Karex, set to list on Bursa Malaysia’s Main Market on 6 Nov with a MYR500.0m market cap, is the world’s single largest condom manufacturer. Investors can subscribe to the stock, for which we expect earnings to bounce by a solid CAGR of 28.3% for FY13-15F, driven by a doubling in capacity as well as the growth in the tender market. We initiate coverage with a BUY call and MYR2.59 TP, pegged to a 16.0x CY14 P/E.

- Production capacity to double to 6bn pieces by 2015. Come 2015, Karex’s effective production capacity will double to 6bn pieces following the completion of its new manufacturing plant in Pontian, Johor, along with the capacity extension of its plants in Port Klang (Malaysia) and Hat Yai, Thailand. This will solidify Karex’s position as the world’s largest condom maker, as well as widen the gap between the company and its closest global competitor, Thai Nippon Rubber Industry Co Ltd, by 2.0bn pieces.

- More growth opportunities in tender market. Due to limited government funding for family planning in some developing countries, organisations such as the United Nations Population Fund (UNFPA) and United States Agency for Development (USAID) have started programmes to distribute condoms free of charge or at subsidised cost. This would likely benefit Karex as UNFPA and USAID are established customers. We also expect more potential contracts in the pipeline.

- Core FY13–15F earnings CAGR of 28.3%. We forecast revenue to reach MYR289m in FY14F from MYR339m in FY15F. Given the better economies of scale and an improving customer mix, we expect the company’s net margin to widen to 13.6% in FY14F from 12.5% in FY13. We forecast core earnings of MYR39.5m and MYR47.8m for FY14F and FY15F respectively.

- Initiate coverage and subscribe, with a 40.0% upside. We value Karex at MYR2.59 per share, based on a target 16.0x CY14 P/E. Although this is at a 11.9% premium over the rubber glove industry’s average P/E of 14.3x, we believe this is justified given the stock’s lower implied PEG of 0.35x, underpinned by a solid FY13–FY15F 2-year net profit CAGR of 28.3% vs rubber glove companies’ average PEG of about 1.2x. We consider our 16.0x CY14 P/E as being in line with our rubber glove players’ target P/E of 15.8x. In view of the 40.0% upside, we are recommending that investors subscribe for the stock. We initiate coverage on Karex with a BUY recommendation.

Executive Summary

Production capacity to double by 2015. Come 2015, Karex’s effective production capacity will double to 6bn pieces following the completion of its new plant in Pontian, Johor, along with the capacity extension to its plants in Port Klang (Malaysia) and Hat Yai, Thailand. This will further solidify its position as the world’s largest condom manufacturer, as well as widen the gap between the company and its closest global competitor, Thai Nippon Rubber Industry Co Ltd, by 2.0bn pieces.

Tapping into new OBM markets. Karex aims to increase the market share of its own brand nameCarex. According to its management, there is plenty of untapped potential in South-East Asia, including Thailand, Vietnam, Indonesia, and the Philippines. The own-brand manufacturer (OBM) market only constituted around 4% of Karex’s FY13 revenue, which means that there is room for growth. With its extensive distribution networks covering over 110 countries, we expect the higher OBM market revenue to lift margins given the better pricing in this market vs that for contract manufacturing.

Established pre-qualified manufacturer. Given the stringent standards in the condom manufacturing industry, manufacturers are subject to strict compliance with industry-specific certifications and regulations. Karex has been a pre-qualified manufacturer for multilateral and bilateral organisations such as Population Services International (PSI), UNFPA, John Snow Inc (JSI) and Crown Agents since 1994. The group has a strong competitive advantage over its peers as it is accredited in 110 countries, in view of the high cost and time consumption in obtaining new accreditation. 

Long-standing relationships with customers. Global condom manufacturers operate on a contract manufacturing basis. Karex has managed to maintain long-standing business relationships with its customers - the longest being 19 years with PSI. For the last three years, its major customers - Crown Agents and PSI/USAID - contributed on average 21% of total revenue. This helps to secure a relatively consistent flow of income and provide the company with a steady stream of cash.

More opportunities for growth in the tender market. Due to limited government funding for family planning in some developing countries, organisations such as UNFPA and USAID have started condom promotion programmes to distribute condoms free of charge or at a subsidised cost. This would likely benefit Karex as UNFPA and USAID are established customers, and we expect to see more potential contracts in the pipeline.

Core FY13–15F earnings CAGR of 28.3%. We forecast revenue to reach MYR289m in FY14F from MYR339m in FY15F. Given better economies of scale and an improving customer mix, we expect net margins to widen from 12.5% in FY13 to 13.6% in FY14F. Our core earnings forecasts are MYR39.5m and MYR47.8m for FY14F and FY15F respectively.

Valuation Summary

Peer comparison. In the absence of a direct comparable locally-listed peer, we draw on the similarities between Karex and the major glove companies in Malaysia, ie Top Glove (TOPG MK, NEUTRAL, FV: MY6.34), Hartalega (HART MK, BUY, FV: MYR7.95), Kossan (KRI MK, BUY, FV: MYR7.53) and Supermax (SUCB MK, BUY, FV: MYR3.01). Also, we make a brief comparison with its globally-listed condom manufacturing peers; however, these peers are also involved in other businesses.

Part of the healthcare sub-segment. Given that both rubber gloves and condoms are classified under the healthcare sub-segment, we believe that it is appropriate to compare Karex with its peers in the rubber glove industry. The medical devices industry is being promoted as one of the growth areas by the Malaysian Government under the Third Industrial Master Plan 2006–2020 and is dominated by the production of rubber-based products. We believe that the industry would continue to grow in line with the Government’s efforts to improve healthcare facilities, together with the increasing global demand for better healthcare products and standards.

Similar manufacturing structure to rubber gloves. The production lines of both rubber gloves and condoms are similar apart from the use of different moulds, with condoms using glass cylinders as opposed to rubber gloves, which are produced using hand moulds. In addition, latex is also the common raw material for both condoms and rubber gloves, making up 35% of total costs compared with 60% for rubber gloves.

P/E valuation. We are using a relative P/E as our primary valuation methodology as this is also the main approach used to value rubber glove manufacturers. We believe that the P/E method is appropriate as the condom industry is still regarded as a growth business. We are not using a DCF approach - as Karex’s FCF is subject to a high number of variables and is neither easily defined nor earned over a pre-determined period. The company also does not have a formal dividend payout policy in place.  

Initiate coverage with a BUY. We are valuing Karex at MYR2.59 per share, based on a target 16.0x CY14 P/E. Although this is at a premium of 11.9% over the rubber glove companies’ industry average P/E of 14.3x, we believe that this is justified given its lower implied PEG of 0.35x, underpinned by a solid FY13–FY15F 2-year net profit CAGR of 28.3%, compared to rubber gloves companies, which trade at an average PEG of around 1.2x. We deem our 16.0x CY14 P/E in line with our rubber glove companies’ target P/E of 15.8x. Our 16.0x CY14 P/E is also deemed reasonably conservative compared to the 20.4x average for its global condom peers (see Figure 3). In view of the 40.0% upside, we initiate coverage with a BUY on Karex.

EV/EBITDA valuation. To cross-check our valuation, we apply EV/EBITDA as our secondary valuation to reflect the company’s intrinsic value against those of listed rubber glove manufacturers. We are pegging a CY14 EV/EBITDA of 10.9x to the stock, which is on par with that for rubber glove companies. We deem our EV/EBITDA-derived FV for Karex - at MYR2.84 - in line with the FV from our primary valuation.

Source: RHB