KAREX (5247) - Karex: A Health-Care Stock with 30% Upside


Lower rubber prices and growing demand for birth control could lift condom maker’s earnings 50%.

Worker checks condoms at the research laboratory of Karex Industries factory in Pontian Besar, Johor,Malaysia. hotographer: Goh Seng Chong /Bloomberg

Can shares in condom giant Karex (5247.MY) bounce back?

The Kuala Lumpur-based company is the world’s biggest maker of latex prophylactics and is reaping the benefits of close proximity to Malaysia’s rubber plantations. Karex manufactures condoms for clients like Reckitt Benckiser ( RB.UK ), whose Durex brand is the world’s second-biggest. Between last summer and the start of this year Karex shares rallied 50%, but have been weaker in 2016. At about MYR3.90, now could be a good time to accumulate shares.

In 2015 Karex’s stock enjoyed tailwinds from favorable movements in the value of the Malaysian ringgit and weaker commodity prices. The company bills its clients in U.S. dollars, meaning the stronger greenback has helped fatten its bottom line, as its results are reported in Malaysian ringgit. Much the company’s costs – mainly locally-sourced rubber – are in the beaten down Malaysian currency.

Karex shares have recently been hit by a rebound in the price of latex. The raw material, much of which is sourced from Malaysian plantations, fell 60% between 2011 and last year, hitting a low of sub-400 Malaysian sen a kilogram. Southeast Asian governments have taken steps in 2016 to prop up sagging rubber prices. Firstly, Malaysia says it will ‘rubberize’ about 600 miles of its roads to stoke demand. Secondly, Kuala Lumpur, along with Indonesia and Thailand, will collectively cut rubber exports for six months to nudge up prices.

Nomura analyst Marcin Spiewak, a Karex bull, thinks the market is over-concerned about a rise in rubber prices this year, which is putting pressure on the stock’s price short-term. He thinks the company can pass on any slight increase in raw material prices to its customers. Spiewak also expects the rubber market to be oversupplied for two years. He’s got a target price on the stock of MYR5 a share - about 30% higher than its current share price.

Spiewak likes Karex’s strategy. The company is now expanding into niche parts of the condom game, as well as cultivating itself as a brand. He points to the recent acquisition of TheyFit for $1.3 million. TheyFit sells custom-sized condoms online, and importantly, has US Federal Drug Administration and European Union approval. The Nomura analyst reckons the deal will help Karex sell its own brands into the these markets. Selling its own condoms could lift operating margins long-term and boost profits, Spiewak reckons.

The global condom market looks like it’s in rude health too. After all, it could be argued birth-control is virtually recession-proof. Still, it’s expected that condom revenues and volumes will grow by an average 10% per year through to 2020. The biggest threats this market faces are probably an HIV vaccination or the discovery of a new, more convenient method of birth-control. Neither look like they’re on the cards any time soon. There are new threats to people’s sexual health though: The Centers for Disease Control and Prevention in February reminded travelers to use condoms amid an outbreak of the mosquito-borne Zika virus. Broker Hong Leong says Zika could lead to more demand for condoms as couples in parts of Latin America the Caribbean avoid pregnancy. Clinical trials for a vaccine aren’t expected to start for 18 months.

The outlook for Karex’s earnings also looks appealing. Brokers think earnings per share could rise 50% in fiscal 2016 to MYR0.13 and sales could increase by a third to about MYR400 million. The company should also increase its free cash flow over the next two years. This means Karex has more money left in the piggy bank after paying suppliers and capital outlay, etc.

On that note, the company announced a bonus share issuance that will see existing shareholders handed one additional share for every two they hold. Companies normally do this when they’re in a healthy financial position and want to boost their stock’s liquidity. While share bonus issuances increase the number of shares traded on the open market, they don’t dilute current stock holders. They can however, affect earnings per share and share price. Karex says it will announce the entitlement date for the share bonus later this year subject to approval. Chue Kwok Yan, an analyst at Affin Hwang Capital, reckons the announcement could give a “positive boost” to the stock’s price in the near term.

Meanwhile, recent earnings look solid as well. In its second quarter Karex increased gross profit margins to more than 37% on cheaper material costs. Sales rose 25% compared to a year ago, in line with estimates.

Currency uncertainty could be counted against the stock. Malaysia’s currency was one of the worst performing in the region last year, but has shown some resilience of late on a slight bounce in oil prices. Still, scandals at state fund 1MDB have kept investors sour on Malaysia’s currency and stock market. The direction of the U.S. dollar is another question mark, given the fading possibility of further Fed hikes this year.

However, the stock isn’t cheap. Karex’s shares trade at 25 times forward earnings. Australian condom play Ansell ( ANN.AU ) looks cheaper, but its earnings have been pressured by falling demand for industrial lubricants and rubber gloves to struggling customers in petrochemicals and automotives. When it comes to condoms then, Karex still looks best-of-breed.

KAREX (5247) - Karex: A Health-Care Stock with 30% Upside
http://www.barrons.com/articles/karex-a-health-care-stock-with-30-upside-1456803076