8 things I learned from the 2019 Karex AGM

Karex Berhad is the world’s largest condom manufacturer by volume in the world. Karex grew rapidly over three decades as a contract manufacturer for well-known global brands such as Durex and Ansell, and by supplying bulk orders to global public health organizations.

In 2014, the company acquired 55% of U.S.-based Global Protection Corp, the company behind the ONE brand of condoms, which gave Karex the rights to distribute the brand in Australia and countries in Asia and North Africa. Karex’s own Carex brand of condoms is also a leading mass-market brand in the Middle East.

Since reaching a peak of RM3.13 on in January 2016, Karex’s share price has plunged by more than 85% to trade below 50 sen for most of 2019. I attended the 2019 AGM to learn what happened and evaluate the management’s strategies to bring the company back onto a path of recovery.

Here are eight things I learned from the 2019 Karex AGM:

1. Revenue fell 7.6% to RM 378.5 million in the financial year ended 30 June 2019 (FY2019), due to a challenging operating environment specifically within the Tender segment. A disruption of orders experienced during the second half of FY2019 also resulted in lower condom sales for the year.

2. In the U.S., President Trump’s budget proposal includes more than $1.7 billion in cuts to Global HIV programs. In Asia, China is scrapping family planning agencies, a hint to end birth limits, as the country is experiencing a rapidly ageing population and shrinking workforce. These trends will be negative for condom sales according to CEO Goh Miah Kiat.

3. Net profit plunged 70% to RM3.1 million in FY2019, due to volatile raw material prices, most notably in latex. Costs for social compliance audits and remediation measures stemming from the foreign worker allegations by The Telegraph further pressured profitability, which resulted in gross margin declining to 23.6% in FY2019, from 26.0% in FY 2018. Net profit in the last three years has fallen substantially, mainly due to uncertainty surrounding humanitarian aid budgets around the world.

4. In January 2019, The UK Telegraph published an article raising allegations on unsatisfactory working conditions for foreign workers and social compliance concerns at Karex’s manufacturing facilities. This resulted in a drop in sales in the second half of FY2019. Karex’s management immediately froze additional foreign worker recruitment, sanctioned an independent external investigation on the allegations, and engaged key stakeholders and customers on the issue. In February, Karex engaged Impactt, an independent company specializing in ethical trade to conduct a thorough investigation. Social compliance initiatives by Karex include installation of locker storage for passports, improvement in the recruitment process, accommodation upgrades, hostel sponsor program, and improving safety and security. In June 2019, Impactt completed their audit and verified that Karex had completed its social compliance.

5. Karex’s Own Brand Manufacturing (OBM) segment contribution as a percentage of revenue has grown from 4% during its IPO in 2014 to 17% in FY2019 and 21% in Q1 2020. At the meeting, Goh explained the rationale behind building Karex’s own consumer brands. As the economies of emerging countries (like Vietnam) continue to grow, foreign aid organisations and governments are cutting funding on free condom programmes leading to consumers having to purchase condoms for themselves. Inevitably, this will result in a decrease in volume, as consumers will only purchase the amount they need. However, Goh foresees that the value in the industry will grow as government purchases are usually done in bulk and at substantially lower prices. He believes that this is where branding will be key to attracting customers. Although the OBM segment is still unprofitable, he is confident that profits will come in time as Karex’s brands gain awareness and scale. ONE Condoms, in particular, continues to receive positive feedback. The brand now has a wider range of products available in Walmart and more retailers have come onboard and started stocking the brand in the U.S.

6. As part of Karex’s strategy to continuously innovate, investment in research and development has increased over the years. As a result, the company has produced product innovations such as ultra-thin, new textures and flavours (exotic ones include durian and nasi lemak for ONE Condoms), and custom sizes. A shareholder expressed his disapproval of the exotic flavours, saying they are weird and unappealing to many. Goh explained that from a marketing perspective, the introduction of such flavours is an effective strategy as they cause controversy which leads to discussions about their condoms, which effectively provides free publicity for Karex. He added that Karex is also active on social media marketing, having worked together with Malaysian YouTubers such as Namewee and Jinnyboy.

7. A shareholder wanted to know how the shortage of labour would be addressed, especially after the freezing of foreign worker recruitment. Goh answered that as minimum wages and the costs of social compliance continue to rise, how the company manages its headcount will be critical factor in maintaining its cost advantages in the industry. He added that Karex has continued to incorporate more automation in its manufacturing process, which have not only improved reliability and productivity — especially with the testing of condoms — but also reduced its dependency on labour moving forward.

8. Karex commissioned its new latex compounding facility in Thailand in FY2019. Goh explained that this has allowed management to maintain better control over the quality and cost of latex formulations. Although still in its infancy, he said it has already begun to bear fruit in enabling Karex to produce thinner condoms more consistently, as well as reduce rejection rates in manufacturing facilities. He assured shareholders that improvements will continue to be made to equip Karex with the tools to better insulate itself from the volatility in the latex market. FY2019 capital expenditures of RM19 million were mainly directed at the commissioning of the latex compounding facility and incorporating more automatic testing machines in production lines.

Liked our analysis of this AGM? Click here to view a complete list of AGMs we’ve attended »

Young Jia Yi

Jia Yi has been an investor since the age of 18, following the investing philosophies of Buffett and Munger. He currently works as an industry analyst in an independent investment research firm. He is passionate about understanding how things are interconnected in the world and enjoys reading in his free time.

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