Karex’s FY18 PATAMI of RM10.1m (-63.8% yoy) came in below both our and consensus expectations, constituting only 89% and 80% of our respective forecasts. Management pointed out that this was due to the decrease in government condom procurement and distribution programs and the constantly rising raw material costs. Despite the increase in revenue on a yoy basis (12.9%), this was not due to higher sales volume but an increase in sales of higher ASP products. In light of this, we maintain our SELL rating with our DCF-based TP of RM0.40.

Lower Revenue Qoq; With Unsustainable Higher Profit

Karex’s revenue was slightly lower qoq due to the slight drag on the tender segment. The reasoning behind the drop was due to the various government ending their free condoms programs, which caused a dip in procurement. Despite registering a slightly higher profit, we surmise that this is due to the OBM segment’s shift in focus on their higher margin products. The decline in distribution cost was due to the overall lower OBM volume. But costs will remain at elevated levels, as management guided cost to be at 20-22% of revenue. The need to grow the OBM segment remains important to combat the weakness in the tender segment.

Higher Cost Hurting Profits

On a yoy basis, Karex’s cost has been steadily increasing as the raw materials associated with oil prices has seen a steady increase over the years. Silicon, which is a condom’s main raw material, has seen an increase from USD2.50 per kg to USD7.00 per kg over the past 3 years. With the various factors causing currency fluctuations, we expect earnings to remain weak in the next quarter..

Reiterate SELL; TP Maintained at RM0.40

We leave our forecast unchanged at this juncture and introduce FY21E forecasts. We have maintained our DCF-based 12-month TP at RM0.40 and we maintain our SELL call on Karex. Assuming that Karex’s fair valuation is at 20x PER (long-term average for the glove sector), investors would be paying for earnings 3 years ahead, hence we believe that the current valuation is lofty. Upside risks: better-than-expected recovery in tender orders; cost-effective distribution and marketing.

Source: Affin Hwang Research - 29 Aug 2018