Highlights

• We visited Karex’s plant in Pontian, Johor and we met with the group’s CEO together with Karex’s financial advisor, ZJ Advisory to get some updates about the company.

• Currently, Pontian is Karex’s largest plant with capacity to produce 2bn pieces of condom per annum, followed by their plant in Hat Yai, Thailand (1.2bn pcs) and Klang, Selangor (0.8bn pcs). By 2016, Karex will have enlarged production capacity of 6bn pcs of condom per annum with 3bn pcs from Pontian, 2.2bn pcs from Hat Yai and 0.8bn pcs from Klang.

• Unlike rubber glove where only sample get tested, we learnt that every single condom produced is tested electronically in a high voltage pin-hole testing machine. Condoms with pinholes will allow electricity to pass from the rubber brush to the mandrel and this will divert the condoms to the reject bin.

• Karex has the capacity to design, develop, re-engineer and customize its key technologies, such as dipping machine, electronic testing machine and foiling machine. This gives Karex flexibility to cater its customer’s varying demands and also results in cost savings and improved efficiency.

• Management shared that about 90% of sales and 30% of costs are dominated by USD; and Karex hedge between 70- 80% of the currency rates at point of invoice. We reiterate that Karex will continue to benefit from favourable currency condition.

• Placement exercise has been completed and our projection of cash balance now stands at RM244.9m for FY15. Approximately 73% of the proceeds will be used for development and business expansion, which in our opinion most likely will be M&A for overseas brand.

• We continue to like Karex’s strategy to grow by acquiring renowned brand(s) and also strategic partnership whereby Karex is in-charge of manufacturing while the other partner taking care of marketing and distribution works.

Risks

• Surge in raw material prices, forex risks, revision on foreign labour policy, successful invention of HIV/AIDS cure, product substitutions for condoms.

Forecasts

• We trimmed our production capacity from 4.50bn pcs to 4.25bn pcs in FY15 as per management guidance.
• We also impute in additional 40.5m new placement shares at RM3.90 per share. As a result, EPS for FY15 – FY17 is diluted between 5% - 13%.

Rating

HOLD , TP: RM4.14

Positives

• World’s largest condom manufacturer; everincreasingglobal condom demand; strong in-house R&D; licensed to export to major part of the world; and successful acquisition of Global Protection Corp.

Negatives

• High dependency on foreign labour and lack oflong-term contracts with customers.

Valuation

• We raised our TP to RM4.14 as we lift our target P/E from 19x to 21x CY16 EPS to reflect the latest figure of its international peers (see Figure #2).

We maintain HOLD recommendation as we believe further upside is capped by its rich valuations (FY16 P/E of 22.5x) after the recent share price run-up (share price advanced by 37.5% since we initiate the coverage in Dec 2014).

Source: Hong Leong Investment Bank Research - 17 Mar 2015