Karex reported a very weak set of results, with FY19 PATAMI of RM2.53m (-75% yoy). This is significantly below both consensus and our estimates, delivering only 48% and 59% of our respective forecast. The losses of RM1m in 4QFY19 was a negative surprise to us, as Karex’s profitability were negatively impacted by both the lower sales volume and the increase in compliance cost to achieve international standard for fair labour practices. As the compliance cost is expected to continue, we are cutting our EPS for FY20-21E by 8.7%-9.2%, but maintaining our DCF-based TP unchanged at RM 0.30. Maintain SELL.

Volume Have Yet to Recover Since the Allegation

We believe that Karex’s sales during the 4QFY19 continued to be negatively affected by the allegation of the mistreatment of its workers, as the independent audits was only completed recently. Although some of the buyers have started repurchasing, some of its major clients have not yet to complete their internal social audits on Karex. As such, we believe that it would take Karex at least another 6-12 months to recover from the loss in sales. Karex also sponsored some of its clients’ audit to help speed up the review process.

Declining Profits, But Cash Flow Improved

To address the problem highlighted in the social audit by an independent consultancy firm, Karex make several changes to its remuneration and improved the accommodation of its migrant workers. As overall labour will continue to increase, Karex is aiming to reduce its labour dependency by 50% within the next 3-years. Despite the lower profitability during the quarter, the net cash has increased to RM30m from RM9m in 1QFY19. The improvement is due to the implementation of new credit controls since last quarter which has successfully reduced its trade receivables.

Maintain SELL With Anunchanged TP of RM0.30

We have cut our EPS forecast for FY20-21E by 8.7%-9.2%, as we believe that sales volume would take at least 6-12 months to recover, while overall margins are also likely to be negatively impacted by the lower operating leverage and higher compliance cost. We have maintained our DCF-based TP at RM0.30 and our SELL call unchanged. There could be downside risk to our forecast, if retailers of its OBM product also suspend their orders.

E

Source: Affin Hwang Research - 29 Aug 2019