Highlights

• Condom shortages that have been experienced in China will become history as China’s one-child policy will be abolished, effective from March 2016. Hence, the abolition of China’s one-child policy will see an end to hitherto booming condom makers, like Karex.

• The change in policy has sent shares of condom makers plummeti ng across major stock exchanges in the worl d’s financial capitals. Since 29 October 2015, Okamoto Industries slumped ci rca 24%, Female Health fell by 19%, Church & Dwight dropped circa 3%, and Reckitt Benckiser declined by about 3%. But this is unlikely to have signi ficant impact on K arex’s total revenue as China market contributed only 3% or less to its total revenue.

• Having said that, the decision by China to relax the one-child policy may cause oversupply in condom due to easing of demand in China. According to Central Intelligence Agency (CIA), China has about estimated 12.49 birth rate every year as compared to average Asia’s birth rate of 18.59 (FIG1). At Asian’s average, China coul d see additional 8.3m new souls every year. In the event of drop in demand in China, there is a possibility of installed capacity oversupply which may lead to price war.

• Demand for condom in China may decline even though there is still a policy limiting two-child per family. In addition, China is the top 4 highest rate of Cont raceptive Prevalence in the world (84.6% in 2006 based on CIA), implying that condom usage in China is likely to drop following one-child policy abolishment.

• However, Karex continues to benefit from strengthening USD during the past few months as it exports condoms to a range of non-Asian nations in Africa, America and Europe which makes up 69% of its end-Jun15 revenue. Moreover, the declining prices of latex, which is Karex’s largest cost, are an added advantage to Karex. According to the Malaysian Rubber Board, the average price of latex in Jan- Nov 2015 was settled at 420.29 sen/kg as opposed to 436.91 sen/kg in CY14.

Risks

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

Forecasts

• No change in forecasts.

Rating

HOLD , TP: RM3.51

Positives

• World’s largest condom manufacturer; everincreasing global 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 of long-term contracts with customers.

Valuation

• HOLD recommendation is maintained with an unchanged target price of RM3.51. Our valuation is pegged to unchanged P/E multiple of 23.8x of CY17 EPS, based on +2SD above 3-year historical average P/E.

Source: Hong Leong Investment Bank Research - 18 Nov 2015