Results Highlights

Engtex’s 2Q2016 net profit gained 41.0% Y.o.Y, to RM20.8 mln on the back of the extended recovery in steel prices which rose to an 18-month high - resulting in higher average selling prices (ASP) of certain manufactured steel products and metal-related trading products. Revenue for the quarter, however, fell marginally by 0.8% Y.o.Y to RM299.4 mln.

For 1H2016, cumulative net profit climbed 25.4% Y.o.Y to RM35.4 mln. Revenue for the period, however, contracted 7.8% Y.o.Y to RM558.5 mln. The reported earnings came in above our estimates as its net profit amounted to 62.1% of our previous full year net profit forecast of RM57.0 mln, while revenue came within our estimates, accounting to 49.7% of our total revenue forecast of RM1.12 bln for 2016.

Segmentally, the group’s wholesale and distribution segment’s pretax profit fell 2.7% Y.o.Y to RM25.1 mln, mainly due to higher financing cost. The manufacturing segment’s pretax profit, however, gained 58.9% Y.o.Y to RM25.2 mln, owing to the higher selling ASP on certain manufactured steel products. The property development segment, meanwhile, recorded a pretax profit of RM0.1 mln as oppose to a pretax loss of RM0.6 mln in the previous corresponding period, on higher contribution from its Kepong project, Amanja.

Meanwhile, the group’s net gearing as at 30th June 2016 stood at 0.95x, within the management guidance of below 1.0x. We also expect the proposed private placement, which will raise up to RM53.5 mln from an issuance of additional 44.6 mln shares, to be completed in 2H2016.

Prospects

With the near completion of the overdue consolidation of water concessionaires, Pengurusan Air Selangor Sdn Bhd has announced tenders for the potential pipe supply for the pipe replacement programme to tackle the Non-Revenue Water issue. The aforementioned company has allocated RM50.0 mln for the replacement of 59 km of most frequently leaking or burst pipe areas in 2016 and 2017 respectively. We note that Engtex has secured a RM25.0 mln contract to supply Ductile Iron (DI) pipes as part as Selangor’s water pipe replacement project in Taman Melawati, Gombak in end-May 2016.

Meanwhile, hot-rolled coils prices continue to gain traction, rising 39.6% Q.o.Q to an average of US$565 per tonne in 2Q2016 (refer to appendix 1). The said recovery came from the improved demand from China’s business activities, coupled with the country’s cut in its production capacity by 45.0 mln metric tonnes in 2016 and another 100-150 mln metric tonnes over the next three to five years. The higher prices could improve the group’s margins going forward as the ASP are also likely to be raised.

Engtex’s current orderbook of approximately RM100.0 mln will sustain its manufacturing segment’s earnings over the next two quarters. We note that the group is also tendering for approximately RM500.0 mln worth of projects from both the public and private sectors. On the property development segment, its unbilled sales of approximately RM35.0 mln will continue to see little contribution to the group’s total earnings as most of its projects are already completed.

Valuation And Recommendation

As the reported earnings came above our estimates, we raised our earnings forecast by 20.0% and 14.0% to RM68.4 mln and RM73.0 mln for 2016 and 2017 respectively to reflect the stronger margins from higher ASP. Consequently, we upgrade our recommendation on Engtex to a BUY with a higher target price at RM1.50 (from RM1.35).

Our target price is derived from ascribing an unchanged target PER of 6.0x to our revised 2016 forecast earnings of its manufacturing and wholesale and distribution businesses, in line with its historical PER. Its property development segment’s valuation, meanwhile, remains unchanged at 0.6x its BV, based on its relatively small-scale property development projects.

Risks to our recommendation and target price include the continuous steel dumping activities from China that could cause price competition among local steel players and potentially leading to further margin compression. Further cooling measures to curb the property sector and tightening of monetary policies imposed by the Government will be unfavourable to its property development segment.

Source: M+ Online Research - 29 Aug 2016