KAREX is expected to meet our RM25m net profit target for FY24, driven by strong sales in high-margin personal lubricants and a strategic shift to higher-margin segments. Furthermore, it is set to deliver its first synthetic condom order in November, which holds promise for significant growth, which we think sufficiently offsets concern on earnings drag from its underutilized glove segment. We keep our forecasts, TP of RM1.10 and OUTPERFORM call.

Remains solid. We anticipate that KAREX will deliver a decent 4QFY24 results, likely bringing full-year profit close to our RM25m estimate. The increasing contribution from high-margin personal lubricant products, now making up over 15% of group turnover (up from single digits last year), supports this positive outlook. Additionally, the company's strategic shift to higher-margin segments - specifically commercial (c. 20%-25%) and OBM (>50%) - from the lower-margin tender segment (7%-10%) is expected to further enhance margins going forward. The commercial, OBM, and tender segments contributed 61%, 19% and 20% to KAREX’s total turnover as of 9MFY24, compared to 59%, 17% and 24% in FY23, respectively.

On track to deliver maiden synthetic condom order. KAREX is on track to deliver its first synthetic condom order to an OEM client in November (2QFY25), targeting the European market for the Christmas season. If the product performs well, KAREX anticipates receiving additional and larger orders for FY26 delivery. Last month, the company received CE certification for these synthetic condoms, which are designed to be more heat-sensitive, thinner, and cost-efficient. While revenue contributions from this product in FY25 are expected to be modest, a more significant impact is projected for FY26 after the OEM client’s assessment of market demand. Based on preliminary estimates, this product could potentially generate approximately RM50m in sales should KAREX secure 3% of the OEM client's synthetic order.

A growing synthetic condom market. The global condom market was valued at USD8b in 2022, with a robust projected 10-year CAGR of 8%- 9%, according to various market research. Natural latex condoms dominate the market, holding 82.4% while synthetic condoms, valued at approximately USD1.4b, made up the remaining 17.6%. Durex holds a dominant position in the industry with a 35.6% market share, according to Osum market research. Demand for synthetic condoms, made from materials like polyisoprene, polyurethane and nitrile, has been growing particularly strong in North America, Europe, and Latin America, where people are more prone to latex allergies. Popular brands in this category include Durex Avanti Bare, SKYN, Trojan Supra, and Okamoto Zero One. These synthetic options are favored for their hypoallergenic properties and are gaining popularity as consumers increasingly seek alternatives to natural latex condoms.

The glove business segment continues to be a drag on KAREX's earnings. Since establishing production lines in 2020, the facilities have been underutilized due to global oversupply in the glove market. The group invested RM40m to set up two production lines and has incurred approximately RM8m annually in maintenance expenses (including depreciation and interest). This segment will likely continue to weigh on earnings unless utilization improves. However, the global glove sector's outlook is improving in the recent quarters, potentially offering modest growth opportunities for KAREX's glove segment (see overleaf for more details).

Forecasts. Maintained.

Valuations. We maintain our TP of RM1.10 based on an unchanged FY25F targeted PER of 25x, at a 20% premium to the average historical 5-year forward PER of its international peers to reflect its dominant market position and strong growth prospect. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Background of the medical glove venture. KAREX entered the medical glove manufacturing sector in 2020 and had invested RM40m to establish two production lines at its Hat Yai plant, which have a combined annual production capacity of 500m gloves. The rationales then were to: (i) enhance its tender order success rate and competitiveness by expanding its range of medical products, and (ii) meet the needs of its existing OEM partners, who were seeking more affordable and reliable medical products, such as gloves. However, the plan did not unfold as expected, as the global glove market became oversaturated with the entry of Chinese gloves, which drove down average selling prices. Consequently, KAREX has decided to adopt a cautious approach and wait for the right opportunity to re- enter the market.

Investment case. We continue to like KAREX for: (i) its leading market position and global reach in the rapidly growing condom industry, projected by industry experts at a CAGR of 8% to 9% over the immediate term, (ii) its strong R&D and product innovation; (iii) its adherence to international standards and certifications, (iv) its strategic shift in moving up higher the value chain, and (v) post-pandemic market recovery and changing consumer preferences, especially in markets like China, and growing preference for high quality innovative condom products. Maintain OUTPERFORM.

Risks to our call include: (i) reduced spending by governments around the world on birth control, (ii) lower acceptance rate for its new synthetic rubber condoms, (iii) less favourable product mix, and (iv) inability to raise prices to safeguard profit margins.

Source: Kenanga Research - 16 Aug 2024