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This article first appeared in The Edge Financial Daily on May 7, 2018

Karex Bhd
(May 4, 76.5 sen)
Maintain sell with a lower target price (TP) of 70 sen:
We believe Karex Bhd could emerge weaker in the second half of financial year 2018 (2HFY18) mainly due to unfavourable foreign exchange movement, and higher distribution and administration costs. Also, we have not seen any signs of recovery in the tender market. As such, we cut our earnings estimates by -24.6%/-26.1%/-24.2% for FY18/FY19/FY20 respectively. Although Karex’s year-to-date (YTD) share price has plunged 40.7%, we believe it has not hit rock bottom yet. We maintain “sell” with a lower TP of 70 sen per share.  

Karex is expected to release its third quarter of FY18 (3QFY18) results by the end of May. To recap, Karex’s 1HFY18 profit declined by 59.3% year-on-year (y-o-y) mainly due to intensified competition in the tender market and ringgit appreciation, which resulted in margin erosion. Looking forward, we now expect this trend to worsen in 3QFY18 as the ringgit appreciated further to average US$1 to RM3.93 in the first quarter of calendar year 2018 (1QCY18) versus US$1 to RM4.16 in 4QCY17. This would compress Karex’s 3QFY18 revenue when its export incomes, which dominate 90% of the group’s revenue, are translated at lower rates. All in, we project a weaker quarter-on-quarter (q-o-q) profit of around RM1 million to RM3 million for 3QFY18. On a cumulative basis, nine months of FY18 core net profit is expected to come in the range of RM8.4 million to RM10.4 million, representing a 58.4% to 66.4% y-o-y contraction.

The own brand manufacturing (OBM) segment may not be contributing much to the group in 2018 as the segment has not achieved critical mass. As such, its FY18 performance would continue to be saddled by high distribution and administrative costs. Management envisaged that its OBM sales would increase to 20% of the group’s revenue (from 15% currently) by 2020, and this is expected to improve sales efficiency and profit margin. In our opinion, we believe it is a tough fight to gain market share in the premium segment which has been dominated by Durex and Okamoto.

Karex is still on the lookout to expand its footprint. The group is targeting to double its point of sales in the US to 24,000 stores. With regard to Singapore and Thailand, it is still in the midst of processing the requisite registrations. Management is confident that its products will be able to be listed on the shelves by the end of this year in both Singapore and Thailand. We expect distribution and administrative costs to be higher this year at 22% of its revenue against 20% in FY17.  

We tweak our FY18 to FY20 earnings forecasts lower by -24.6%/-26.1%/-24.2% after revising our FY18 ringgit assumption to US$1 to RM4.09 (from RM4.13 previously) for FY18, and administration and distribution costs higher by 2.4% for FY18 to FY20.  

We lower Karex’s TP to 70 sen per share (previously 93 sen per share) based on an unchanged price-earnings multiple of 25 times. Despite the challenging market condition and earnings weakness, we still believe our valuation multiple of 25 times is reasonable given its position as the world’s largest condom manufacturer. However, we reiterate our “sell” recommendation due to the bleak outlook for the tender market. — TA Securities Research, May 4

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