KAREX’s FY24 results and dividends exceeded our forecast, with net profit more than doubling, driven by strong margins on improved product mix. Its outlook remains positive, supported by the roll-out of high-margin synthetic products and increased contributions from personal lubricant. We lowered our FY25F net profit by 5% amid reduced exposure from the tender market, and gestation period for new products. Introducing our FY26 forecasts, we raised our TP by 2% from RM1.10 to RM1.12 (on calendarised FY25 earnings) and maintain our OUTPERFORM call.

KAREX's FY24 core net profit of RM27.6m exceeded our expectations by 11% (no consensus estimates available due to lack of coverage), driven by a better-than-expected product mix and stabilized input costs, which boosted margins. It declared a surprise 0.5 sen dividend, bringing the full-year DPS to 1.5 sen (compared to our estimate of 1.0 sen), translating to a payout ratio of 67% (against its policy of at least 25%).

YoY, FY24 revenue declined by 5%, mainly due to weakness in the tender market, partially offset by strong demand for personal lubricants. This shift reflects KAREX's strategic move to reduce exposure from the less stable and less profitable tender market, largely funded by humanitarian aid programs. Despite the revenue decline, profitability improved, with gross profit margin rising to 33.7% from 25.5% a year ago, supported by stabilized input costs, better product mix and a 39% increase in high-margin (>50%) personal lubricant sales to RM76m (accounted for 15% of the group’s total sales vs. 10% a year ago). This growth was driven by new FDA regulations reclassifying personal lubricants as medical devices. A one-off, post- tax impairment provision of RM4.2m related to the glove facility was recorded in 4Q. Excluding this exceptional item, core net profit surged 164% to RM27.6m.

QoQ, 4QFY24 revenue declined by 3% due to lower condom sales in the tender market, partially offset by higher personal lubricant sales.This led to a higher proportion of commercial market sales, improving gross profit margin to 35.3% from 33.7% in the previous quarter.However, the glove facility provision of impairment resulted in a 37% decrease in PBT and a 20% decrease in PAT.

Outlook. KAREX expects to secure high-value orders for condoms and personal lubricants by leveraging its strong industry reputation, diverse product range, and regulatory expertise. While the shift between tender and commercial markets may disrupt traditional sales channels in the short term, the Group sees medium-term growth opportunities. Additionally, the move toward synthetic condoms in some markets, with maiden delivery in November 2024 presents a significant opportunity to expand market share moving forward.

Forecasts. We have reduced our FY25F net profit by 5% to account for lower sales in the tender market and gestation period for new synthetic products. Additionally, we introduce our FY26 forecast, expecting the group to achieve a net profit of RM51m, driven by a continued favorable product mix and higher gross profit margin.

Valuations. We raise our TP by 2% to RM1.12 (from RM1.10) based on blended CY25 EPS (previously FY25 EPS) with an unchanged targeted PER of 25x. This represents a 20% premium to the average historical 5-year forward PER of its international peers to reflect its dominant market position and strong growth prospects. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Background of its medical nitrile glove venture. KAREX entered the medical glove manufacturing sector in 2020 and had invested RM29.3m 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 The glove business has incurred RM7.8m annually in idle expenses, primarily from depreciation and interest on borrowings. As at the end of FY24, the glove facility has a net book value of RM20.7m after a RM5.2m provision.

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 government around the world on birth control, (ii) underwhelming response to its new synthetic rubber condoms, (iii) a less favourable product mix, and (iv) inability to raise prices to defend profit margins.

Source: Kenanga Research - 26 Aug 2024