Results Highlights

• Engtex’s 2Q2018 net profit sank 53.8% Y.o.Y to RM6.3 mln, dragged down by: (i) volatility in international and domestic metal prices that resulted in margins erosion in the wholesale and distribution segment, (ii) higher operating cost from the completed property development projects in Kepong and Selayang, and (iii) the hospitality segment has yet to breakeven. Revenue for the quarter, however, rose marginally by 0.5% Y.o.Y to RM286.1 mln.

• For 1H2018, cumulative net profit slipped 48.7% Y.o.Y to RM16.2 mln. Revenue for the period, however, grew 8.5% Y.o.Y to RM584.3 mln. The reported earnings fell short of our expectations, amounting to only 33.6% of our previous estimated net profit of RM48.1 mln. The reported revenue, however, came within our expectations, accounting to 50.1% our full year estimated revenue of RM1.17 bln. The lower-than expected net profit was due to lower margins recorded in the wholesale and distribution segment, coupled with the escalation of construction cost in its property development projects.

• Segmentally in 1H2018, the group’s wholesale and distribution segment’s pretax profit fell 7.2% Y.o.Y to RM18.2 mln, amid the fluctuation in international and domestic metal prices. The manufacturing segment’s pretax profit sank 59.2% Y.o.Y to RM10.9 mln on higher raw material costs, coupled with the recognition of a disposal gain of a vacant industrial land last year. The property development segment’s pretax loss stood at RM2.2 mln vs. a net profit of RM1.8 mln amid the increase in operating cost for completed projects, whilst the hospitality division remains in the red (pretax loss of RM3.3 mln vs. pretax loss of RM2.7 mln in 1H2017), dragged down by depreciation charges and finance cost.

Prospects

The long overdue Selangor water issue has taken a giant step to resolution after the owners (Gamuda Bhd and Kumpulan Perangsang Selangor Bhd) of Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (SPLASH) have accepted the State government’s takeover offer with the terms and conditions of share purchase agreement to be finalised by 14th September 2018. We reckon that the move bodes well for Engtex as it potentially paves the way to resolve Selangor’s water crisis by accelerating the Selangor’s water treatment plants upgrade and pipe replacement programs in the next 1-2 years.

Moving forward, Engtex’s manufacturing orderbook of approximately RM130.0 mln will continue to provide earnings visibility over the next quarter. Meanwhile, Engtex’s new steel pipe plant in Kuantan and steel mill plant in Melaka that recently commenced operations is expected to breakeven next year, generating an additional RM300.0 mln of revenue per annum in 2019.

Hot-rolled coil prices continues to trend higher, averaging at US$881.39 (+17.7% Q.o.Q) in 2Q2018, boosted by capacity cuts in China, coupled with strong global demand. Albeit that, wire rod price stabilised, rising marginally by 0.4% Q.o.Q to an average of US$678.87 per tonne in 2Q2018 amid the sluggish demand from Europe. With higher materials cost, however, we expect Engtex’s margins to remain soft in 2H2018.

Its property development segment has unbilled sales of approximately RM15.0 mln will provide earnings visibility over the next two years, while unsold stocks amounting to approximately RM150.0 mln will be recognized upon completion of sales. Meanwhile, the group’s hospitality division could remain in the red in 2018 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 slashed our earnings estimates by 16.6% and 16.9% to RM40.1 mln and RM45.4 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 both its property and hospitality segments. Still, we maintain our HOLD recommendation on Engtex, but with a lower target price of RM1.05 (from RM1.15). We continue to like Engtex for its position as one of the leading steel pipe manufacturers in Malaysia, having experienced supplying steel pipes for water treatment and pipe replacement projects in Malaysia that should help it to weather the more challenging operating environment

Our target price was derived from ascribing a unchanged target PER of 8.0x to our 2019 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 2019 earnings due to smaller contribution to the group.

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 lead 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 - 3 Sept 2018