KAREX's growth outlook remains positive. The shipment of its first batch of high-margin synthetic products to Europe, alongside increasing contributions from personal lubricants, are expected to support margin expansion moving forward. While forex headwinds and tax impacts weighed on 1QFY25 results, the company's underlying business fundamentals remain robust. With expectations of a forex reversal and continued strategic execution, KAREX is well-positioned for stronger performance in subsequent quarters. Post review, we maintain our earnings forecasts with an unchanged TP of RM1.12 and OUTPERFORM call.

KAREX posted 1QFY25 net profit of RM1.4m, broadly within expectations, representing 3.2% of our full-year forecast and 3.5% of the consensus estimate. The performance was hindered by sharp forex fluctuations, leading to about RM4m in unrealised forex losses and a higher-than-anticipated effective tax rate in Thailand. The elevated tax was attributed to non-tax-deductible forex losses from intercompany loans denominated in USD. We expect these impacts to reverse in the coming quarters if the USD/MYR exchange rate stabilises at current levels.

YoY, revenue grew by 4%, supported by stronger commercial sales of condoms and higher demand for personal lubricants, which contributed 17% of total revenue (up from 15% in FY24). Excluding forex impact, revenue growth would have been 14% YoY, reaching RM148m. GP margin expanded to 31.9% (from 30.7% a year ago), reflecting the company's strategy to prioritise higher-margin products while reducing exposure to lower-margin tender markets. However, PAT fell 73% YoY, impacted by forex volatility and increased tax expenses.

QoQ, revenue increased by 9%, driven by stronger condom sales to the commercial market and growing demand for medical products such as catheters and probe covers. The proportion of commercial market sales rose to 70% (from 64% in the previous quarter). Nonetheless, adverse forex movements compressed gross profit margin to 31.9% (from 35.3% in 4QFY24), resulting in a 12% decline in PBT to RM4.6m.

Unrealised gain tax in Thailand. KAREX's higher tax expense in 1QFY25 was mainly due to an unrealised gain on the USD intercompany loan of its Thailand subsidiary (Innolatex Thailand Limited) from its Malaysia parent company (Karex Berhad). With the Thai Baht strengthening against the USD, the subsidiary's repayment obligation in THB effectively decreased, creating a gain on paper, which is taxable under Thailand tax laws. Hence, it increased KAREX's tax burden which has a direct impact on PAT about 70%. Conversely, if the USD strengthens, it will create an unrealised loss on paper, leading to potential tax relief. Note that, Malaysia tax regulations do not impose such tax on similar unrealised gains.

Outlook. KAREX continues to expect high-value orders for condoms and personal lubricants by leveraging its strong industry reputation, diverse product range, and regulatory expertise. While the shift between tender and commercial markets may disrupt traditional sales channels in the short term, the group sees medium-term growth opportunities. The company has delivered the first batch of synthetic condoms (made from an innovative, first-of-its-kind material) to the European market, with the U.S. market expected to follow around April. This high-margin product positions KAREX as a leader in this category, offering significant potential for market share expansion. Additionally, in response to higher operational costs driven by minimum wage hikes, KAREX plans to increase its average selling price (ASP), supporting its strategy to sustain profitability.

Forecasts. Maintained, where earnings are expected continued driven by favourable product mix and stronger gross profit margin.

Valuations. We maintain our TP of RM1.12 based on an unchanged CY25F targeted PER of 25x, at a 20% premium to the average historical 5-year forward PER of its international peers to reflect its dominant market position and strong growth prospect. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us.

Investment case. We continue to like KAREX for: (i) its leading market position and global reach in the rapidly growing condom industry, projected by industry experts at a CAGR of 8% to 9% over the immediate term, (ii) its strong R&D and product innovation, (iii) its adherence to international standards and certifications, (iv) its strategic shift in moving up higher the value chain, and (v) growing preference for high quality innovative condom products. Maintain OUTPERFORM.

Risks to our call include: (i) reduced spending by government around the world on birth control, (ii) low acceptance rate for its new synthetic rubber condoms, (iii) less favourable product mix, and (iv) inability to raise prices to defend profit margins.

Source: Kenanga Research - 22 Nov 2024