Karex: Bottom-line dropped sharply

Background

Karex Berhad ('Karex') is involved in the manufacture and sales of condoms, lubricating jelly and other medical devices such as catheters and probe covers. It has 3 manufacturing facilities located in Pontian, Johor; Port Klang, Selangor; and, Hat Yai, Thailand. These facilities employ a workforce of 2,000 employees and can produce 4 billion pieces of condom per annum. This makes Karex the largest condom manufacturer in the world.

Recent Financial Performance

Karex's bottom-line has grown rapidly over the past 2 years due to steady growth in revenue & profit margin. In QE31/12/2015, its profit margin contracted sharply. The drop continued in the latest quarter. This profit margin compression, coupled with a drop in top-line, resulted in a sharp drop in its bottom-line in QE31/3/2016. The company explained that the net profit dropped q-o-q due to "lower sales, lower profit margin and foreign exchange losses in current quarter" as well as the absence of a "one-off gain from a bargain purchase of RM 4.7million". 


Table: Karex' last 10 quarters' P&L


Chart 1: Karex' last 10 quarters' P&L

Financial Position

Karex's financial position as at 31/3/2016 is deemed very healthy. Its current ratio stood at 7 X while total liabilities to equity stood at only 0.15 X.

Valuation

Karex (closed at RM2.32 last Friday) is now trading at a PER of 32x (based on last 4 quarters' EPS of 7.18 sen). Based on its rapid growth of 32%, its PEG ratio is at 1X. Thus, its high PER is considered acceptable in view of its high growth of 32%. However, the high PER means that it must continue to grow at the elevated rate of 32%. That's why investors should be asking this question: Is the recent drop in bottom-line a temporary setback or is it a transition to a lower growth rate? If it is the latter, we can expect investors to reduce their holding of this overvalued stock!

Technical Outlook

Karex is in a long-term uptrend line, SS with support at RM2.30. Its upside may be capped by a medium-term downtrend line, RR at RM2.50. A break below RM2.30 could signal the end of its uptrend while a break above RM2.50 would signal the continuation of its prior uptrend.


Chart 2: Karex's weekly chart as at May 27, 2016 (Source: ShareInvestor.com)

Conclusion

Based on weaker financial performance and possible overvaluation, it may be advisable to reduce your position on Karex. However, your selling can be carried out slowly since the technical outlook for the stock is still bullish.

Note: 
In addition to the disclaimer in the preamble to my blog, I hereby confirm that I do not have any relevant interest in, or any interest in the acquisition or disposal of, Karex.