Karex’s 2QFY20 core PATMI of RM1.6m brought 1HFY20 core PATMI of RM0.7m came above expectations. The deviation was mainly due to higher than expected revenue contribution from recovery of condom sales. We adjust our earnings forecasts of FY20 to RM1.6m (from RM0.2m), FY21 to RM2.8m (from RM0.7m) and FY22 to RM7.0m (from RM6.4m) to reflect the improvement in margins following no more social compliance payments after 3QFY20. Maintain our SELL call with unchanged TP RM0.36. Our valuation is based on 0.75x FY21 BVPS of 49.2 sen (-1.25SD below its 2 year mean).

Above expectations. 2QFY20 core PATMI of RM1.6m (vs. -RM0.9m QoQ, -34.6% YoY) brought 1HFY20 core PATMI of RM0.7m (-85.3% YoY). Core PATMI was derived after adjusting for net EI of -RM0.7m on unrealised foreign exchange gain and provision on receivables. The results were above expectations due to improved sales for Sexual Wellness (+13.9% QoQ) and Medical (+20.2% QoQ) segments.

Dividend. Declared single interim dividend of 0.5 sen, going ex on 10th March 2020.

QoQ. Revenue improved to RM109.1m (from RM95.7m; +14.0% QoQ) thanks to higher contributions from Sexual Wellness (+13.9% QoQ) and Medical (+20.2% QoQ) segments. Lower latex prices during the quarter also aided in the improvement of gross profit (+17.3% QoQ). This then lead to Karex returning to black with core PATMI of RM1.6m (vs. -RM0.9m in 1QFY20).

YoY. Revenue fell by -3.9% due to lower contribution from the Sexual Wellness segment (-4.5% YoY) which was affected by reduced orders from the Tender and Commercial segments, however this was slightly cushioned by improvements in other segments (+12.2% YoY). Even though raw material cost eased, the ongoing social compliance costs continued to exert pressure on profitability, which resulted to a core PATMI of RM1.6m (-34.6% YoY).

YTD. Revenue of RM204.8m was flattish (-0.4% YoY) mainly supported by the Sexual Wellness segment. Profitability was held back by less favourable sales coupled with the ongoing social compliance payments. Hence, a core PATMI decline of RM0.7m (- 85.3% YoY) from RM4.7m (1HFY19).

Outlook. The global condom industry is expected to remain challenging with shifting trends in condom purchasing patterns, uncertainty surrounding humanitarian aid budgets around the world, rising costs for raw material as well as social compliance. Karex will continue to leverage on cost advantages via the implementation of automation (currently c. 40%) and persisting with the investment into Own Brand segment. Furthermore we understand that 3QFY20 would be the final quarter that Karex would be making social compliance payment, hence beyond that, earnings should improve. Other than that, with the COVID-19, we feel Karex would benefit with the transition of orders from China to Malaysia’s condom makers.

Forecast. We tweak our earnings forecast of FY20 to RM1.6m (from RM0.2m), FY21 to RM2.8m (from RM0.7m) and FY22 to RM7.0m (from RM6.4m) to reflect the improvement in margins following the completion of social compliance payment in 3QFY20.

Maintain SELL, TP: RM0.36. Although Karex showed a meagre improvement in this quarter, we remain cautious because their margins remains at historic lows, whilst near term prospects remain pressured by sticky ASP as well as expected social compliance costs in 3QFY20. We maintain our SELL call. Our TP is a function of 0.75x FY21 BVPS of 49.2 sen (-1.25SD below its 2 year mean).

Source: Hong Leong Investment Bank Research - 26 Feb 2020