Karex upgraded to Hold from Reduce after fall in share price

KUALA LUMPUR: CIMB Equities Research has upgraded the world's largest condom maker Karex to Hold from Reduce given a 40.4% decline in the share price since end-May 2017. 

“After reflecting our EPS cuts, our 12-month TP is lowered to RM1.40, based on an unchanged 28 times CY18 price-to-earnings P/E (-one standard deviation of its three-year historical mean). 

“Despite a weak near-term outlook, Karex’s market positioning as the largest condom maker globally and growing own branded products (OBM) exposure should support current valuations,” it said. 

CIMB Research said it would turn more positive on stronger-than-expected tender marker volumes and/or decline in OBM expenses,” it said.

CIMB Research said Karex’s FY17 revenue grew 5.3% on-year mainly thanks to higher condom sales, including its OBM. Earnings before interest, tax, depreciation and amortisation (EBITDA) margins, however, waned to 14.3% (-9.1% pts on-year ).

The reasons were due to: i) an increase in operating expenses, especially in OBM segment, ii) higher latex raw material prices and iii) stiffer competition in the tender segment. 

Hence, FY17 core net profit (after accounting for one-off expenses of RM3.1mil) declined to RM32.7mil (-48.2% on-year). Overall, FY17 core net profit came in below at 81% of the research house's estimate.

The research house said Karex's 4QFY17 revenue was flat at RM91.6m (-0.6% on-quarter), as higher tender sales were offset by weak average selling prices (ASPs) from stiff pricing competition. 

On top of lower ASPs, another issue was an increase in latex raw material prices in 4QFY17. It gathered that latex prices were locked in at a high rate in 3QFY17 (raw materials are usually bought  two-three months in advance) resulting in severe margin squeeze. 

This led to 4QFY17 EBITDA margins falling to 7.7% (-7.7% on-quarter) while core net profit waned to RM2.9mil (-66.2% on-year).

CIMB Research said the sexual wellness division (condoms and lubricants) remains the biggest contributor for Karex, making up 91% of FY17 revenue. 

In this division, the tender segment contributed 36% of revenue, followed by the commercial (50%) and OBM segments (14%). 

“Note that OBM’s FY17 contribution has grown by 6% pts on-year to 14% vs. 8% in FY16. The strong growth exhibited in the OBM segment was mainly thanks to: i) higher contribution from all condom brands, ii) more aggressive marketing efforts and iii) new product launches.

CIMB Research said in tandem with the weaker-than-expected results, it was are cutting its FY18-19F estimates by 16.5-17.1%.This is mainly to account for a weaker-than-expected recovery in ASPs and higher operating expenses. 

“Post our EPS cuts, we still expect Karex to record a 35.2% on-year jump in net profit. This should be backed by: i) improvement in ASP in the tender segment due to weaker competition, ii) higher contribution from the OBM segment
and iii) more stable latex prices,” it said.