(March 3, RM4.14)
Initiated at buy with a target price (TP) of RM5.10. Karex currently trades at forecast financial year ending June 30, 2016 (FY16F) price-earnings ratio (PER) of 16.4 times (earnings per share, EPS of 24.7 sen), representing a 13% discount to the 19 times PER at major condom brand owners.
We believe the discount will narrow, given the stronger earnings growth profile and rising proportion of Karex’s own-brand business.
Our discounted cash flow (DCF)-based TP of RM5.10 assumes a weighted average cost of capital (WACC) of 9.8% and a terminal growth rate of 5%.
Karex is the world’s largest condom maker, accounting for roughly one-sixth of global production in 2014.
Its 26 years of production experience and economies of scale from having double the capacity of its nearest competitor (Thai Nippon Rubber Co) give Karex an industry-leading 30% gross margin on average selling prices (ASPs) of 2.73 US cents (98.8 sen).
For the financial year ended June 30, 2014 (FY14) to FY17F, we expect the group to chart a strong net earnings compound annual growth rate (CAGR) of 36%, based on 50% growth in capacity to six billion pieces while maintaining an optimal utilisation rate of 75% to 80%; improving ASP by 2% per annum to 2.84 US cents as its own-brand sales rise to 6% of the total, from 4% in FY14; and a weaker ringgit against the US dollar.
Even excluding the foreign exchange impact, the net profit CAGR will still be a healthy 25%, we estimate.
The company has announced a private placement to raise about RM150 million to build up its cash reserves to RM210 million.
Management has said it is on the lookout for merger and acquisition opportunities to build its own-brand business.
Karex benefits from a weaker ringgit as 90% of its sales are US dollar-based while almost all its costs are in the local currency.
We expect the push towards increasing the proportion of own-brand sales to lift ASPs over the long term. — Nomura Research, March 3
This article first appeared in The Edge Financial Daily, on March 4, 2015.