Karex reported a very weak set of results, 1QFY19 PATAMI of RM2.0m (-53% yoy; +36% qoq) which fell short of both our and consensus expectations, delivering only 13% of our respective forecast. Although management guided that the weak performance was due to delays in shipping several of the tender orders, we believe that the demand for tender market remains lacklustre. As such we are cutting our FY19- 21E earnings by 1.2% - 16.9%, while maintaining our DCF based TP of RM0.40 and SELL call unchanged.

Better Qoq Earnings Mainly Due to Lower Tax

Although PATAMI for 1QFY19 grew by 36% qoq, we believe that it is not an indicator that profitability of Karex has bottomed up, as PBT for the quarter is still down by 14% qoq. While GP margin for Karex has recovered from the low of 25.3% in 4QFY18 to 26.8% in 1QFY19, management has attributed this to the strengthening of USD against RM. Certainly, it would be beneficial for Karex if the USD/RM would remain at the current level, but the margin is unsustainable if the currency moves against Karex favour.

Delays in Shipment for Tender Orders Put Pressure on Profitability

Management guided that the performance for the quarter could have been better if not for the delay in shipment for some of its tender orders, which we believe amounted to around RM10-15m. Based on our estimates, assuming that the orders were fulfilled during the 1QFY19, we believe that earnings would be uplifted by around 5%-8%, which is still insufficient to reverse the current yoy decline in profitability. Management would need to grow revenue more aggressively to deliver sustainable earnings growth.

Maintain SELL With An Unchanged TP of RM 0.40

While the long-term outlook of Karex venturing into OBM remains attractive, we believe that the short-term outlook of Karex remains challenging due to weak demand from the tender market and also the elevated cost from the OBM segment. We have cut our FY19-20E earnings by 1.2%-16.9% to factor in the current quarter performance, while maintaining our SELL call and DCF-based TP unchanged at RM 0.40.

Risks to our call

Upside risks: better-than-expected recovery in tender orders; cost-effective distribution and marketing

Source: Affin Hwang Research - 27 Nov 2018