Karex’s profit for 1QFY18E declined by 48% yoy to RM4.2m, which is below both our and consensus estimates, as it only constitutes to 9- 10% of FY18E forecasts. Although revenue grew by 34% yoy, due to stronger volume from the tender market, the gain was offset by the higher fixed cost related to its OBM market. As we believe that Karex’s OBM segment has yet to achieve critical mass, we are lowering our near-term revenue and margin assumption, which leads to a lower DCF-based TP of RM1.20. Maintain SELL.

Stronger Revenue But Not Reflective of Profitability

Despite achieving a record revenue of RM107m during the quarter, 1QFY18 was certainly not the best quarter for Karex, as its net profit was down by 48% yoy, but recovered from the low of RM2.9m (+46.3% qoq) in 4QFY17. Management indicated that the revenue growth was derived from higher sales volume from the tender market. However, the margin for the segment is still below its historical average, due to more competitive pricing as demand from the tender market remains weak.

OBM Expenses Remain High

Distribution and administrative costs remain high as Karex continues with its brand-building exercise with planned expansion into Singapore and Thailand by FY18. While management has guided that such expenses may plateau as it consolidates its advertising activities and aims for a more targeted distribution, we believe these costs remain disproportionately high in the short term relative to the additional revenue generated. The process to become a serious condom brand owner remains a painful transition for Karex, all while the tender market continues to be more competitive.

Lowering Our Forecast; TP Reduced to RM1.20 and Maintain SELL

Despite the higher sales volume, we believe that earnings growth for the year would likely be flattish, as lower product margin and higher fixed cost remain a challenge for Karex. Although we are still positive on the longterm outlook of Karex in transforming itself to become a competitive brand in the OBM market, the short-term earnings growth is expected to be volatile. We are cutting our revenue and margin assumptions, which lead to a lower DCF-based TP at RM1.20, but maintaining our SELL call.

Source: Affin Hwang Research - 27 Nov 2017