Karex’s 1H19 core PATAMI of RM4.7m (-50.2% YoY) was below ours and consensus expectation. The deviations in the results are mainly due to less favourable product mix skewed towards tender segment and more competitive ASP. We adjust our FY19-21 forecast downward by 20%, 16% and 15% to better reflect the group’s lower operating leverage amidst a soft ASP environment and market share growth driven policy. Maintain our SELL call with a lower TP of RM0.37.

Below. 1H19 core PATAMI of RM4.7m (-50.7% YoY) came in below expectations, accounting for 37.6% and 35.8% of HLIB’s and consensus full year estimates. The results were below due to less favourable product mix in 2Q19.

QoQ. Revenue grew 23.2% QoQ to RM113.6m (from RM92.2m). GP margin declined by 5.4ppts QoQ (21.4% vs. 26.8%) on the back of a less favourable product mix and pressured ASP from the tender segment. Distribution costs (freighting) were flattish QoQ (-3%) offset by higher admin expenses (+6%). This resulted in core PATAMI of RM2.4m (+9.6% QoQ).

YoY. Revenue grew by 2.7% to RM113.6m driven by the sexual wellness division which saw a sales improving by 1.7% YoY due to more tender orders from being shipped out in 2Q19. The less favourable sales mix resulted in lower margins which subsequently resulted in core PATAMI declining by 49.7% YoY.

YTD. Revenue declined by 5.7% YoY due to lower contributions from the sexual wellness division (-7% YoY) driven namely by ASP’s. Despite the group being able to contain its costs, the unfavourable ASP environment continues to drag earnings, resulting in core PATAMI declining by -50.2% YoY to RM4.7m (from RM9.4m).

Outlook. In FY19 we expect Karex to continue to grow its exposure in the commercial and OBM segment to make up for the fluctuations from the tender segment. In light of the foreign worker issues, we understand that some orders from the UK have been suspended pending an audit by their distributors. We understand that Karex is working hard to remedy this negative perception and expects sales to continue nonetheless. We thus can expect a slower 3Q19 as a result. On that note, the global condom industry is still in consolidation mode and Karex is focused on growing its market share in the near term.

Forecast. We adjust out FY19-21 earnings downward by -20%,-16%,-15% as we account for a lower GP margin from the tender segment.

Maintain SELL, TP: RM0.37. Post earnings revision our TP reduces to RM.037 (from RM0.43). Our valuation is based on CY20 earnings pegged to a P/E multiple of 24.1x. Near term prospects remain pressured by sticky ASP and volatilities in the tender market.

Source: Hong Leong Investment Bank Research - 26 Feb 2019