Business Background
Kossan Rubber Industries Bhd manufactures industrial rubber products and disposable latex gloves. The firm has three primary businesses: Gloves, Technical Rubber Products, Cleanroom Products, and Others. The Gloves segment generates over 85% revenue and 90% profits of the company, with TRP generating 9% profits, Cleanroom Products and others contributes less than 1% profits.
The Gloves business manufactures medical grade examination gloves and specialty gloves for healthcare and industrial applications, with 72% nitrile and 28% latex gloves. In early 2017, Kossan is operating at a capacity of 22 billion pieces of gloves per year, in comparison to Hartalega's capacity of 23 billion pieces per year.
The Technical Rubber Products business manufactures and distributes high technical input rubber products, mainly applied in automotive and infrastructure segments in USA market.
The Cleanroom Products business sells rubber products that can be used in cleanrooms.
The majority of Kossan Rubber’s revenue is generated through exports outside of Malaysia.
Expansion Plan
Ongoing projects: Plant 16, 17 and 18 in Jalan Meru Klang with capacity of 3.0, 1.5 and 3.0 billion pc of gloves per year respectively for each plant. Initial upcoming plans: 4 phases of development on a 56 acres land in Bestari Jaya, with 4.5 billion pc of gloves per year for each phase. Previously the target is to increase production capacity from 22 billion to 47.5 billion pc of gloves per year by 2023.
Initially the company plans to commence plant 16 in Q3 2017 and plant 17 & 18 in year 2018. However, the commissioning of plant 16 has been delayed quarter after quarter, mainly due to water supply interruption leading to delay in submission of building plan thus unable to commence in time. Recently management has guided in latest quarter report and AGM that the issues has been resolved and plant 16 will be fully operating in July 2018. As plant 17 and 18 are following the same design as plant 16 in the same location, they foresee these two plants will not be facing the same issue and target to be commenced by Q3 2018 and Q1 2019 respectively. One of the surprising, exciting yet controversial move of the year is the company acquired a large piece of land in Bidor measuring 824 acres (333 ha), at the price of RM 82m for future expansion in Mar 2018. Prior to that, the company has also bought another large piece of land measuring 98 acres (40 ha) in Banting Kuala Langat at the price of RM 96m for the same purpose as well. This increases the net gearing of the company from 6% to 16% recently. To get a better comparison, Hartalega NGC land size is about 49 ha, having 6 plants housed within the land using only about 38 ha of the land area, with a total production capacity of 28 billion pc of gloves per year under NGC alone. With plant 16, 17, 18 of Kossan experiencing delays, construction work yet to begin in Bestari Jaya (4 phases development until 2022), and the group just acquired a large piece of land in Banting in Aug 2017 with area size comparable to HARTA NGC, the recent acquisition of Bidor land that is 6-7 times larger than NGC does spark some controversy among the investment community as it tightens the cash level of the company and increase interest expenses as people foresee that Kossan may not be able to utilize such expansion in capacity within the next few years.
Management later clarified that they plan to sell the two pieces of land in Bestari Jaya and Banting that they acquired for RM 40m and RM 90m in 2013 and 2017 respectively for a total cash consideration of RM 200m. This will reduce the net gearing level and interest expenses of the company and free out the cash invested for land acquisition in Bidor to fund part of the construction work on the land. I'm opined that management make the right move as they didn't see such opportunities coming while planning their expansion in Bestari Jaya and land acquisition in Banting.
Key takeaways from Year 2018 AGM
Commissioning of plant 16 was affected by water supply issues thus leading to delay in submission of building plan. Plant 16 will be fully operating in July 2018, followed by commissioning of plant 17 by Q3 2018 and plant 18 by Q1 2019.
Product quotations for gloves are revised on monthly basis, and the company also perform currency hedging on its receivables by purchasing just the right necessary amount of forward contract (no gambling), thus no major concerns over weakening of dollar or currency fluctuations.
The land in Bidor is a strategic arrangement for the company's expansion plan. Apart from fair access to Port Klang in less than 2 hours, easy availability of workforce and sufficient utility sources such as natural gas, water and electricity, Tan Sri Lim also highlighted that the land has access to underground and river water. This is very important as water supply has been the major problems for glove manufacturing plants, which causes the delay commissioning of plant 16, 17 & 18 previously.
They have checked with the Perak state government to confirm that they are allowed to access water supply from rivers nearby. He also expressed a little relief that Perak state return under the governance of federal government, or else there could be some challenges in making related arrangements when the state government of that land is different from federal government.
The management plan to utilize 323 acres (~130 ha) of the 824 acres land in Bidor for future expansion within the next 6 - 8 years. Once they are done with submission and approval for the land, they will let go the previous expansion plan in Bestari Jaya and fully focus on the large piece of land in Bidor. The estimated capex would be RM 1.5 billion to add another 34 billion pc of gloves per year to their capacity. The capacity could have go even larger if market demand is good as the land area is very big. The management plans to subdivide and sell some of the extra land space to invite related suppliers to setup their factories, so that they could integrate the entire manufacturing process.
Tan Sri Lim is looking forward to transform his manufacturing plant to the next level. During the AGM, one of the shareholders asked Tan Sri Lim to guide the shareholders on the estimated figure for potential profit margin of this "dream plant" and if this "dream plant" will enable the company to catch up with the profit margin of leading peers like Hartalega. However, Tan Sri refused to disclose any specific figure and too much details on technical aspect of the plant, he just chuckled and responded "Why not?".
In November 2017, the Group followed the launch of its patented Low Derma Technology gloves last year with the introduction of the world’s first Halal-certified gloves (certified by JAKIM) under the brand name Confidenz™. These powder-free nitrile gloves places KOSSAN at the forefront of a solution to meet the stringent demands of the Halal industry, not just for the food sector, but also for the entire Halal value chain. Tan Sri Lim stressed that we always aim to differentiate ourselves in the market, innovating wide range of products that cater for different needs across many different industries. Therefore, he does not believe in price war to bang prices as it would compromise product quality. We should see ourselves and our product as adding value to our customers, instead of bagging and "kowtow" to the customer.
China regulation policies on environmental pollution has drastically affect the supply chain of chemicals, gloves, steel and raw materials in China since 2017. This also drives up the demand and prices of gloves.
Technical Rubber Products (TRP) experienced eroding profit margin last year as there's a lag in adjusting selling price accordingly to the sharp increase in raw materials. According to Tan Sri, pricing adjustments for TRP are not versatile like gloves, as it's engaged with automotive and infrastructure projects and costing given has a longer time frame of 6 - 12 months.
Personally I would like to point out several negative notes during the AGM as well:
Below satisfactory corporate governance in complying to some of the listing requirements - MSWG raised concern that Kossan did not disclosed Director's renumeration on individual name.
The handling of Investor Relations (IR) is also below satisfactory and probably not meeting the expectations of most attendees as there are totally no slides presentation given at all throughout the entire AGM. Shareholders pointed out that the management should have present some slides not only in addressing several questions raised by MSWG which will make things easier for the audience to digest the content, but also some key financial highlights and outlook of the company. Personally I'm surprised that this issue happens in the likes of Kossan and they have a lot to work on in these areas.
Editor's comment on Outlook and Prospect:
Fundamental Analysis (FA)
Several factors that resulted huge gap in market capital between Kossan and Hartalega despite having similar production capacity:
Significantly lower profit margin of 9.3% in recent quarter as compared to 18% from Hartalega. The net profit margin of Kossan are ranging between 10-12% over the past few years.
Delay in commissioning of plant 16, 17 and 18 while both Hartalega and Top Glove are able to progress with their newly added capacity last year. In early 2017, Kossan's capacity of 22 billion pc was comparable to Hartalega's capacity of 23 billion pc. But Hartalega's capacity already increased to 28 billion pc recently as new plant commenced. Visible growth in net profits for recent quarterly performance does influence the perception of fair valuation, resulting Hartalega and Top Glove to deserve higher PE ratio.
Superior qualitative factors that allows Hartalega to achieve better operating efficiency than its peers. Apart from innovations in gloves materials and production design that allows them to produce gloves at lower cost, they are also able to setup larger capacity for the same area space given as it utilizes an automated transport system to transport finished goods to storage.
Having Hartalega to be the next potential candidate listed as KLCI index counters would serve as a catalyst for higher PE ratio. However, this doesn't add any real value from business perspective.
2. As plant 16, 17 and 18 of Kossan fully commenced, capacity will increase from 22 billion pc to 29.5 billion pc within a year from now. If according to initial plans with next 4 phases of expansion in Bestari Jaya, it could have a total capacity of 47.5 billion pc per year by 2023, as compared to Harta NGC 42.5 billion pc per year by 2021. With new plans on Bidor land, Kossan will put Bestari Jaya plan on hold, and focus on Bidor upon completion of plant 18 in Jalan Meru, Klang. With an additional capacity of 34 billion pc in Bidor, that could increase total capacity to 63.5 billion pc by 2024-2026, with abundant of land space for future expansion whereas so far no future plans revealed by Harta after NGC fully completed by 2021.
3. If things go according to plan, CAGR % for capacity growth over the next 5 years for Kossan would be on par to Harta at average growth rate ~15% p.a. Kossan should also have comparable if not higher production capacity than Harta (It's likely that Harta would also reveal plans to further expand capacity after NGC is fully completed). We believe that with new plant automation technology, better plant integration, and production of premium LOW DERMA gloves and Halal Certified gloves, there should be a reasonable improvement in profit margin in the future. At this stage, it may not be realistic to expect profit margin of Kossan to catch up with Harta, but even if Kossan could close up the gap by lifting up profit margin to somewhere between 13-14% (assuming no variables in currency and raw material cost as compared to now) would be good enough to give future earnings a quantum leap, which will also increase the fair valuation of Kossan.
4. It's worth to take note that recently between the price of RM 6.38 - 7.20, Kossan is presenting a relatively undemanding valuation of PE 22 - 25 representing a market cap of RM 4.5 billion whereas Hartalega is commanding PE 46 at RM 6.10, representing market cap of RM 20.2 billion. It pays less than 23% market capital to invest in Kossan with the similar scale of nitrile gloves business and future capacity growth rate.
Technical Analysis (TA)
In May - July 2017, a technical reversal in trend was observed.
Then share price increase to highest of RM 8.79 within 7 months before a technical reversal in trend was observed in Mar 2018.
Share price later decline from a high of RM 8.79 to a low of RM 6.38 and recently supported around RM 7.00 area.
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Disclaimer: The information shared in this article are meant for case study and educational purposes only, not a recommendation to buy or sell. Analysis given are mainly personal opinion of the editor and we are not liable for any inaccuracy in the information given and any financial losses or damages made. Stock trading and investment are risky in nature. Please consult your broker and licensed financial consultant for advice.