Results

• Below Expectation: 4QFY16 core PATAMI fell by 24% YoY, bringing FY16 to RM66m, accounting for 91% of HLIB and consensus full year estimates.

Deviations

• Mainly due to lower margin arising from reduced selling price and rising production cost.

Highlights

• YoY: Revenue increased by 4% mainly attributed to higher volume of condom sales. However, PATAMI fell by 24% in tandem with drop in margin from 34% to 29% due to lower ASP from tender segment.

• QoQ: PATAMI fell by 13% mainly reflecting full effect of lower ASP, especially from tender segment.

• Utilisation rate remain flat at 65% mainly due to softening of tender segment (fell from 43% to 37% as total revenue) as the surge in refugee crisis in Europe has disrupted the healthcare budget for government and non-government bodies. However, with the depleting stock level, purchasing order should recover in next few quarters.

• With the expected recovery in tender market, we can expect ASP to be revised higher. This suggests current gross profit margin of 28.5% is already at the bottom and should recover in FY17.

• In a separate announcement, Karex proposed to acquire condom business from Line One, a US company which owns brand names like Trustex, Fantasy and Kamelon for US$8m (about 3x of FY15 revenue). This is the fourth acquisition within a year. We are positive on the deal as this complements Global Protection distribution business in US under healthcare segment and provides products cross selling opportunity.

• After the acquisition, Karex’s cash pil e remai ns strong at RM112m, allowing it to continue looking for potential acquisition.

• In the long term, we see tremendous growth potential on the OBM business for Karex given its ongoing effort to tap into different market through organic and inorganic growth. GPM margin for OBM segment is much higher at above 40% as compared to tender segment at 20% and commercial at 30%.

• In addition, Karex had recently secured contract from Walmart, which estimated at US$5m per annum (50% increase in revenue for Global Protection).

Risks

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

Forecasts

• FY17 and FY18 earnings forecasts are reduced by 6% and 5% respectively after we incorporate lower selling price and utilisation.

Rating

HOLD

• Positives – World’s largest condom manufacturer; Zika virus outbreaks; ever-increasing global condom demand; strong in-house R&D; licensed to export to major part of the world.

• Negatives – High dependency on foreign labour and lack of long-term contracts with customers.

Valuation

We maintain our HOLD recommendation with our TP lowered from RM2.44 to RM2.31 by pegging on unchanged P/E multiple of 24.5x of CY17 EPS post earnings adjustment.

Source: Hong Leong Investment Bank Research - 1 Sep 2016