Karex’s 1QFY16 results came in line, at 24%/27% of our/consensus estimates respectively, as earnings were up 28.4% QoQ on margin expansion due to a better product mix and a stronger USD. We reiterate our BUY call with a revised TP of MYR4.56 (from MYR4.08, 16% upside).

1QFY16 results. 1QFY16 (Jun) earnings were in line, making up 24%/27% of our/consensus estimates respectively. Revenue fell 3.6% QoQ due to lower sales volume booked, which resulted in a MYR15m increase in inventory. Nonetheless, earnings rose 28.4% QoQ on the back of a better product mix as well as favourable currency movements and raw material prices. Consequently, EBIT margin improved to 33.4% in 1QFY16 (4QFY15: 24.7%), but we expect FY16 margins to normalise to more comfortable levels of 25-27% once forex rates stabilise.

Outlook. We expect Karex to post stronger results for the remainder of FY16, as the additional capacity of 1bn pieces (+25%) in Pontian, Johor, is scheduled to come online in 2QFY16, coupled with a faster-than-expected turnaround of the recently-acquired Medical Latex Dua SB (MLD). Karex is also launching the ONE condom brand in Malaysia in Dec 2015, with the target of expanding the brand to the rest of the Asia-Pacific by 4QFY16. We also expect further M&A activity for Karex, as per the utilisation schedule of its private placement in Feb 2015. The company is currently sitting on net cash of MYR186.5m.

Forecast. We make no changes to our earnings assumptions but revise our cost of equity to 9.3% (from 10%), in light of the higher scarcity premium being applied to the sector. This is as the market accords higher valuations to firms that deliver robust earnings growth amidst the weaker macroeconomic environment.

Maintain BUY. We continue to be excited about the prospects of Karex’s original equipment manufacturing (OEM) and own brand manufacturing (OBM) segments. Maintain BUY with a higher DCF-derived TP of MYR4.56 (16% upside, CoE: 9.3%, TG: 3%), implying FY16F P/E of 32.5x. In our opinion, this is justified, given that Karex only trades at 1.3x PEG vs its peers’ much heftier average of 3.3x (Figure 6). Karex also has a dominant position in the OEM segment at 5bn pieces of annual capacity, double that of its closest competitor. Downside risks to our recommendation are potential delay in both OEM and OBM expansion plans and the reversal of the USD strength.

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Karex Bhd is the world's largest condom manufacturer with an annual capacity of 5bn condoms.

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Source: RHB Research - 1 Dec 2015