Karex Bhd
(Feb 10, RM2.39)
Maintain add with a lower target price (TP) of RM2.65: Karex Bhd is set to release its second quarter of financial year 2017 (2QFY17) results on Feb 24. In our view, 2QFY17 net profit should come in sequentially stronger at RM10 million to RM15 million. However, this is a sharp year-on-year (y-o-y) decline from a high base in the second quarter of 2016 (2QFY16). Note that there was strong strengthening of the US dollar and drop in latex prices in 2QFY16. On the bright side, we think 2QFY17’s revenue and gross profit margins should also improve q-o-q from better sales volume, especially in tender markers, and additional foreign exchange gains. 

Karex will begin to market its own brand manufacturer (OBM) products in one of the UK’s largest retail chains focusing on health and beauty products. This will be piloted via Pasante, acquired in late-May 2016. This development is a positive surprise, escalating the group’s OBM segment faster than expected, especially into the European markets. Nevertheless, revenue contribution from this foray should be minimal in the near term as we expect the early quantities to be limited while additional one-off costs will offset bulk of initial gains. 

The 22% year-to-date (YTD) surge in latex prices has raised concerns as latex cost accounts for some 24% of Karex’s total operating cost. However, management gave assurance that the group has hedged forward a significant portion of its latex needs up to mid-March 2017. We note that the group has increased the average selling prices of its products recently, and may continue to do so depending on latex prices. However, there would be a time lag as any price revisions due to latex price hikes will only be reflected after four to six months. 

Given the latest operational updates, we lower our forecast FY17 (FY17F) to FY19F earnings per share (EPS) by 0.9% to 9.5%. This is to account for the recent spike in latex prices, as we increase our latex costs estimates to RM5.50 per kg for FY17F to FY19F from RM4.25 per kg previously. Furthermore, the earlier-than-expected foray into a UK retail chain would also result in higher administration and marketing expenses such as listing fees, additional workforce and increase in logistics costs to cater for this new venture. 

Our EPS revision lowers our TP to RM2.65, still based on an unchanged 29 times its 2018 cumulative forecast price-earnings ratio. We continue to like the group’s long-term prospects, especially its transformation into a formidable OBM player, and its unparalleled lead in the tender markets. Although near-term numbers may face headwinds from higher marketing and raw material costs, we view any share price dips as opportunities to accumulate the stock. Risks to our “add” call are a stronger ringgit and higher latex prices. — CIMB Research, Feb 10