Results

• Below Expectation: 1QFY18 PATAMI of RM4.1m (-48.8% yoy, +43.2% qoq) was below expectations, accounting for 7.9% and 8.7% of HLIB and consensus full year estimates.

Deviations

• (i) Higher marketing and distribution expenses related to expansion of OBM segment, and (ii) competitive ASP from the tender market.

Highlights

• Yoy : Record revenue of RM107.6m (+34.4% yoy) was achieved on higher volumes from the sexual wellness division, offset by higher admin (+28.0% yoy) and distribution expenses (+101% yoy). Subsequently, PATAMI fell by 48.8% to RM4.2m. Management guided that distribution expenses increased significantly due to higher freight costs on the back of consolidation in the shipping industry.

• Qoq : Revenue increased to RM91.6m (+17.4% qoq) due to improved sales in the tender and commercial segment. Gross margins remained at c.26% as ASP remained competitive. Resultantly, PATAMI improved to RM4.2m (+43.2% qoq) on the back of volume growth.

• Management guided that bulk of the volume growth was underpinned by higher orders shipped to Africa (tender segment) and Asia (commercial segment).

• The launch of the MyOne brand in the USA occurred in 1Q18. We can expect higher investments from this brand moving forward. To note MyOne will offer the USA market a customization of 10 lengths, 9 widths and 60 sizes.

• On R&D, Karex is in the midst of experimenting with synthetic materials which are thinner than the thinnest latex condoms available currently (20 microns vs 40 microns).

• Outlook: We continue to expect ASP to remain competitive on the back of a consolidating global condom market. Furthermore, higher brand investment coupled with higher distributions costs would continue to impact profitability.

Risks

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

Forecasts

• We reduce our FY18-20 earnings by 58%-35% on the expectation of a persistent competitive operating environment and higher cost.

Rating

• Whilst we are long-term positive on its ambition to grow its OBM segment, significant investments in this category will continue to impact profitability in the near term. Downgrade to a SELL .

Valuation

• Post earnings revision, our TP reduces to RM1.04 (from RM1.37). We roll our valuation into CY19 and raise our P/E multiple to 28x (-0.5SD) from 24x (-1SD) (Figure #5) as we believe a lower discount is warranted on the back of volume and market share growth exhibited, despite the lacklustre earnings.

Source: Hong Leong Investment Bank Research - 27 Nov 2017