Result Highlights

• Engtex's 302017 net profit declined 5.8% Y.o.Y to RM10.8 min, dragged down by  the softer demand for certain metal-related products amid the volatility in metal  prices, whilst its hospitality division that was launched in 402016 remains in the  red. Revenue for the quarter, however, added 3.3% Y.o.Y to R14260.1 min. For  9142017, cumulative net profit decreased 9.8% Y.o.Y to RM42.3 min. Revenue for  the period fell marginally by 1.4% Y.o.Y to 81.4798.7 min. 
• The reported earnings came in slightly below our forecasts - accounting to 71.9%  our previous full year estimated net profit of RM65.2 min, while the reported  revenue came within our expectations, accounting to 74.7% of our 2017 revenue  forecast of RM1.07 bin. 
• Segmentally, the group's wholesale and distribution segments pretax profit  decreased 23.7% Y.o.Y to RM27.5 min due to softer demand amid the volatility in  metal prices. The manufacturing segments pretax profit, however, expanded 10.4%  Y.o.Y to RM34.9 min with the increased sales of mild steel concrete-lined pipes and  certain steel products. The property development segment pretax profit jumped to  RM2.8 min (from RM0.3 min recorded in in the previous corresponding quarter) on  higher billings from the Amanja project, whilst the hospitality division recorded a  pretax loss of RI1/413.5 min after a years operation. 
• Meanwhile, the group's net gearing as at 30th September 2017 stood at 0.7x, down  from 0.8x in 1 H2017. Moving forward, Engtex aims to pare down its gearing to 0.5x  via the utilisation of proceeds from the conversion of its 148.5 min Warrants-A. An  interim dividend of 0.75 sen per share was declared. 

Prospects

Once again, the extended deadline for the takeover of SPLASH by Air Selangor has lapsed in October 2017 after the Federal Government has yet to provide a valuation assessment for the takeover deal. With no resolution in place, the deal has been pushed to a new deadline in July 2018. The situation appears to more severe with Puncak Niaga Bhd seeking to claim damages, interest on damages and costs of loss of local and foreign business opportunities totaling RM13.49 bln. The above events will delay the much needed pipe replacement projects that would in turn sap the demand for Engtex’s pipes.

On its own, Engtex’s new steel pipe plant in Kuantan, Pahang and a steel mill plant in Merlimau, Melaka will be completed and operational in 1Q2018. Upon completion of both plants, we expect an additional contribution of approximately RM100.0 mln to the group’s topline for 2018.

Moving forward, Engtex’s outstanding manufacturing orderbook of approximately RM200.0 mln (up from RM152.0 mln in 2Q2017) will provide earnings visibility over the next 3-4 months. In the meantime, the group is tendering approximately RM350.0 mln worth of piping projects. We believe that Engtex stands as one of the beneficiaries of the RM1.40 bln allocation to reduce non-revenue water programme, coupled with RM200.0 mln allocation to FELDA for water supply to rural developments in Budget 2018.

After a sharp rally in 2016, hot-rolled coil prices stabilised, trading at an average US$622.75 (+1.1% Q.o.Q) per tonne in 3Q2017 (refer to Appendix 1). On the other hand, wire rod prices rose to an average of US$639.99 (+16.3% Q.o.Q) per tonne in 3Q2017 (refer to Appendix 2). The said improvement vs. the preceding quarter was due to the Chinese government’s effort in slashing capacity in bid to crack down environmental pollution, despite the solid global demand.

Its property development segment that has an unbilled sales and unsold units worth RM22.2 mln and RM150.0 mln respectively will provide earnings visibility over the next two years. We expect some nine bumiputra units from Engtex’s Tiara Residence project that were released for sale to the general public to be sold in progressively towards 2018. Meanwhile, the group’s three projects under the hospitality division will continue to see minimal contributions over the next two years.

Valuation and Recommendation

With the reported earnings coming below our expectations, we trim our earnings estimates by 10.1% and 5.6% to RM58.6 mln and RM70.1 mln for 2017 and 2018 respectively after adjusting for margins contraction in the manufacturing segment, coupled with higher effective tax rate at 27.0% (vs 26.0% previously).

However, we maintain our BUY recommendation on Engtex with a lower target price of RM1.35 (from RM1.40). Our target price was derived from ascribing a unchanged target PER of 8.0x to our 2018 earnings forecast of its manufacturing and wholesale and distribution businesses, in line with its historical PER. Its property development segment’s valuation 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 - 24 Nov 2017