12/FY13*)

300,000 250,000 200,000 150,000 100,000 50,000 0 No. of workers Avg. profit per worker (RM) Avg. rev per worker (RM)
Source: Companies, TA Securities

Kossan 5,200 19,647 237,308

Top Glove 11,000 18,430 210,405

Hartalega* 3,700 63,412 278,928

Supermax 3,500 34,777 284,964

7.0 Risks Akin to other glove manufacturers, Kossans earnings will be influenced by material prices, exchange rate, energy cost and labour cost. Before proceeding, we would like to reiterate that the sensitivity analysis conducted below is based on the assumption that prices remain unchanged in respect to increases or decreases in cost. 7.1 Material prices As discussed earlier, material price is the largest component of cost, making up 55% of total cost. With this, fluctuations in material prices, specifically the price of latex and nitrile plays an important role in the determination of earnings. Keeping everything else constant, a 10 sen (1.7%) increase in the price of latex decreases earnings by 3.0%. For nitrile, a 10 sen (1.8%) increase in the price of nitrile will decrease earnings by 2.9%. With near record stock levels and continued global uncertainties, we expect material prices to remain soft for the foreseeable future. We are currently predicting latex and nitrile prices of RM6.00/kg and RM5.60/kg respectively. The main determinants of latex and nitrile prices include the demand for automotive vehicles and the respective supply of latex and nitrile.
Figure 12: Price of Crude Oil, Natural Rubber and Synthetic Latex
USD/bbl 160 140 120 100 80 60 40 20 0 Jan-05 2 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 8 6 4 RM/KG 12 10

Crude Oil

Latex

Nitrile

Source: WTI, MRB, Companies, TA Securities

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Figure 13: Sensitivity Analysis on Latex price

% Change in Earnings
15.0 10.0 5.0 0.0 -0.40 -5.0 -10.0 -15.0
\

12.1 9.1 6.0 3.0 RM/kg -0.30 -0.20 -0.10 Base +0.10 +0.20 +0.30 +0.40 Price -3.0 -6.0 -9.1 -12.1

Source: Companies, TA Securities

Figure 14: Sensitivity Analysis on Nitrile price

% %Change Change in Earnings

15.0 10.0 5.0 0.0 -0.40 -0.30 -0.20 -0.10 -5.0 -10.0 -15.0
\

11.6 8.7 5.8 2.9 RM/kg Base +0.10 +0.20 +0.30 +0.40 Price -2.9 -5.8 -8.7 -11.6

Source: Companies, TA Securities

7.2 Exchange rate Secondly, most sales conducted by Kossan are denominated in USD. As a result, fluctuations in the USD/MYR rate will have an impact on earnings. That being said, this impact is minimized by the purchase of materials and chemicals in USD. Incorporating this, we note that a 10 sen appreciation/depreciation (3.2%) in the USD/MYR rate will increase/decrease earnings by 2.2%, ceteris paribus. We are currently predicting a year end USD/MYR rate of between RM3.05 to RM3.11.
Figure 15: USD/MYR Rate
3.4 3.3 3.2 3.1 3 2.9 2.8 2.7
May-10 Sep-10 May-11 Sep-11 May-12 Sep-12 May-13 Nov-10 Jan-11 Nov-11 Jan-12 Nov-12 Mar-11 Mar-12 Jan-13 Jul-10 Jul-11 Jul-12 Mar-13 Jul-13

Source: Bloomberg, TA Securities

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Figure 16: Sensitivity Analysis on USD/MYR Rate

% Change in Earnings
10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0
\

8.6 6.5 4.3 2.2 RM -0.40 -0.30 -0.20 -0.10 -2.2 -4.3 -6.5 -8.6 Base Rate +0.10 +0.20 +0.30 +0.40

Source: Companies, TA Securities

7.3 Energy cost Meanwhile, energy cost used mainly for the heating of gloves makes up 9% of Kossans total cost. Of this, 6% is derived from natural gas and 3% from electricity. With the potential removal of government subsidies, natural gas prices are expected to rise from the current average of RM16.07/mmbtu to within RM40.00/mmbtu in the near future. Based on our back of the envelope calculations, a RM5.00/mmbtu (31.1%) increase in natural gas price will decrease earnings by 18.0%. In preparation, glove manufacturers including Kossan have been looking towards biomass as a potential substitute for natural gas. However, as the price of biomass increase in tandem with demand growth, energy costs will ultimately rise as a result of the reduced subsidies.
Figure 17: Sensitivity Analysis on Natural Gas Price
%Change in Earnings
100.0 80.0 60.0 40.0 20.0 0.0 -20.0 -40.0 -60.0 -80.0 -100.0
\

73.2 54.9 36.6 18.3 RM/mmbtu -RM20 -RM15 -RM10 -RM5 Base Price +RM5 +RM10 +RM15 +RM20 -18.3 -36.6 -54.9 -73.2

Source: Companies, TA Securities

7.4 Labour cost Being a labour intensive industry, labour cost makes up 9% of total cost. Hence, fluctuation in cost will be influenced by changes to wages such as the recent implementation of the minimum wage policy. Based on the current no. of workers, every RM100 increase in monthly wages will increase cost by RM6.24mn.

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Earnings forecast and Assumptions

Table 3: Assumptions

Drivers Assumption Capacity (bn) Utisation rate (%) Average ASP

Source: Companies, TA Securities

FY13 15.6 85.0 27

FY14 19.7 85.0 27

FY15 22.8 83.0 27

Our broad based assumptions for FY13 to FY15 include the commissioning of plants as scheduled. This assumption ignores the potential of delays and trusts that plants will be fully commissioned within its expected time frame. In other words, our assumed capacity for FY13/FY14/FY15 is 15.6bn/19.7bn/22.8bn pieces of gloves/annum. FY14 capacity will be boosted by the expected completion of three plants between 4QFY13 and 1QFY14. Secondly, we expect the average price of latex and nitrile to remain stable at RM6.00/kg and RM5.60/kg, Prices are expected to be kept down by maturing plantations in Thailand, Cambodia and Vietnam. Further catalyst includes the slowdown in Chinas car market arising from the tapering of economic activities, which would impose less pressure on latex price escalation. We assume average ASPs to remain stable at USD27/thousand gloves. Here, we expect offsetting impacts from Kossans venture into higher margin gloves and potential competition. There will be a positive impact on ASPs as Kossan increase production of the higher priced specialty gloves. However, as rival glove manufacturers continue to increase installed capacities, we do not discount the possibility of reduced ASPs due to increased competition. Lastly, we expect the capacity utilization rate to remain stable at 85% over the next two years and decrease to 83% in FY15. Over the next two years, the utilization rate will be supported by the strong continued demand for nitrile gloves. However, in FY15, as capacities from rival glove manufacturers begin to come aboard, we expect a decrease in the utilization rate to 83%. Based on the above assumptions, we derive our FY13/FY14/FY15 earnings estimates of RM132.5mn/RM155.2mn/RM176.3mn. This translates to an earnings growth of 29.7%/17.1%/13.6% in FY13/FY14/FY15.

Valuation and Recommendations Using our target industry PE multiple of 14x, we fairly value Kossan at RM6.80/share. Taking into account proceeds from capital gains and dividend yield, this translates into a total return of 16.2%. We also like Kossan for its affordable exposure to the glove manufacturing industry. Kossans FY14 PER of 12.4x is undemanding vs. the industrys average of 14.7x (see Table 5). With that, we initiate coverage on Kossan with a BUY recommendation. Key opportunities and threats include: 1) Plan to double total installed capacity to 32bn pieces of gloves/annum by 2018; 2) Shifting focus towards higher margin gloves such as special purpose and nitrile gloves; 3) Expansion of TRP facilities with potential of high margins for customized products; 4) Onset of competition from local glove manufacturers who are continually increasing total installed capacity; 5) Expected rise in natural gas prices from RM16.07/mmbtu to RM40.00/mmbtu.

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Table 4: Earnings Summary Profit & Loss (RMmn)

FYE Dec 31 Revenue Other income Total Cost PBT Taxation Net profit EPS EPS Growth DPS Div Yield PER 2011 1,090.0 10.4 (980.0) 112.9 (21.8) 89.7 28.0 (20.9) 7.0 1.1 21.7 2012 1,234.0 4.4 (1,093.6) 138.5 (33.7) 102.2 32.0 13.9 12.0 2.0 19.1 2013f 1,272.3 4.6 (1,097.5) 171.9 (36.0) 132.5 41.5 29.7 18.7 3.1 14.7 2014f 1,536.0 4.9 (1,331.2) 202.8 (43.7) 155.2 48.5 17.1 21.8 3.6 12.6 2015f 1,731.1 5.1 (1,497.5) 232.6 (51.8) 176.3 55.1 13.6 24.8 4.1 11.1

(sen) (%) (sen) (%) (x)

Balance Sheet (RMmn)

FYE Dec 31 PPE Others Fixed Asset Cash Others Current Asset Total assets ST debt Other liabilities Current Liability Shareholders' funds & MI LT borrowings Others LT liabilities Total Liabilities + equity 2011 433.0 5.1 438.0 51.6 322.8 374.4 812.4 134.0 112.0 245.9 506.3 26.0 34.2 60.2 812.4 2012 514.4 5.1 519.4 99.8 370.7 470.5 989.9 160.7 123.7 284.4 617.4 38.3 49.8 88.1 989.9 2013f 547.5 5.1 552.5 140.0 364.4 504.4 1,056.9 144.5 134.5 279.0 693.7 34.4 49.8 84.2 1,056.9 2014f 578.3 5.1 583.4 114.2 451.7 565.9 1,149.3 129.8 155.7 285.5 783.0 30.9 49.8 80.7 1,149.3 2015f 606.1 5.1 611.2 134.4 507.9 642.2 1,253.4 116.7 174.7 291.3 884.5 27.8 49.8 77.6 1,253.4

Cash Flow (RMmn)

FYE Dec 31 PBT Adjustments Dep. & amortisation Changes in WC Operational cash flow Capex Others Investment cash flow Debt raised/(repaid) Equity raised(repaid) Others Financial cash flow Net cash flow Opening cash Forex Closing cash & cash equivalents 2011 112.9 (56.4) 40.3 (50.9) 45.9 (39.8) (7.6) (47.4) (11.8) (0.4) (19.2) (31.5) (32.9) 80.7 0.0 47.7 2012 138.5 (55.0) 45.1 (35.7) 92.9 (82.8) 2.5 (80.4) 43.1 0.0 (9.7) 33.4 45.9 47.7 0.0 93.7 2013f 171.9 (95.6) 46.9 17.1 140.3 (80.0) 0.0 (80.0) (20.2) 0.0 0.0 (20.2) 40.1 93.7 0.0 133.8 2014f 202.8 (113.5) 49.1 (66.1) 72.4 (80.0) 0.0 (80.0) (18.1) 0.0 0.0 (18.1) (25.7) 133.8 0.0 108.1 2015f 232.6 (131.1) 52.2 (37.3) 116.4 (80.0) 0.0 (80.0) (16.3) 0.0 0.0 (16.3) 20.1 108.1 0.0 128.2

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TA Securities
A Member of the TA Group

12-Aug-13
2011 19.1 11.3 10.4 2012 18.6 11.3 11.2 2013f 20.7 13.0 13.5 2014f 21.5 14.1 13.2 2015f 21.7 14.7 13.4

Ratios
FYE Dec 31 Profitability ratios ROE (%) ROA (%) PBT Margins (%) Liquidity ratios Current ratio Quick ratio

(x) (x)

1.5 0.9

1.7 1.1

1.8 1.2

2.0 1.3

2.2 1.4

Leverage ratios Total liabilities / equity (x) Net debt / Equity (x) Growth ratios Sales Pretax Total assets

0.6 0.2

0.6 0.2

0.5 0.1

0.5 0.1

0.4 0.0

(%) (%) (%)

4.1 (19.7) 4.5

13.2 22.6 21.8

3.1 24.2 6.8

20.7 18.0 8.7

12.7 14.7 9.1

Table 5: Peers Comparison

EPS Price (RM) 6.08 2.30 6.85 6.04 TP (RM) 7.10 2.70 7.40 6.80 Mkt Cap RM mn 3,769.0 1,562.2 5,027.9 1,924.3 3,453.0 FY13 (sen) 33.6 19.0 32.0 41.5 28.2
ROE FY13 (%) 15.6 14.7 33.8 20.7 21.4 FY14 (%) 16.6 16.8 31.8 21.5 21.7 FY13 (sen) 17.2 5.7 14.5 18.7 12.5

Top Glove Supermax Hartalega Kossan Simple average

BUY BUY HOLD BUY

FY14 (sen) 38.8 24.2 36.4 48.5 33.2

EPS Growth FY13 FY14 (%) (%) 2.7 15.4 6.4 27.3 (42.0) 13.8 29.7 17.1 (11.0) 18.8
DPS FY14 (sen) 19.8 7.3 16.4 21.8 14.5

PER FY13 (x) 18.1 12.1 21.4 14.6 17.2 FY14 (x) 15.7 9.5 18.8 12.4 14.7

Top Glove Supermax Hartalega Kossan Simple average

NTA/Share FY13 FY14 (x) (x) 2.2 2.4 1.3 1.5 1.0 1.2 2.1 2.4 1.5 1.7

P/NTA FY13 FY14 (x) (x) 2.8 2.5 1.7 1.5 6.6 5.5 2.9 2.5 3.7 3.2

Div yield FY13 FY14 (%) (%) 2.8 3.3 2.5 3.2 2.1 2.4 3.1 3.6 2.5 2.9

Disclaimer
The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein.
for TA SECURITIES HOLDINGS BERHAD(14948-M)
MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048

(A Participating Organisation of Bursa Malaysia Securities Berhad)

Kaladher Govindan Head of Research

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