Despite turning profitable in 2QFY20, we believe overall results for 6MFY20 still disappointed, as 6MFY20 core loss of RM0.1m was significantly below consensus and our estimates. Consensus and Affin were forecasting PATAMI of RM2.3m and RM3.3m, respectively for FY20E. Although pricing in the tender market has started to improve, it is still not enough to compensate for higher labour costs. As such, we are cutting our EPS forecast for FY20-22E by 7.1-50.6% but maintain our DCF-based TP of RM0.25 unchanged. Reiterate SELL. Karex declared a 0.5 sen interim DPS, which was a positive surprise to us.

Potential Beneficiary of Covid-19

Competition in the tender market has been challenging over the past 2-3 years, due to competition from China manufacturers as they started participating in international contracts after the local government stopped procuring condoms. Management believes that competition has started to ease, as GP margin for tender orders improved (but still below historical average) in recent months. The recent supply disruption in China due to Covid-19 has also resulted in default of several tender orders by the China manufacturers. We believe the current situation could help to expedite the consolidation among the players, which can help to stabilise selling prices.

Guiding for a Better GP Margin

Management is guiding future GP margin to be at 25-26%, which is an improvement from the current 21.6% in 2QFY20. We believe the target is achievable only in FY21E, despite the recovery in tender selling price, as Karex is still burdened by the social compliance costs of around RM0.5m/quarter, which will only end in 3QFY20. Once the compensation is fully paid out, we expect a meaningful margin recovery in the following quarters. Karex has also launched its OBM (ONE) into new markets (Thailand, Vietnam and Singapore) recently, which is contributing positively to its margin.

Maintain SELL With An Unchanged TP of RM0.25

Although we expect an improving operating outlook, we are cutting our EPS forecast for FY20-22E by 7.1% to 50.6% to factor in our new margin assumptions. However, we keep our DCF-based TP unchanged at RM0.25 and reiterate our SELL call. Upside risks: better-than-expected recovery in tender orders; cost-effective distribution and marketing.

Source: Affin Hwang Research - 26 Feb 2020