This article first appeared in The Edge Financial Daily on June 1, 2017 - June 7, 2017

Karex Bhd
(May 31, RM1.80)
Maintain hold with a lower target price of RM1.97: Karex Bhd’s first nine months of financial year 2017 (9MFY17) profit after tax and minority interests (Patmi) of RM25 million (down 54% year-on-year [y-o-y]) was below expectations, accounting for 48% and 47% of Hong Leong Investment Bank and consensus full-year estimates respectively. 

The deviations in the results are mainly due to higher marketing and distribution expenses related to the expansion of the own-brand manufacturing (OBM) segment and continued depressed average selling price (ASP) from the tender market. 

Year to date, revenue grew 3.4% y-o-y despite the tougher tender market and compressed ASP environment. This is reflective of the strides made in the OBM segment (double-digit growth y-o-y). 

Gross margins were within the comfort levels of 30% to 33%. Nonetheless, Patmi declined 54% y-o-y on continued investment in the OBM segment. 

Revenue grew 4.5% y-o-y but Patmi fell 28.3% due to the depressed ASP environment coupled with the steep increase in latex prices y-o-y. 

There was a growth in orders from the African tender market (up 4 percentage points [ppts] q-o-q), partially offset by a decline in orders from the Americas (down 4ppts q-o-q).

The group is making a push into the UK and US consumer market as the company continues its efforts in expanding into the OBM segment. As such, we continue to expect marketing and administration expenses to grow in tandem with the size of its commercial campaigns.

A strong US dollar should help mitigate the impact of rising raw material prices. Latex price has been hovering around RM6.50 per kg from around RM8 per kg at the beginning of the year. We maintain a RM4.30 per US dollar in our FY17, FY18 and FY19 assumptions. 

Risks are a surge in raw material prices, foreign exchange risks, revision on foreign labour policy, and successful development of HIV/AIDS cure. — Hong Leong Investment Bank Research, May 31