Results

• Below Expectation: 1QFY17 core PATAMI fell by 27% QoQ to RM9.1m, accounting for 11% and 12% of HLIB and consensus full year estimates respectively.

Deviations

• Mainly due to delay of RM13m worth of orders, higher distribution expense and one-off expenses with the consolidation of Pasente (circa RM1m).

Highlights

• YoY : Revenue increased by 5% mainly attributed to the consolidation of Pasente. However, core PATAMI fell by 59% in tandem with drop in margin from 36% to 31% due to lower ASP from tender segment.

• QoQ : Core PATAMI fell by 27% mainly due to higher distribution expenses.

• We understand revenue could be higher by RM13m in 1QFY17 if not due to delay in delivery of certain commercial and tender orders. Core PATAMI could have achieved RM12-13m level which is similar to previous quarter.

• Utilisation rate weakened from 65% to 60% level mainly due to softening of tender segment (fell from 32% to 29% as total revenue). However, with the depleting stock level (decreased from average of 12 months to 5-6 months currently), purchasing order should start to pick up in next quarter with more significant improvement to be seen in 3Q and 4Q17.

• In view of the i) recovery in tender order and ASP, ii) maiden contribution from Walmart’s distribution in Oct17 (US$5m pa) and iii) weakening bias of Ringgit, we opine that earnings could have bottomed in 1QFY17 and rebound in 2H17.

• With the consolidation of Pasente, revenue from Europe has almost doubled from 12% to 22% in 1QFY17. We see tremendous growth with cross selling opportunity between One brand and Pasente. Karex is targeting to launch its One brand condom into UK in June 17.

• In the long term, we continue to like the company’s effort in growing its OBM business through organic and inorganic growth. GP margin for OBM segment is much higher at above 40% as compared to tender segment at 20% and commercial at 30%.

Risks

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

Forecasts

• FY17 earnings forecast is reduced by 11% after we incorporate lower utilisation rate (due to delay in certain order and slower than expected pick up in tender segment). FY18 and FY9 earnings are largely unchanged.

Rating

HOLD ↔

• Valuation remains rich at this level. However, we are long term positive on its ambition on OBM segment to capture the huge upside on margin expansion.

Valuation

• We maintain our HOLD recommendation with our TP lowered from RM2.31 to RM2.20 by pegging to unchanged P/E multiple of 24.5x of CY17 EPS post earnings adjustment

Source: Hong Leong Investment Bank Research - 30 Nov 2016