Karex’s 1QFY19 Core PATAMI of RM2.2m (-50.7% YoY) was below ours and consensus expectation. The deviation is mainly due to timing issues resulting in delays of several large tender orders being booked in 1Q19. We adjust our FY19-20 forecast downward by 48-40% to better reflect the group’s lower operating leverage amidst a soft ASP environment and an overall higher cost structure moving forward. Maintain our SELL call with a lower TP of RM0.43. Our valuation is based on CY20 earnings pegged to an unchanged P/E multiple of 24.1x.

Below. 1QFY19 core PATAMI of RM2.2m (-50.7% YoY) came in below expectations, accounting for 12.8% and 14.7% of HLIB’s and consensus full year estimates. The results were below due to timing issues resulting in delays of several large tender orders being shipped out compounded by persistent softness in ASP.

QoQ. Revenue came in flattish at RM92.2m (from RM93.4m;-1.3% QoQ). GP margins showed an improvement of 1.5ppts QoQ (26.8% vs. 25.3%) on the back of a more favourable forex environment and improving ASP. Distribution costs (freighting) were higher QoQ (+15%) offset by flat admin expenses (+3%). Subsequently, core PATAMI of RM2.2m (+1.1% QoQ) came in flat in tandem with topline.

YoY. Revenue declined by 14.3% from RM107.6m dragged by the sexual wellness division which saw a sales declining by 15.9% YoY due to timing issues that resulted in several large tender orders from being shipped out in time for the close of 1QFY19. 2Q19 should reflect these sales, whilst adjusting for the timing differences, revenues would have been flattish YoY. This subsequently resulted in core PATAMI declining by 62.2% YoY.

Outlook. In FY19 we continue to expect Karex to continue to grow its exposure in the commercial and OBM segment to make up for the fluctuations from the tender segment.

Forecast. We adjust our FY19-20 forecast downward by 48-40% to better reflect the group’s lower operating leverage amidst a soft ASP environment and an overall higher cost structure moving forward. We introduce our FY21 numbers.

Maintain SELL, TP: RM0.43. Post earnings adjustment our TP decreases to RM0.43 (from RM0.51). We also take the opportunity to roll our valuation into CY20. Our valuation is based on CY20 earnings pegged to an unchanged P/E multiple of 24.1x. We maintain our SELL call. Whilst we are long term positive on its ambition to capture the huge upside in margin expansion from the OBM segment; near term prospects remain pressured by sticky ASP and persistent softness in the tender market.

Source: Hong Leong Investment Bank Research - 27 Nov 2018