Results Highlights

• Engtex’s 3Q2018 net profit slumped 72.3% Y.o.Y to RM3.0 mln, dragged down by: (i) volatility in international and domestic metal prices that resulted in a margin erosion in both the manufacturing as well as wholesale and distribution segments, (ii) increased operating costs arising from the start-up of two new manufacturing plants, and (iii) higher operating cost for the completed property development projects in Kepong and Selayang. Revenue for the quarter, however, rose 21.2% Y.o.Y to RM315.2 mln.

• For 9M2018, cumulative net profit dipped 54.7% Y.o.Y to RM19.2 mln. Revenue for the period, however, grew 12.6% Y.o.Y to RM899.5 mln. The reported earnings fell short of our expectations, amounting to only 47.9% of our previous estimated net profit of RM40.1 mln. The reported revenue, however, came within our expectations, accounting to 76.9% our full year estimated revenue of RM1.17 bln. YTD, the lowerthan-expected net profit was due to lower margins recorded in both the manufacturing and wholesale and distribution segments, coupled with the higher effective tax rate at 30.1% vs. our forecast of 27.0%.

• Segmentally in 9M2018, the group’s wholesale and distribution segment’s pretax profit fell 6.3% Y.o.Y to RM25.8 mln due to the fluctuation in international and domestic metal prices. The manufacturing segment’s pretax profit sank 66.1% Y.o.Y to RM11.8 mln on additional operating cost from two new manufacturing plants located in Melaka and Pahang. The property development segment’s pretax loss stood at RM3.2 mln vs. a net profit of RM2.8 mln, amid the increase in operating cost for completed projects, whilst the hospitality division remains in the red (pretax loss of RM4.8 mln vs. pretax loss of RM4.8 mln in 9M2017), dragged down by depreciation charges and finance cost.

Prospects

Syarikat Pengeluar Air Selangor Holdings Bhd (Splash Holdings) has entered into a conditional agreement to sell its water treatment concessionaire, Syarikat Pengeluar Air Sungai Selangor Sdn Bhd to the Selangor government for RM2.55 bln at end-September 2018. The move could address Selangor’s water crisis by accelerating the ongoing pipe replacement program in the foreseeable future and could bode well for Engtex’s pipe manufacturing business in due course.

Moving forward, Engtex’s manufacturing orderbook of approximately RM150.0 mln will continue to provide earnings visibility over the next quarter. Meanwhile, we reckon that Engtex’s new steel pipe plant in Kuantan and steel mill plant in Melaka that commenced operations back in 1H2018, is expected to breakeven in late 2019.

Hot-rolled coil prices continue to trend higher, averaging at US$888.63 (+0.8% Q.o.Q) in 3Q2018 (see Appendix 1), boosted by capacity cuts in China coupled with rising global demand. Likewise, wire rod price gained, rising marginally by 0.9% Q.o.Q to an average of US$684.87 per tonne in 3Q2018 amid the moderating demand from Europe. With higher materials cost, however, we expect Engtex’s margins to remain soft for the remainder of the year.

Its property development segment, unbilled sales of approximately RM20.0 mln will provide earnings visibility over the next two years, while unsold stocks amounting to approximately RM150.0 mln will be recognised upon completion of sales. Meanwhile, the group’s hospitality division could remain in the red in both 2018 and 2019 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 40.4% and 14.6% to RM24.0 mln and RM39.7 mln for 2018 and 2019 respectively to account for the lower margins from the manufacturing segment, arising from the additional costs from the two new manufacturing plants, coupled with the higher effective tax rate. We reckon that Engtex’s earnings growth will be choppy, premised to the volatile metal and steel prices, whilst the pipe replacement programme will only see gradual and small contribution from different phases due to the lack of clarity in the project timeline.

Consequently, we downgrade our recommendation on Engtex to SELL (from Hold) with a lower target price of RM0.80 (from RM1.05) amid the cut in its margins and the challenging operating environment. Our target price was derived from ascribing a unchanged target PER of 8.0x to our revised 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 toits 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 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 - 23 Nov 2018