Karex’s 9MFY18 core PATAMI of RM12.6m (-42.3% YoY) was below our expectation and consensus. The deviations in the results are mainly due to higher A&P and distribution expenses, depressed ASP, unfavourable forex movements and higher input costs YoY. Our FY18-20 forecast is revised downward by 22%/38%/41%. Post earnings revision, out TP decreases to RM0.51 (from RM0.93). Despite the soft outlook, we feel that much of this has been reflected with the share price tumbling 69% YTD; thus we are upgrading to a HOLD (from a Sell) on the back of (i) confirmed ASP revision and (ii) the implementation of margin improvement measures moving forward.

Below. 9M18 core PATAMI of RM12.6m (-42.3% YoY) was below expectations, accounting for 71.2% and 63.8% of HLIB and consensus full year estimates. The results were below due to (i) higher A&P expenses (ii) competitive ASP (iii) rising input costs in tandem with the increase in the price of crude oil and (iv) an appreciating RM vs. USD.

QoQ. Revenue decreased to RM96.5m from RM110.5m (-12.7% QoQ) on the back of a higher base in 2Q18 (historical record), despite this GP margins improved by 0.2ppts QoQ to 26.9% on a more favourable product mix. Distribution costs (freighting) were lower QoQ (-21%) as Karex shifted towards the commercial segment in 3Q18. Despite this, core PATAMI of RM3.7m (-36.4% QoQ) came in lower, attributable to unfavourable forex movements.

YoY. Revenue grew 4.6% to RM96.5m on higher sales from sexual wellness (+3.1%) and medical segments (+20.8%). Despite this, EBITDA declined to RM5.4m (- 57.1%) attributed to a higher fixed costs, input costs (namely packaging and silicone oil) and an unfavourable forex environment. Consequently, EBITDA margin declined by 8.1ppts to 5.6% YoY.

YTD: Revenue of RM314.6m (+16.6% YoY) was achieved on the back of a stronger performance in the sexual wellness division (+18.5% YoY). GP margin declined to 26.5% (9M17: 32.4%) due to competitive pricing as well as unfavourable forex. EBITDA declined to RM21.4m (-46.4% YoY) attributed to higher distribution (+46.4%) and admin expenses (+18.8%) and input costs (silicone oil c. +200% YoY).

Margins to improve. Management guided that ASP’s have been revised across the board, with orders from March/April onwards reflective of the price adjustments. We expect the improved product mix will continue to buffer the weaker contributions from the tender segment. Management also guided that moving forward the group has started to quote their products FOB from CIF (where they had to absorb any swings in freight costs) previously. This should aid in normalizing freight costs moving forward.

Forecast. We revise our FY18-20 forecasts downward by 22-41% as we factor in an overall higher cost structure for the group moving forward.

Upgrade to HOLD, TP: RM0.51. Post earnings revision our TP reduces to RM0.51 (from RM0.93). Our valuation is based on CY19 EPS pegged to a P/E multiple of 24.1x (-1SD below mean). Despite the soft outlook, we feel that much of this has been reflected with the share price tumbling 69% YTD. As such, we are upgrading to a HOLD (from a Sell) on the back of (i) confirmed ASP revision and (ii) the implementation of margin improvement measures moving forward.

Source: Hong Leong Investment Bank Research - 1 Jun 2018