Despite the recent share price correction by 24% post the release of its 1HFY18 results in end Feb, we are maintaining our SELL call on Karex, as we lower DCF-based TP of RM0.60 and cut our EPS for FY18-20E by 0.7-19%. We believe that current stock valuation is still too demanding in view of the high risk of earnings disappointment despite the recent downgrades.

Record Revenue Comes at a Cost

Although Karex was able to deliver record revenue in the recent quarter, driven by higher contribution from both the OBM segment and Tender segment, it was achieved by sacrificing on margins, as GP margin fell to 26.7%, significantly lower than the c. 31% it achieved historically. Despite forecasting revenue growth into FY19-20E, we still believe that margin will likely remain under pressure, as the tender market is likely to remain weak and more expenses is still needed as Karex expands into new markets.

Tender Market Still Facing Headwinds

Tender market demand will likely remain soft, despite the pledge by nations to increase their funding to AIDS organisations, as recent studies

have indicated that funding is already on a decline since 2014. We are expecting the trend to continue as the current US government has proposed a 6-18% cut in their funding, which currently contributes around 70% of the international funding. The increase in private donor funding in insufficient to compensate for the decline. Tender market is 38% of Karex revenue in the 1HFY18.

Expecting Too Much Too Soon. Maintain SELL With RM0.60 TP

Based on current consensus, Karex is now trading at 53x FY18E PER, which might seem reasonable given the 2-year (FY18-20E) earnings CAGR growth of 38%. But, we believe that consensus is too optimistic over a recovery, despite the earnings miss since 2016. Rather, we think that Karex will take a further 3-5 years before its earnings recover to its FY16 level. As such we are maintaining our SELL call with a lower DCF based TP of RM0.60.

Source: Affin Hwang Research - 10 Apr 2018