We expect earnings to recover vs FY20 lows from (i) sales shift back to the lucrative OBM channel and (ii) commencement of glove manufacturing. After factoring additional earnings from Karex’s glove venture, we increase our FY22/23 forecasts by 26.8%/22.1%. Our TP of RM1.19 (pegged to -0.25 SD 5 year average P/B) of 2.42) remains unchanged. Maintain BUY, we like Karex for its earnings recovery outlook.

We met with Karex recently and came away feeling positive on the group’s prospects going forward.

Price recovery accompanied by higher costs. Since condom selling prices fell by c. 30-40% (since FY17), Karex claimed prices have nearly fully recovered. Karex shared they have incurred higher costs in FY21, from (i) raw material costs which have risen considerably (Figure #1), (ii) freight costs which have more than tripled and (iii) spending incurred to curb the spread of Covid-19 (testing and other measures). However, we gathered Karex was able to pass on the higher costs to customers due to the overall lower market supply, as a number of smaller players in the market saw operational difficulties during the pandemic or have exited the market altogether.

Glove venture on track. Karex is on track to begin production of medical gloves in July-21, with two production lines expected to produce up to 40m pieces per month by Aug-21. Note that our glove FY22/23 ASP assumptions for Karex of USD35/27 are below other glove counters under our coverage as we reckon Karex may not be able to achieve the pricing of their established counterparts, considering they are a new entrant into the industry (Figure #2).

Vaccine roll out in USA and UK should lead to rebound in OBM sales. To recap, Karex’s sales to the OBM market shrank to 10% of sexual wellness sales in 2QFY21 (from 18% in FY20). Karex attributed this to lesser sales to the US (due to universities going online during the pandemic leading to lesser distribution of condoms on campuses and dormitories) and the UK (National Health Service clinics shutting down due to various lockdown measures). With the roll out vaccines in the US (20.6% of the population vaccinated) and UK (34.9% of the population vaccinated) gaining traction, we expect OBM sales to rebound in FY22.

Long-term OBM sales growth strategy. Karex intend to grow their OBM sales in South East Asia as economic development would shift sales in these regions from tender to OEM/OBM. Note that currently, a high proportion of condom sales in developing SEA nations (Philippines, Indonesia) are purchased by NGOs and organisations (tender market) to be distributed for free in order to curb the spread of sexually transmitted diseases. As these countries modernise, funding for these organisations are expected to be reduced, which would in turn lead to consumers buying condoms on the commercial market independently. This would shift sales from the tender channel to OEM or OBM. Note that gross profit margins are significantly better in for OEM (~20%) and OBM (>45%) compared to tender (10-12%).

Forecast. After factoring additional earnings from Karex’s glove venture, we increase our FY22/23 forecasts by 26.8%/22.1% but keep our FY21 forecasts unchanged as glove production is only expected to begin in FY22.

Maintain BUY, TP: RM1.19. Our TP of RM1.19 (pegged to -0.25SD to 5-year average P/B of 2.42x) remains unchanged. Despite raising our forecasts, we decided to keep our TP and PB valuation methodology as FY21 core PATMI of RM13.6m still remains far below Karex’s FY16’s peak earnings of RM80.2m. Still, we continue to like Karex for its earnings recovery outlook.

Source: Hong Leong Investment Bank Research - 16 Mar 2021