Maintain hold at RM3.14 with revised fair value RM3.71: We are maintaining our 'hold' rating on Kossan with a lower fair value of RM3.71, post a downward earnings adjustment and the rolling forward of our valuation base year from FY11F to FY12F. We continue to peg our valuation to a price-earnings ratio of 10 times FY12F earnings ' at a 30% discount to its 10-year mean.
Following a recent company visit, we have trimmed our FY11F/13F earnings per share by -7% to -9% after incorporating lower margin assumptions due to further normalisation in margins (1QFY11: -1 percentage point quarter-on-quarter [q-o-q]). We now forecast an earnings before interest, tax, depreciation and amortisation (Ebitda) margin of 16% for FY11F, against 18% previously.
We understand the upcoming 2QFY11F earnings will likely be flattish on a q-o-q basis. We observe the earnings underperformance mimics the trend seen in the recent results of peers, underpinning our longstanding view that it is too premature to turn constructive on the sector at this juncture.
While management has attributed it largely to continued lacklustre demand for rubber gloves on minimal inventory holding by customers amid elevated latex prices, our channel checks reveal price undercutting has been rife within the basic natural rubber (NR) gloves segment. However, the impact on Kossan's earnings has been relatively subdued, owing mainly to its more balanced product portfolio mix of 60:40 in nitrile:latex gloves.
The group's earnings growth will continue to be primarily centred on better-margin glove variants as underpinned by its high utilisation rate of circa 90%.
We expect earnings contribution from 51%-owned Cleanera HK Ltd to rise from 10% to approximately 14% to 15% of group earnings on the back of increased capacity. Recall, Cleanera is principally involved in the manufacturing of cleanroom products such as masks, wipes and gloves.
The group has recently completed its US$3.06 million (RM9.3 million) acquisition of Cleanera and management remains confident of achieving a payback of 1.5 years. We expect a more aggressive marketing campaign to result in an increased market share for cleanroom products in China going forward.
Potential stock re-rating catalysts include: (i) a meaningful easing of the latex price; (ii) better-than-expected 2Q results. '
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