Results Highlights

• Engtex’s 1Q2018 net profit fell 44.8% Y.o.Y to RM9.9 mln as the previous corresponding period’s earnings included a one-time gain of RM7.1 mln from the sale of a piece of vacant industrial land in Johor. Revenue for the quarter, however, gained 17.5% Y.o.Y to RM298.2 mln.

• The reported earnings fell short of our expectations, amounting to only 15.9% of our estimated net profit of RM62.1 mln. The reported revenue, however, came within our expectations, accounting to 25.7% our full year estimated revenue of RM1.16 bln. The lower-than-expected net profit was due to lower margins recorded in the manufacturing segment, coupled with the escalation of construction cost in its property development project – Amanja, Kepong.

• Segmentally in 1Q2018, the group’s wholesale and distribution segment’s pretax profit climbed 39.5% Y.o.Y to RM9.0 mln, lifted by the demand recovery for certain metal related trading products. The manufacturing segment’s pretax profit, however, slipped 53.9% Y.o.Y to RM8.6 mln after the segment’s earnings was boosted by a disposal gain of the vacant industrial land last year.

• The property development segment’s pretax loss stood at RM1.9 mln vs. a net profit of RM1.0 mln, amid the increase in construction cost for Amanja Kepong, whilst the hospitality division remains in the red (pretax loss of RM1.6 mln vs. pretax loss of RM1.5 mln in 1Q2017), dragged down by depreciation charges and finance cost. Meanwhile, the group’s net gearing as at 1Q2018 rose to 0.7x (from 0.6x in 4Q2017). Moving forward, Engtex aims to pare down its gearing to 0.5x by 2020 on minimal CAPEX spending for its plant expansion.

Prospects

Following the unexpected change in the Federal Government, we expect the new government to place priority in resolving the Selangor water issue that has been long delayed. This bodes well for Engtex as it is one of the largest pipe supplier in Malaysia. Already, Engtex is supplying its water pipes for part of the Selangor pipe replacement program over the past year and its average utilisation rate of below 50.0% will be ample for it to meet new orders.

Moving forward, Engtex’s manufacturing orderbook of approximately RM300.0 mln will continue to provide earnings visibility over the next quarter. We expect Engtex’s expansion plan that revolves around the production of larger diameter ductile iron pipe to 1,200 mm (from 800 mm) to be completed by 4Q2018.

Hot-rolled coil prices have rallied, averaging at US$748.61 (+21.6% Q.o.Q) in 1Q2018 after U.S. President Donald Trump imposed a 10.0% tariff on the imports of aluminium and a 25.0% tariff on imports of steel. Despite that, the rally in wire rod prices have abated moving into 1Q2018, falling 4.4% Q.o.Q to an average of US$676.12 per tonne in 4Q2017 amid the sluggish demand from Europe. With higher materials cost, however, we expect Engtex’s margins to be affected going forward.

Its property development segment, with unbilled sales of approximately RM20.0 mln, will provide earnings visibility over the next two years. Meanwhile, the group’s three projects under the hospitality division could remain in the red in view of the competitive room rates across various hotels that offer similar facilities.

Valuation and Recommendation

With the reported earnings coming below our forecast, we trimmed earnings estimates by 22.6% and 16.2% to RM48.1 mln and RM54.6 mln for 2018 and 2019 respectively to account for the lower margins from the manufacturing segment that is likely to endure stiffer price competition and higher raw material cost, coupled with the higher cost incurred in the Amanja, Kepong property development project. Consequently, we downgrade Engtex to HOLD (from BUY) recommendation with a lower target price of RM1.15 (from RM1.30). Our target price was derived from ascribing a unchanged target PER of 8.0x to our revised 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, while its hospitality segment earnings is pegged to an unchanged PER of 6.0x to its 2018 earnings due to smaller contribution to the group.

Risks to our recommendation and target price include the continuous steel dumpingactivities 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 - 25 May 2018