· The world’s largest… Many investors came to know of KAREX as the world’s largest condom manufacturer when it was listed on the Main Market of Bursa Malaysia in November 2013. Beside manufacturing and distributing condoms, a small portion of KAREX’s revenue is derived from the distribution of lubricants as well as other plastic products such as catheters and probe covers. As the world’s largest condom manufacturer, KAREX has the capacity to produce 4.0bn pieces of condom/year as of end-2014.

· …but still expanding. KAREX's annual capacity will be further expanded to 5.0bn condoms by end-2015. We understand that the Group aims to expand annual production capacity to 7.0b condoms by 2017 (implying a CAGR of 20.5% from 2014). In addition, the Group had on 13 October 2015 acquired Medical- Latex (Dua) Sdn Bhd (MLD) from Beiersdorf AG which will provide expansion leverage for the Group’s Original Brand Manufacturing market segment. The acquisition will grant the Group ownership of MLD’s in-house brands with a growing popularity in Malaysia and Singapore, namely the ESP and N’JOY brands. Through MLD, KAREX has also been granted the right of first refusal to acquire Beiersdorf AG’s ‘DUO’ and “HARMONY’ condom brands. The Group also acquired Global Protection Corporation in October 2014, allowing KAREX to tap into the regional popularity and distribution of the ‘ONE’ condom brand.

· Enjoying the perks of strengthening USD and declining cost of latex. KAREX exports condoms to a range of non-Asian countries in America, Europe and Africa which makes up 69% of its total end-Jun15 (or end-FY15) revenue. This enables the Group to benefit from the progressive weakening of the MYR during the past few months. Based on its FY14 Annual Report, the management believes that a 10% weakening of MYR/USD will increase net profit by RM3.3m from RM34.6m (or +9.6%). In addition, the decline in global latex prices proved advantageous to the Group. FY15 saw the average price of latex settling at 425.9 sen/kg as opposed to 502.5 sen/kg in FY14 (as indicated by the Malaysian Rubber Board).

· Growing steadily. As of end-FY15, the Group demonstrated an increase in revenue by 14.8% QoQ to RM78.9m while the revenue grew by 35.3% YoY to RM297.4m. Condoms remain the primary revenue contributor in FY15 at 92% of total revenue, slightly lesser than its 93% share in FY14 with the growing demand of catheters, probe covers and lubricants. YoY, the Group’s plant utilisation rate fell to 73.7% of its 4.0bn condoms/year capacity from 75.4%, below the 3-year average of 76.7%. The lower capacity utilisation was in line with lower capacity utilisation in 2H15 (71.0%) (vs. 76.4% in 1H15). We understand that the lower utilisation rate in 2H15 was due to: (i) the increase in sales to commercial market (as opposed to tender market) and (ii) the higher production capacity after expansion. However, cushioned by the weaker MYR and lower raw material costs, KAREX is still able to grow its net profit by 13.8% QoQ in 4Q15 or 73.7% YoY in end-FY15 to RM15.2m and RM60.1m, respectively. In FY15, gross margin, PBT margin and net margin hit 33.0%, 24.8% and 20.2% as opposed to 29.1%, 18.9% and 15.7% in FY14, respectively.

· In the coming years, we project the Group’s end-FY16 and end-FY17 revenue to stand at RM407.4m and RM527.0m, implying an average 2-year growth of >30%. This is in line with the assumptions that the management realises its FY17 production capacity goal of 7.0bn condoms/year and a consistent utilisation rate of 72.5%. We also estimate that the Group requires RM50.0m capex each year to achieve this milestone. Nonetheless, given KAREX’s strong profitability and cash balances, we believe that the Group is still likely to maintain its net cash position throughout.

· Not Rated. KAREX is trading at FY16E and FY17E PERs of 29.4x and 24.9x. These valuations are higher than the average FY16E PER of the Healthcare and Glove sectors. Hence, we believe the above-mentioned positive factors could have been priced-in until we see significant earnings/price catalysts. Coupled with an unattractive dividend yield of <1% for the near future, assuming the management continues to allocate funds for expansion purposes, we reckon that the stock could have already been fair valued at this level, hence our “Not Rated” call. Nonetheless, should KAREX trade at the highest FY16E PER among the Healthcare and Gloves stocks of 33.6x, which is inline with its 2-year historical average PER, it can potentially be valued at RM3.80 on the back of our FY16E EPS estimate of 11.3 sen. 

Source: Kenanga Research - 15 Oct 2015