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Valuation Gap To Narrow With Regional Expansion

|About: Intelsat SA (I)

Rubber is very important in today's world. Tires and tubes are the largest consumers of rubber. The remaining are taken up by the general rubber goods sector, which includes all products except tires and tubes. It is used in the manufacture of doors and window profiles, hoses, belts, matting, flooring, and dampeners. Gloves are also large consumers of rubber, although the type of rubber used is that of the concentrated latex. And that is where Kossan Rubber (7153.KL) is finding a fertile market niche.

Malaysian glove makers account for approximately 60% of the global glove capacity a position which was achieved through the combination of the proximity to key raw materials, good infrastructure, R&D, development of supporting industries and support from the government agencies. Glove makers in general realize that they need to expand their capacity, not only in terms of production but also in product mix to stay competitive.

The long-term demand growth for gloves is sustainable in view of the strong support from the developed countries. Data also shows that healthcare expenditure is on an uptrend for most countries and that may indirectly drive glove demand.

Emerging economies have the potential to become a game changer for future demand as their populations become increasingly more aware of the importance of hygiene and as demand for higher quality healthcare services escalate.

Information from the World Health Organization (WHO) indicates that these countries have been increasing their healthcare expenditure in 2000-2010 and we believe the momentum will keep growing in the future as they develop. As more hospitals are built, more healthcare workers (doctors, nurses and general workers) will be required and thus, more medical standard gloves will be used in the upcoming years.

Founded in 1979, Kossan Rubber Industries first offered a range of bearings that were often used in the marine industry. But with the growing glove market , Kossan ventured into the sector, introducing the first glove production line in August 1988. Today, Kossan has a full capacity of 49 state-of-the-art production lines that are able of producing a stunning 3.9 billion pieces of gloves per annum. Kossan's stellar performances has resulted in a business network that extends to more than 100 countries around the world, including the USA, Canada, Europe, Asia Pacific, Latin America, Middle East and Australia.

Favorable raw material prices and competitive currency. The steady easing in the price of latex since April 2011 and the currently stable price appears to be working in favor of the glove makers. We believe that as long as the price of natural latex hovers between RM6.00 and RM7.00 per kg, glove makers should be able to reap robust margins. Elsewhere, the price trend for nitrile (which uses butadiene as a proxy) also appears to be encouraging. The recent fluctuations in USD have led to great volatility in rubber prices. Looking at the competitiveness of RM against other major rubber glove exporting countries based on data, we find the RM still competitive and Malaysia still leading in the global rubber glove industry.

Glove demand still resilient and going strong

Kossan has rolled out its expansion plan for 2012-2014, focusing mainly on nitrile gloves, surgical gloves and clean room products. The expansion will add 10% to 15% of new capacity annually. The company aims to achieve a target capacity of 14.0bn pieces from 12.0bn pieces at the beginning of 2012 - an additional 660m pieces of surgical gloves and 1.4bn pieces of nitrile gloves.

The company also planned to expand into Indonesia to grow its revenue in technical rubber products.

Kossan also manufactures rubber rollers, PU products, extruded rubber, bridge bearing pads, bridge expansion joints, and other products. Its strategy involves opting to be competitive through the provision of good services and quality products and reducing Malaysia's dependence on imported rubber goods. In addition, the company looks to increase its production of nitrile or synthetic gloves, which generally commands better profit margin.

Some numbers…

In its 2012 annual report, net income in the quarter ended 30 September 2012 compared to previous year quarter was higher by 22.11%, partly due to lower latex price. The increase in the financial period ended 30 September 2012 was within management's expectation. Profit before taxation increased by 28.12% due to lower material price and increased capacity utilization. Turnover in clean-room division continued to grow due to the efforts by the Group to penetrate new market with new products.

In its prospect for 2013, the company expects the technical rubber products division to grow steadily. Management is confident prevailing profits can be maintained for the remaining quarter of the financial year. Strong demand is expected In the gloves division. The commissioning of new surgical gloves production line is expected to boost growth from January 2013.

Recently, it boosted its manufacturing capacity by 20% to 12 billion pieces annually from 10 billion. Its CEO, Mr. Lim Kuang Sia said the company had invested $23.23 million to increase capacity. It took delivery of 11 double former production lines, while the new lines have the capacity to produce 2 billion gloves per annum. In addition, the company is targeting to add 8.0bn pieces within the next 5 years beginning 2013 with new production lines that are highly versatile and interchangeable which will minimize downtime.

Kossan, with an ROE of ~18%, is trading at just 9x FY13 earnings compared to Topglove and Supermax, with ROEs in the 15%, are at ~15.0x their FY13 earnings. The valuation gap should narrow as (NYSE:I) Kossan moves up the value chain by increasing sales of its higher margin nitrile gloves; (ii) Kossan's product mix at 50-50 natural vs synthetic rubber means it is less sensitive to natural rubber price fluctuations; (NASDAQ:III) Kossan has historically been quite generous in rewarding shareholders via bonus issues and at a recent investor conference the CEO mentioned they are exploring Free Warrants in the near future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.