We came away feeling more optimistic on Karex’s prospects after our recent company visit. We reiterate our BUY recommendation and revise our TP to MYR4.08 (from MYR3.58, 19% upside). In particular, we expect better 1QFY16 results led by increased operating efficiency, improved product mix and a stronger USD.

Stronger 1QFY16 (Jun). We expect 1QFY16 earnings to be 18-21% higher QoQ on the back of better-than-anticipated operating efficiency improvements, favourable product mix and a stronger USD. We believethat the increased operating efficiency was primarily led by Karex’s automation drive and the realisation of greater cost scales. The company also guided for a more favourable product mix resulting in improvedmargins, citing examples of tender orders with preference for less plainvanilla condoms (eg, more coloured condoms). The USD has also appreciated by 10.9% QoQ against the MYR. Recall that Karex retains the prerogative on any forex savings as it does not have any obligation to share the benefits with its clients. We forecast that net margins would improve to 25.2% for the quarter (4QFY15: 22%) and earnings to come in around MYR20m-21m, roughly 12% above consensus estimates.

MLD turnaround. We also understand that the turnaround of recentlyacquired Medical Latex Dua SB (MLD) is likely to be faster than anticipated. While initially guiding to breakeven within 12 months, management is now confident of a turnaround within three months after bringing down costs. This was with the centralisation of raw material purchases and increasing operational utilisation to 70%. At acquisition, MLD had 40% utilization. Karex is also to announce the launch of the ONE condom in Malaysia in December, marking the expansion of its own brand manufacturer (OBM) ambitions in the Asia-Pacific region.

Maintain BUY. We update our FY16-18 USD forex assumptions to 4.27/4.30/4.27 respectively. Coupled with Karex’s latest marginsexperience, we upgrade our FY16-18 earnings forecast by 11-14%. Maintain BUY with a revised MYR4.08 TP (19% upside, CoE: 10%, TG:3%) with an implied 29x FY16F P/E. It is currently trading at 24.4x FY16F P/E, below its 26.4x historical 1SD trading band. W e believe thisis unwarranted given its leadership position in the condom market. The downside risk to our call would be delays in either/both original equipment manufacturer (OEM) and OBM expansions, as well as recovery of the MYR.