Goh: ‘For long-term investors, our story has not changed in terms of core direction. Our fundamentals remain intact.’
AFTER a good run in the last three years, Karex Bhd
seems to have now lost some favour of investors. Concerns are growing over the medium-term prospects of the condom and rubber product manufacturer that has posted five consecutive quarters of earnings decline.
Once a hot stock, the counter came under heavy selling pressure over the week after reporting another set of disappointing financial results for its third quarter ended March 31, 2017.
The knee-jerk reaction saw Karex’s share price plunge 38 sen, or 18.5%, within two days to close at a two-year low of RM1.67 on Thursday before rebounding yesterday to close at RM1.72.
Essentially, the decline in Karex’s share price over the last five trading days was equivalent to a loss of RM401mil in market capitalisation.
Year-to-date, the counter has fallen about 28%.
At present level, Karex is trading at 26 times consensus earnings estimate for the financial year ending June 30, 2018 (FY18), and about 19 times consensus FY19 earnings estimate.
Medium-term bearish
Meanwhile, in a move to reflect their lacklustre earnings growth expectations for Karex, at least two research houses have downgraded their ratings on the company and ascribed lower target prices for the counter, while most other research houses that have updated their outlook on the company over the week have cut their fair values for the stock.
For instance, CIMB Research, which has downgraded its call on Karex to “reduce” from “hold” and cut its target price for the counter to RM1.70 from RM2.32 previously, notes that the current valuations for the counter seems expensive, while the near-to-medium-term outlook for the company remains weak.
“While Karex’s long-term potential remains bright due to its growing OBM (original brand manufacturing) exposure and its position as the largest global condom manufacturer, we think current valuations are expensive.
“Its share price is likely to be hit by the weak results and we advise investors to only re-look into this stock on further weakness,” CIMB Research explains in its report.
The brokerage has cut its earnings expectations for Karex by 24.2% to 25.1% for FY17 to FY19 to take into account lower average selling prices, increase in operating expenses and higher latex prices.
CIMB Research says although it expects earnings growth to return by FY18, Karex’s valuation of 34 times the expected earnings for 2018 seems “stretched”, as the near-to-medium-term outlook for the company remains weak because of strong competition in the tender market, volatile raw material prices and high distribution expenses.
It explains: “In the tender segment, pricing competition is unlikely to soften, given the budget cuts by NGOs and government bodies. The group’s profit margins are also likely to remain under pressure as average selling prices have remained weak despite the significant increase in latex prices since the end of December 2016.”
“Moreover, Karex’s high distribution and administrative expenses are likely to continue to rise, given its aggressive expansion plans for its OBM segment,” CIMB Research says.
Separately, AffinHwang Capital, which has cut its target price for Karex to RM1.90 from RM2.20 while maintaining its call on the counter at “hold”, concurs that the latter’s near-term earnings growth is unlikely to be exciting.
“We expect the tender market to stay soft for 2017 on the back of capacity glut, a low industry utilisation rate and spending cuts by NGOs, which are likely to impact Karex’s average pricing,” AffinHwang Capital explains.
“While the OBM contribution continues to grow, albeit from a low base, customer-acquisition costs should stay elevated, leading to pressure on the margins,” it adds.
AffinHwang Capital points out in its report that it is Karex’s growing OBM market that has convicted it to maintain its “hold” call on the company.
Overall, there are now six “hold” recommendations on Karex against one “sell” and one “buy”, according to a Bloomberg survey of eight analysts. The poll shows the target prices put in by these analysts for Karex range from RM1.70 to RM2.40.
Fundamentals intact
Karex group chief executive Goh Miah Kiat, however, is unperturbed by the noises.
He stresses that the long-term fundamentals of the group remains intact, as the group continues to focus on growing its business.
“We are constantly focused on growing our business. For long-term investors, our story has not changed in terms of core direction. Our fundamentals remain intact,” Goh says.
“And we are confident that we are moving in the right track, as evidenced by the increase in our sales numbers. I’d be worried if my sales numbers dropped; but the fact that they had continued to increase means there is growing demand for our products,” he tells StarBizWeek.
According to Goh, the heavy operational expenses that had weighed on the group’s earnings for the last few quarters were incurred because the group was investing for its future growth and growing its own brands.
While he concedes that Karex is indeed facing some headwinds in its operations, he reassures that the challenges are only temporary in nature.
“The headwinds – such as pricing pressure and volatile rubber prices – are short term. We’ve been through this before, with the worst seen in 2011, when rubber prices hit RM11 per kg, and we came back on a stronger footing,” Goh says.
“We can usually pass on the cost increases to our customers, but this process will take time,” he adds.
In a positive note, latex prices have eased, currently hovering at around RM6.50 per kg, compared with around RM8 per kg at the beginning of the year.
Tender comeback
According to Goh, the tender segment, which accounts for about 40% of Karex group’s earnings, is seeing a market that is gradually coming back to life after having suffered for the last one year due to budget cuts by governments and NGOs.
“It has been tough for the tender market for the last one year due to budget reallocation by some governments and NGOs, particularly in Europe, from the health sector to humanitarian causes as they deal with the mass migration and refugee crises in their countries. This resulted in lower condom sales volume.
“But the market is back – we are getting emergency orders,” Goh says, noting that demand for condoms will be supported by the fact that there is still no substitution for the product.
Karex – which operates three manufacturing facilities in Malaysia, specifically in Pontian and Senai in Johor, and Port Klang, Selangor, and one plant in Hat Yai, Thailand – produces about five billion pieces of condom per year. Besides producing for third parties, the company also manufactures condoms under its own brands, namely Carex and INNO, which are mainly exported to Middle Eastern countries.
Karex’s capacity utilisation at present stands at a low of 60% due in part to the weak tender market. Nevertheless, the group expects its capacity utilisation rate to improve to 65% in the near term.
“Our business is not just about manufacturing products. We are building an international brand as we move into a bigger part of our growth story,” Goh points out.
In what he calls an “impressive feat”, Goh says Karex has managed to grow its own brand business from accounting for about 3% of the group’s revenue when it made its debut on the stock market in November 2013 to around 15% of the group’s revenue now.
He says the group is currently focused on pushing its products further into the UK and North American consumer markets to expand sales.
Despite registering higher revenue for the third quarter ended March 31, 2017, Karex saw its net profit fall 28.3% to RM6.9mil, or 0.69 sen per share, from RM9.6mil, or 0.96 sen per share, in the corresponding period last year on higher distribution expenses.
During the period in review, the group’s revenue grew 4.5% to RM92.2mil, thanks to higher sales in the tender segment.
For the cumulative nine-month period, Karex’s net profit declined 54.1% to RM25mil from RM54.6mil in the previous corresponding quarter, resulting in its earnings per share falling to 2.50 sen from 5.44 sen.
The group’s revenue, on the other hand, increased 3.4% to RM269.8mil for the nine months to March 2017 from RM260.9mil previously.
The company has yet to declare any dividend for the current financial year. In FY16, it paid out a dividend of two sen per share as well as a bonus issue of up to 334 million new shares on the basis of one bonus share for every two existing shares held.
Meanwhile, Karex’s cash balances have been halved to around RM82.4mil as at March 31, 2017. This compared with its cash and cash equivalents RM162.6mil a year ago. The group’s total borrowings, on the other hand, fell marginally to RM24.3mil against RM25.9mil previously.
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