Results

• Below Expectation: FY17 PATAMI of RM27.9m (-57.2% yoy) was below expectations, accounting for 67.6% and 70.7% of HLIB and consensus full year estimates.

Deviations

• The deviations stem from (i) higher marketing and distribution expenses related to the expansion of the OBM segment, (ii) depressed ASP from the tender market and (iii) a spike in latex prices in early CY17.

Highlights

• FY17: Revenue grew 5.3% yoy to RM361.5m despite the tougher tender market and compressed ASP environment. PATAMI declined 57.2% to RM27.9m from RM64m in FY16 on the above mentioned factors.
• Yoy: Revenue grew 10.8% yoy to RM91.6m on higher volumes from the sexual wellness division, offset by higher admin and distribution expenses. PATAMI fell by 74% to RM2.9m. Management guided that distribution expenses (+43.6% yoy) and admin expenses (+36.5% yoy) have plateaued and such volatility will cease to exist in FY18.
• Qoq: Revenue was flattish qoq due to a recovery in the tender segment partially offset by the spike in latex prices in early CY17, resulting in a higher average unit cost. Resultantly, PATAMI declined 58% qoq to RM2.9m.
• The tender market which accounts for c.40% of revenue historically ended FY17 at a low of 37%. There have been nascent signs of recovery in volumes in 4Q17 on the back of the group’s low pricing strategy to grow their market share.
• Management guided that the volume recovery was underpinned by some normalization in orders from NGOs. Whilst, recent tenders won are at a higher ASP as they are able to pass on the higher raw material prices.
• On the OBM front, Karex will be entering the Singapore and Thailand retail market in FY18 with a pricing-driven entry strategy. For perspective, retail prices will be c. 20%-30% lower than Durex in the Thai market.
• In FY18, we continue to expect ASP to remain relatively low despite signs of recovery in 4Q17 due to the consolidating global condom market. Nevertheless, we expect a better performance relative to FY17 on the back of returning volumes partially offset by higher a higher cost base.

Risks

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

Forecasts

• We reduce our FY18-19 earnings by 29%-30% on the expectation of a persistent competitive operating environment and a higher cost base. We introduce FY20 numbers.

Rating

Whilst we are long term positive on its ambition to grow its OBM segment, it remains to be seen if the price competition has subsided in the near term. Maintain HOLD.

Valuation

• Post earnings revision our TP reduces to RM1.37 (from RM1.97) based on P/E multiple of 24x pegged to CY18 EPS based on -1SD below historical average (Figure #5).

Source: Hong Leong Investment Bank Research - 30 Aug 2017