Good News Already Factored in

• Karex reported a strong set of results, as 1QFY21 PATAMI of RM4.5m (+212% qoq) is above both our and consensus estimates, at 38% and 43% of the respective forecasts
• The better performance was due to improved efficiency from a higher degree of automation and higher contribution from better-margin commercial sales
• We raise our earnings forecasts for FY21-23E by 21%-41% to factor in the new development, raise our P/BV-based 12-month TP to RM0.90, and upgrade our call to HOLD from SELL

Stronger commercial sales compensated for the decline in the tender market

We were expecting sales for the tender market to stabilise; however, as some ports in the African continent remain shut due to the current COVID-19 outbreak, sales for the tender market have contracted by 8.6% qoq in 1QFY21. Despite the decline in tender market sales, the 35% qoq increase in commercial sales was a positive surprise to us. Management guided that the improvement could have been led by both fulfilment of backlog orders and also higher demand from its clients. The commercial sales mainly focus on providing pharmacies, convenience stores and CVS with their home brands, and are higher margin compared to the sales for the tender market.

Higher Degree of Automation Drives Margin Higher

Apart from the favourable sales mix, Karex is starting to see benefits from a higher degree of automation installed at its production line over the past months. While Karex’s production processes are not fully automated yet, we believe that the packaging process is unlikely to be fully automated and will be the bottleneck for Karex. However, we believe it would be challenging for Karex to maintain the current EBITDA margin at 11.6%, as some of the sales in 1QFY21 were due to fulfilment of backlog orders. The higher commercial sales could also be due to retailers anticipating higher demand from lockdowns across the globe.

Upgrade to HOLD With a Higher TP of RM0.90

We raise our EPS forecasts for FY21-23E by 21%-41% to factor in the improvement in efficiency and higher demand from the commercial segment. We raise our TP to RM0.90 from RM0.50, based on 2.0x our FY21 BVPS estimate (from 1.0x previously). We also upgrade our call to HOLD from SELL, as we believe that the current share price already fully reflects the latest development (the venture into glove manufacturing). Risks to our call include: i) better-than-expected margin, and ii) higher-than-expected decline in tender orders.

Source: Affin Hwang Research - 24 Nov 2020