Karex - Am I given a 2nd chance?

Yes, It has been a stock that I admire since its IPO and hope to have it in my portfolio.

When Karex’s IPO was announced in  2013, many were attracted to the world’s biggest condom producer – Malaysia Boleh. Institutional investors favour this stock that offer promising growth story then – expansion plan and OBM strategy. I was also tempted to be its shareholder and wanted to buy on 1^st day of IPO  but was disappointed when it opened at such a high premium (>50%). So I waited and waited and gradually put it aside as the price continued to rise to higher valuation.

The past few quarters poor financial performance has dragged it share price and the most recent quarter has really tested the institutional investors patience, hence resulted in quite a sharp correction in the share price, so I asked myself – am I given a 2^nd chance to own a part of the world’s biggest condom producer? 

As usual, let’s look at some financials :-

Despite the sharp fall in profit and share price, those who have invested during the IPO or within 1^st year after IPO, they are still sitting at very high return.

		RM	No of shares	Market Cap (Rm'000)
IPO Price		1.85	270,000,000	499,500	6/11/2013
Adjusted for all bonus issue**		0.55
Current Price		1.81	1,002,375,000	1,814,299	6/6/2017
Total % return (excluding dividend)		229.1%		263%
CAGR		39.4%		43.3%
Bonus Issue**
Feb-14	1 for 2
Apr-15	1 for 2
Apr-16	1 for 2

Karex’s past financial performance:-

	Proforma	Actual			Actual
		(Audited)			(Unaudited)
Financial Year Ended 30 June	2013	2014	2015	2016	2017
	RM'000	RM'000	RM'000	RM'000	RM'000
No. Of Months	12	12	12	12	9
Revenue	231,389	285,332	298,094	343,617	269,819
Cost of goods sold	-171,472	-203,703	-200,307	-229,070	-182,434
Gross profit	59,917	81,629	97,787	114,547	87,385
	26%	29%	33%	33%	32%
Administrative expenses	-10,068	-12,488	-21,563	-33,899	-28,188
	-4%	-4%	-7%	-10%	-10%
Distribution expenses	-9,698	-11,558	-14,969	-19,146	-25,340
	-4%	-4%	-5%	-6%	-9%
Other operating expenses	-3,645	-3,111	-548	-262	-4,830
	-2%	-1%	0%	0%	-2%
Other operating income	1,988	758	10,420*	13,225*	2,782
Result From Operating Activities	38,494	55,230	71,127	74,465	31,809
Finance costs	-2,500	-2,134	-1,174	-654	-799
Interest income	150	1,332	3,329	5,539	2,239
Profit Before Taxation	36,144	54,428	73,282	79,350	33,249
Income tax expense	-7,116	-9,260	-13,552	-12,927	-7,451
Profit For The Financial Year/Period	29,028	45,168	59,730	66,423	25,798
	13%	16%	20%	19%	10%
Total Equity	178,164	223,332	432,390	479,672	496,523
ROE		25%	27%	15%	5%
Basic Earnings Per Share (sen)	3.75	5.23	6.34	6.65	2.5
Operating Cash flow	(21,001)	25,576	45,270	43,749	4,858
Capex		(9,914)	(46,315)	(44,052)	(15,833)
Free Cashflow (Note 1)	(21,001)	15,662	(1,045)	(303)	(10,975)
Cash	49,534	85,592	207,718	144,269	83,540
Total debts		(21,594)	(22,882)	(25,895)	(24,343)
Net cash/ (debt)	49,534	63,998	184,836	118,374	59,197
*Other Income mainly consists of
Forex gain			10,067	8,877
Bargain Purchase				3,956
	-	-	10,067	12,833	-

There was significant jump in Admin & Distribution Expenses, which was in line with Karex’s strategy to focus on Own Brand Manufacturer (OBM) and marketing its own brand more aggressively. 2015 & 2016, similar to many exporters eg furniture companies, the increase in profit was boosted by forex gain. Those were the main reasons behind the drop in financial performance for 9M FY17.

Note 1: The company has carried out a private placement to fund the expansion at Pontian’s factory & facilities, otherwise, one look at the FCF will put me off immediately.

Since there are so much coverage on this company by research house, let’s take a look at a few valuations (because I think it will be very time consuming to perform valuation for Karex, so just rely on experts for reference):-

	Current Market price	1.81	PE 26 times FY 18
Research house	Valuation	Upside /(downside)%
CIMB	1.7	-6.1%
Affin Hwang	1.9	5.0%
TA	2.4	32.6%	PE 30 times FY 18

A quick comparison of Market capitalisation (gain 263% since IPO to current price Rm1.81, not the highest share price yet) vs financial performance (profit grew 129% - FY16 vs FY13), too much growth expectation had been factored in the share price. Assuming market cap follows profit performance, it should only be around Rm 1.14 billion ( or Rm1.14 per share), of course one may say I can’t use IPO valuation as base because it is usually priced attractively to entice investor during IPO. Fine, there should be some premium to the largest condom producer with growth expectation. But the OBM strategy to build ONE brand will take time and its OEM and tender segment are facing stiff competition as per its MD interview appeared on Edge Financial Daily 5 Jun 2017. So, I would be very happy if I can get it closer to Rm1.14 ( a little early, may be I am still dreaming here).

I personally still believe Karex is a good company in the long run and agree that OBM strategy is the right direction to avoid stiff competition and enjoy economic moat later, but whether it is a good investment depend on whether I can enter at a price that still offer attractive return (CIMB & Affin think I will not but TA is very bullish). Otherwise, I would rather remain as secret admirer and still let go a “second chance”. I will wait for another quarter if there is another round of sales….