This article first appeared in The Edge Malaysia Weekly on March 25, 2019 - March 31, 2019

FOR some, investing is exciting, thrilling, empowering and even spine-tingling. The renowned investor Warren Buffett put it best when he said: “A bull market is like sex. It feels best just before it ends.”

But there is little pleasure when the share price spirals downwards with no end in sight. Investors have probably lost their appetite for Karex Bhd. Its share price sank to 38 sen apiece in January — a new low since listing on Bursa Malaysia in 2013 — on the back of declining corporate earnings.

Investors looking for a bright spot in its first half performance will be disappointed as the net profit of the world’s largest condom manufacturer plunged by more than half to RM3.25 million in the six months to end-December (1HFY2019), compared with the same period a year ago.

Certainly one of the sexiest stocks on Bursa Malaysia in 2016, as investors chased its share price to some RM3 over the greater part of the year, Karex’s comedown has been hard. But is it time to sever ties?

Group CEO Goh Miah Kiat asks for a second chance as Karex anticipates a recovery in its earnings margin in FY2020 because global tender pricing is starting to pick up.

“We do expect margins to improve but, obviously, there are some headwinds here and there. Sometimes it is difficult to tell,” he tells The Edge in an interview during Invest Malaysia 2019. He thinks FY2020 “should be a better year”, in part because of a consolidation in the sector as a growing number of factories are shut down in China amid tighter regulatory requirements and the country’s blue-sky policy push.

Goh says global tender pricing is on the mend after a sharp decline in the last few years, which dented the group’s financial performance. The tender market is mainly to supply condoms to government and non-governmental organisations.

“What we have been seeing of late is based on the closest indicator, which is global tender pricing. Generally, it has been on an upward trend because every factory also knows that it must be sustainable at the end of the day. Everybody is like, ‘okay, I think it’s time’ [to stop competing on price]. They have to make a profit as well to make sure that there is enough to be reinvested into the company,” Goh says.

He says tender pricing has declined by about a fifth in the past few years from its peak, resulting in significant margin erosion in the tender segment because condom budgets have been cut by European governments and the US.

“I would say that from the peak, it has probably dropped about 20%. So, at times, our entire margin eroded at the tender pricing. But prices have sort of recovered. Not yet the peak but I would say that things have improved quite a lot.”

Since Donald Trump was elected US president, the budget allocation for the President’s Emergency Plan for AIDS Relief (PEPFAR) has been slashed by 40%.

However, Goh maintains that the worst is over for the company as demand is increasing.

Even so, investors might need more persuading. One of Forbes Asia’s 200 Best Under A Billion companies in 2016, when the stock was also an analyst favourite, Karex appears to have lost its mojo.

From its peak of about RM3 in 2016, the condom manufacturer has lost more than 80% of its value and is currently trading at about 43.5 sen.

Its decline has tracked its faltering bottom line, which had surged to an all-time high of RM66.7 million in FY2016 before sinking to RM10.4 million in FY2018, notwithstanding a  record revenue of RM408 million.

Product innovation key to premium segment

Goh believes innovation will give Karex the edge in its own brand manufacturing (OBM) segment; the company invests about 2% of its revenue in research and development.

“The next change in this industry is more innovative products. If a company has not been focusing on and investing in innovative products, I think it is going to be a challenge. But I am excited because I think Karex has the right tools for the next wave of change.”

These include condoms in various sizes and those that come in different flavours, particularly those that suit local taste buds, such as its nasi lemak and durian flavour condoms.

In fact, an Amazon guide puts Karex’s ONE Zero Condoms among its top 10 recommended prophylactics as it is 25% thinner than other ONE condoms. Goh says the ONE brand is now the second most popular in Malaysia after world leader, Durex, and that the group intends to intensify its branding efforts.

For its financial year ended June 30, 2018 (FY2018), the OBM segment contributed 15% to total revenue, compared with 8% in FY2016 and a mere 3% before its initial public offering in 2013.

Goh projects that the OBM segment will contribute 30% to 40% of total revenue in five years. With a presence in Malaysia, the US, the UK and Canada, the group is looking to Europe, Singapore and Thailand, although the rollout in new markets will be via e-commerce to reduce promotional expenses.

“The focus will be on online sales with condoms in various sizes. We need to carve our own niche in this new market,” he says.

Investors might be wary of embracing Karex after the steep plunge in its share price over the last few years, but if its own brands can successfully tap the end consumer segment, the stock could be worth another look, given the company’s attractive gross margins of about 40%.

But it is also worth noting that the precipitous decline in Karex’s value occurred when the group was expanding its OBM business.

Perhaps investors need to find the right entry price where valuations are not as stretched.

The group is currently trading at a trailing 75 times price-earnings ratio and a forward 40 times PER. In comparison, Reckitt Benckiser Group PLC, which owns Durex, is trading at a trailing PER of 20.6 times and a forward PER of 18.1 times.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.