Results Highlights

• Engtex’s 3Q2016 net profit rose 3.3% Y.o.Y to RM11.5 mln on the back of the higher average selling prices (ASP) of certain manufactured steel products and metalrelated trading products, which offsets the softening market demand that saw revenue declining 4.2% Y.o.Y to RM251.7 mln.

• For 9M2016, cumulative net profit added 19.2% Y.o.Y to RM46.9 mln. Revenue for the period, however, decreased 6.7% Y.o.Y to RM810.3 mln. Both the reported earnings and revenue came in below our estimates as its net profit only amounted to 62.9% of our previous full year net profit forecast of RM74.8 mln, while its revenue amounted to 68.4% of our last revenue forecast of RM1.18 bln for 2016.

• Segmentally, the group’s wholesale and distribution segment’s pretax profit added 4.0% Y.o.Y to RM36.0 mln, lifted by the recovery in steel prices. The manufacturing segment’s pretax profit improved 33.6% Y.o.Y to RM31.6 mln, owing to the higher selling ASP on certain manufactured steel products. The property development segment, meanwhile, recorded a pretax profit of RM0.3 mln as oppose to a pretax loss of RM1.5 mln in the previous corresponding period on higher contribution from its Kepong project, Amanja.

• Meanwhile, the group’s net gearing, as at 30th September 2016, fell to 0.8x (from 0.95x in 2Q2016), mainly due to a shorter cash conversion cycle, coupled with minimal capex incurred during the quarter after construction of the piling pipe line is completed and is scheduled to commence operations in 1H2017.

Prospects

The deadline for the takeover offer for the last domestic water concessionaire, Syarikat Pengeluar Air Selangor Holdings Bhd (SPLASH) by the Selangor government has lapsed in early October 2016. We think that the aforementioned deal is likely to be concluded in the following year and this could again delay some of pipe replacement programmes in the state. Moving forward, Engtex could instead capitalise on the recent Budget 2017 allotment of RM500.0 mln for the establishment of a Water Supply Fund to address water supply issues throughout the country.

Elsewhere, the restructuring of Kelantan water services industry was concluded in 3Q2016. The National Water Services Commission (SPAN) has targeted three years to increase the water supply coverage in the aforementioned state to 75.0% (from 60.0% at present). This will encompass the upgrading of current water assets and the construction of new water infrastructure assets. Consequently, the move will generate of some 800.0 mln litres of water per day (MLD), whilst reducing non-revenue water to 35.0% (from 48.0%).

After a sharp recovery in 1H2016, hot-rolled coils prices begun to taper but still manage to climb 3.0% Q.o.Q to an average of US$582 per tonne in 3Q2016 (refer to appendix 1). The contraction was mainly due to the sluggish trade exports data from China which saw a 10.0% Y.o.Y decline in exports in September 2016. Nevertheless, the marginally higher prices could sustain the group’s earnings and margins moving forward.

Engtex’s current manufacturing 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 supply contracts 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 below our estimates, we trimmed our earnings forecast by 18.7% and 20.4% to RM60.8 mln and RM62.9 mln for 2016 and 2017 respectively to reflect the weaker margins due to normalisation of average selling prices (ASP) after the rally in steel prices faded. Consequently, we downgrade our recommendation on Engtex to a HOLD with a lower target price at RM1.30 (from RM1.50). Our target price is derived from ascribing an unchanged target PER of 6.0x to our revised 2017 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 due to 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: Mplus Research - 29 Nov 2016