Kossan ... Feb10

S & P Kossan Rubber Industries

Recent Developments

• Kossan is benefiting from strong glove demand with confirmed glove orders up to mid-2010. The group is embarking on an expansion plan, starting with 1.7 bln glove pieces in mid-2010. A second expansion targets to bring in a further 1.7 bln glove pieces in capacity by 3Q10. At end-2010, we believe Kossan’s production capacity will rise to 14.5 bln pieces from 11 bln currently. The expansion plans require
additional capex of MYR50 mln, which will be funded internally.

• The new capacity will cater for the production of nitrile gloves (for larger customers), which carry higher margins for Kossan. As such, 2010-2011 product mix will see nitrile glove contribution rise to 40% from 25%. The new lines will not only generate higher margins but due to its focus on larger clients, will reduce downtime, thereby pushing up production yield and reducing wastage.

• The group is also seeing strong order pick-up from its technical rubber production (TRP) division, as customers start replacing or stocking up on parts. The division is currently working on two shifts, a vast improvement from less than one shift nine months ago.

• The present high latex cost does not concern Kossan, as it is able to easily pass on rising costs to customers. Furthermore, it expects latex prices to decline after the wintering period and we project latex price at MYR5.00/kg for 2010 overall, from the current spot price of MYR6.90/kg. We look for Kossan to post strong 2010 earnings growth, helped by robust sales volume and expanding margins from increasing
contribution from nitrile gloves.

Recommendation & Investment Risks

• We maintain our Strong Buy recommendation with a higher 12-month target price of MYR7.50 (from MYR6.00).

• We raise our target PER to 11x (from 8.5x) against our projected 2010 EPS for Kossan and add our estimated 12-month net DPS of 7.9 sen. The target multiple is in line with peer average and its historical PER trading average. The higher target multiple reflects higher peer valuations and positive demand-supply industry dynamics.

• We remain positive on Kossan’s business going into 2010. We expect: (i) the group’s core profitability and margin to expand, led by its new high-grade nitrile gloves, (ii) higher demand for gloves in reaction to the spread of the A(H1N1) flu pandemic and (iii) a stable cost structure. We believe these positive factors would support the outperformance of Kossan’s share price over the mid to long term.

• Risks to our recommendation and target price include potential delays in the commissioning of new production lines and a stronger-thanexpected appreciation of MYR as over 90% of its revenue (gloves and TRP) are derived from exports, while about 70% of its costs are in USD.