Karex’s 1QFY20 core loss of -RM0.3m was below ours and consensus expectation. The deviation was mainly due to high raw material prices. Revenue improved (+3.9% YoY) on stronger sales from the Commercial and Own Brand segments. Higher raw material prices and ongoing social compliance resulted to core loss of -RM0.3m. We adjust our FY20-21 forecast downward by 95-90% to better reflect the group’s overall higher cost structure moving forward. Maintain our SELL call with unchanged TP RM0.36. Our valuation is based on 0.75x FY20 BVPS of 48.9 sen (-1.25 SD below its 2 year mean).

Below expectations. 1QFY20 revenue of RM95.7m (+7.4% QoQ, +3.9% YoY) trickled down to a core loss of -RM0.3m (4QFY19: -RM1.6m, 1QFY19: RM2.2m). The results were below expectations mainly due to high raw material prices.

QoQ. Revenue improved to RM95.7m (from RM89.1m; +7.4% QoQ) on the back of higher condom sales volume from both Commercial and Tender markets. COGS increased by 8.2% from higher raw material prices and ongoing payment of social compliance costs; this hurt earnings to core loss of -RM0.3m (4QFY19: -RM1.6m).

YoY. Revenue increased by +3.9% due to better contribution from the Sexual Wellness segment (+5.1% YoY) thanks to stronger condom sales from the Commercial and Own Brand segments. Increase in COGS (+12% YoY) with higher raw material prices and the ongoing social compliance costs continued to exert pressure on profitability, which resulted to swinging to red of -RM0.3m (1QFY19: RM2.2m).

Outlook. The global condom industry is expected to remain challenging with shifting trends in condom purchasing patterns and uncertainty surrounding humanitarian aid budgets around the world. Furthermore, rising costs for raw material and more importantly, social compliance will continue to affect profitability in the near term.

Forecast. Post earnings revision we reduce our FY20-21 earnings forecast downward by -95% and -90% (effect of low base cutting) to reflect the higher raw material prices moving forward. We introduce our FY22 numbers.

Maintain SELL, TP: RM0.36. While we remain long term positive on Karex’s ambition to capture the huge upside in margin expansion from the Own Brand segment; near term prospects remain pressured by sticky ASP, volatilities in the tender market and social compliance costs. Maintain our SELL call. Our TP is a function of 0.75x FY20 BVPS of 48.9 sen (-1.25SD below its 2 year mean).

Source: Hong Leong Investment Bank Research - 5 Dec 2019