Results

• Below: 1H18 PATAMI of RM7.4m (-59.3% yoy) was below expectations, accounting for 34.1% and 23.4% 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

• YTD: Record revenue of RM218.1m (+22.8% yoy) was achieved on the back of a stronger performance in the sexual wellness division (+26.9% yoy). Patami declined to RM7.4m (-59.3% yoy) attributed to higher distribution (+69.3%) and admin expenses (+19%) namely attributed to their forays into the OBM segment. GP margin declined to 26.4% (1H17: 32%) due to competitive pricing as well as the strengthening MYR.

• Qoq : Revenue increased to RM110.5m (+2.7% qoq) due to improved sales in the tender segment. Higher distribution costs (freighting) resulted in a lower Patami of RM3.2m (- 22.3% qoq). GP margin improved by 0.6ppts qoq to 26.7% on the back of improved sales from their OBM segment.

• We opine that ASP in tender market are at the point of inflection as management guided that clients would be cautious on the quality of the condoms should ASP in the market continue to slide further. To note, their OBM segment continues to gain traction with sales now positioned at 16% of revenue.

• The group remains focused on growing its ONE brand in the USA. As at FY17 the group has a presence in c.12,000 stores across the USA and is targeting to double this to c.24,000 stores by FY18.

• Karex also intends to grow the Pasante brand in the Middle East where UK brands are viewed in a favourable light, with Jordan and the UAE being the key focus.

• Outlook: We continue to expect ASP to remain competitive in the near term 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 adjust our FY18/19/20 earnings downward by 18%/5%/13% as we take into account a higher D&A assumption on the back of the groups OBM growth strategy.

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. Maintain SELL .

Valuation

• Post earnings revision our TP reduces to RM0.93 from RM1.04 Our valuation is based on CY19 pegged to a P/E multiple to 28x (-0.5SD) (Figure #5).

Source: Hong Leong Investment Bank Research - 1 Mar 2018