KAREX is rapidly expanding its synthetic condom production, with first shipments already dispatched to Europe and plans underway to significantly scale up capacity. The strategic partnership with an OEM client and entry into high-potential markets position KAREX to capitalize on the growing demand for synthetic condoms, which offer great margins. While this segment currently contributes modestly to overall production, its high margins and growth prospects bode well for future earnings. We maintain our forecasts, TP of RM1.12 and OUTPERFORM call.

We came away from a recent visit to KAREX's manufacturing plant in Hat Yai, Thailand, feeling positive of its long-term prospects. The key takeaways are as follows:

1. Expansion of Synthetic Condoms Production. KAREX is ramping up its synthetic condom production. Currently, the Hat Yai plant is operating two lines with a combined annual capacity of 50m pieces, while a third line is expected to commence by the end of November, with further plans to add one new line each month, reaching a total of six lines at the Hat Yai site. This expansion will increase the annual production capacity to approximately 150m pieces (25m pieces per line). Even further ahead, KAREX is planning to add 10 additional lines, bringing total lines to 16 by end of 2025, which could boost total capacity to 400m pieces annually, about 6.7% of total production. Synthetic condoms offer a high gross profit margin of over 50%, as guided by the management, which is significantly above the company's overall margin of 35%. Although synthetic condoms currently contribute less than 5% of total production, this expansion is expected to enhance profitability and drive future earnings growth.
2. Strategic Partnership and Market Expansion. KAREX has an exclusive two-year partnership with a prominent OEM client, recognized globally as a market leader with a strong international presence which is committed to a substantial marketing investment to promote KAREX's new synthetic condoms. The first shipments have already been sent to key European markets, including France, Belgium, Germany, the Netherlands, and Luxembourg, with shipments to the United States expected around April 2025. After one year, i.e. by end of 2025, KAREX will have the clearance to sell the product under its own brand name, creating additional revenue streams. Positioned as a premium offering, this patented synthetic product is expected to be competitively priced within the premium segment (currently priced around RM60 for 10 pieces).
3. Navigating Financial Headwinds from Currency Fluctuations and Wage Increases. The recent strengthening of the MYR against the USD is expected to have a short-term impact on KAREX's financial performance, as overseas profits denominated in USD will translate into fewer MYR, reducing reported revenue and earnings.

Additionally, the increase in Malaysia's minimum wage from RM1,500 to RM1,700 will add approximately RM1m to quarterly labour costs, considering KAREX employs around 1,500 workers in Malaysia, while the workers in Thailand won't be affected by the adjustment. Despite these challenges, the company does not expect any further impairments provision related to its glove business in the coming quarter and is exploring cost mitigation strategies, including operational efficiencies. From our understanding, cost of production in Hat Yai is considered lower than its Malaysia plant due to lower tax and cheaper land.

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 presents a significant opportunity to expand market share moving forward.

Forecasts. Maintained.

Valuations. We maintain our TP of RM1.12 based on an unchanged CY25F 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 6).

Background of KAREX's Synthetic Condom. KAREX entered the synthetic condom market with recent FDA and European CE approvals, enabling it to distribute these products across key regions. The synthetic condom segment, valued at approximately USD1.4b and accounting for 17.6% of the global USD8b condom industry, is growing rapidly, driven by the demand for latex-free alternatives in North America, Latin America, and Europe, where the populations are more prone to latex allergies. Popular synthetic condoms in the current market include Durex Avanti Bare, SKYN, Trojan Supra, and Okamoto Zero One. Unlike competitors using materials like polyurethane (PU) and polyisoprene (PI), KAREX's synthetic product is made from a new unique blend, cost-effective material, marking it as the first and only material of its kind on the market, with higher margins.

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 - 5 Nov 2024