Karex's OEM partner, which is preparing for a significant launch of a synthetic condom, has increased its orders, we learnt, in anticipation of strong consumer demand. Expansion of synthetic condom production at its Hat Yai plant offers considerable earnings potential, thanks to the high margins of this product. Additionally, the growing demand for medical-grade lubricants supports the group's positive outlook on sales volumes, but we revise FY25-26F earnings lower by 12-4% after recalibrating for forex translation impact. As we also roll forward our base year from CY25 to FY26 on unchanged PER of 25x, taken together, our target price is raised slightly to RM1.16 (from RM1.12), and we maintain our OUTPERFORM call.

We came away from a meeting with KAREX and continued to feel positive of its long-term prospects. The key takeaways are as follows:

Waiting for a big launch. Karex is awaiting a major launch from its OEM partner, a global market leader, which is preparing to introduce a new synthetic condom designed to significantly enhance body heat transfer.

While this is not new information and this new condom has also yet to hit the shelves, we learnt that the partner wants to secure adequate inventory before launching. This resulted in Karex benefitting from increased orders, indicating the partner's strong confidence in robust consumer demand. The synthetic condom, made from lower-cost nitrile material, is expected to have a notable competitive advantage in pricing compared to natural condoms, which incur higher material costs by 30%-50%.

Ramping up synthetic condoms production. Karex is continuing to expand its synthetic condom production, with significant ramp-up plans underway. Currently, the group's Hat Yai plant operates three lines with a combined annual capacity of 75m pieces. However, the company plans to add approximately one new production line each month, reaching a total of six lines by June, which will increase annual production capacity to about 150m pieces (25m pieces per line). Looking further ahead, Karex intends to add an additional 10 lines, bringing the total number of lines to 16 by the end of 2025. This expansion will boost annual capacity to 400m pieces, representing around 6.7% of total production. Synthetic condoms are particularly lucrative for Karex, offering a high gross profit margin of over 50%, significantly surpassing the company's overall margin of 35%.

Rising demand for medical-grade lubricants. The group's lubricant segment is expected to continue contributing positively to Karex's growth, accounting for 17% of total sales in 1QFY25, up from 15% in FY24. This growth is primarily driven by an increase in private label orders, as awareness of the benefits of personal lubricant usage continues to rise.

Additionally, as a manufacturer of medical-grade personal lubricants, Karex continues to benefit from the US FDA ruling, which reclassified personal lubricants as medical devices rather than cosmetic products. Furthermore, Karex plans to expand its product offerings to include synthetic, silicone, and hybrid lubricants, positioning itself to capitalize on a growing market with diverse consumer needs.

Moderate recovery in forex. Karex recorded an unrealised forex loss of RM4m in 1QFY25 due to significant fluctuations in exchange rates, as the MYR strengthened against the USD from RM4.715 to RM4.121 in end- September 2024. Although the MYR has since weakened, closing at RM4.468 by the end of CY24, the losses suffered in 1QFY25 is unlikely to be fully reversed. Moving forward, we expect MYR likely to stabilise at its current level. Overseas profits denominated in USD are expected to translate into lower reported MYR earnings going forward versus our initial forex assumptions of RM4.70, against our latest assumption of RM4.50 for both the FY25 and FY26. This resulted in our earnings adjustment downward.

Outlook. Karex is well-positioned to secure high-value orders for condoms and personal lubricants, leveraging its strong industry reputation, diverse product range, and regulatory expertise. While the transition from tender to commercial markets may disrupt traditional sales channels in the short term, the Group sees promising medium-term growth opportunities. Furthermore, the increasing adoption of synthetic condoms in some markets presents a significant opportunity to expand its market share moving forward.

Forecasts. We lowered our FY25-26 net profit forecasts by 12-4%, following adjustments to our revenue and operating margin assumptions, which reflected a slower earnings growth from forex translation impact.

Valuations. We have raised our target price to RM1.16 (from RM1.12 previously), after rolling our valuation basis to FY26 (from CY25 previously), maintaining a targeted PER of 25x. This is at a 20% premium to the average historical 5-year forward PER of its international peers, reflecting Karex's dominant market position and strong growth prospects. No adjustments have been made to our target price based on ESG, given the company's 3-star rating as appraised by us (see Page 4).

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 - 27 Jan 2025