Results Highlights

• Engtex’s 4Q2018 net loss stood at RM7.0 mln vs. a net profit of RM12.1 mln recorded in the previous corresponding quarter, dragged down by: (i) increases in procurement cost for certain metal and steel products, (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 fell marginally by 0.4% Y.o.Y to RM308.5 mln.

• For 2018, cumulative net profit slumped 75.7% Y.o.Y to RM12.1 mln. Revenue for the year, however, grew 9.0% Y.o.Y to RM1.21 bln. The reported earnings fell short of our expectations, amounting to only 50.3% of our estimated net profit of RM24.0 mln. The reported revenue, however, came slightly above our expectations, accounting to 103.3% our full year revenue of RM1.17 bln. The lower-than-expected net profit was due to lower margins recorded in both the manufacturing and wholesale and distribution segments, higher finance cost and the higher effective tax rate at 45.9% vs. our forecast of 30.0%.

• In 2018, the group’s wholesale and distribution segment’s pretax profit fell 22.2% Y.o.Y to RM30.1 mln due to higher procurement cost in certain metal related trading products. The manufacturing segment’s pretax profit sank 90.0% Y.o.Y to RM4.8 mln on additional operating cost from two new manufacturing plants located in Melaka and Pahang and inventory write-off amounting to RM3.4 mln. The property development segment’s pretax loss stood at RM3.8 mln vs. a pretax profit of RM1.7 mln amid the sluggish property sales, whilst the hospitality division remains in the red (pretax loss of RM0.9 mln vs. pretax loss of RM0.7 mln in 2017), dragged down by depreciation charges and finance cost.

Prospects

The completion of the acquisition of Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (SPLASH) by Pengurusan Air Selangor Bhd at the end of February will allow investments to be channeled to upgrading water infrastructure in the Selangor state. We reckon that this bodes well for Engtex – a proxy to one of Malaysia’s key water infrastructure supply player. In the meantime, Engtex could also capitalise on Selangor government’s allocation of RM223.4 mln for water supply infrastructure development in its 2019 Budget, of which RM130.0 mln will be utilised for the construction of the Labohan Dagang Phase 1 water treatment plant and RM25.0 mln for Labohan Dagang Phase 2 as well as for a detailed study on the development of a water treatment plant in Rasau.

Moving forward, Engtex’s manufacturing orderbook of approximately RM300.0 mln will continue to provide earnings visibility over the next two quarters. Meanwhile, we reckon that Engtex’s new steel pipe plant in Kuantan and steel mill plant in Melaka that commenced operations back in 1H2018, will only breakeven in late 2019/early 2020. Despite that, we expect the start-up costs for the two new manufacturing plants to continue biting into the group’s margins.

After a sharp rally since end-2017, hot-rolled coil prices retreated, averaging at US$833.75 (-6.2% Q.o.Q) in 4Q2018 (see Appendix 1) as demand faltered after China’s car sales declined. Likewise, wire rod prices has also peaked in end-October 2018 before staging a sharp pullback, declining 3.8% Q.o.Q to an average of US$658.78 per tonne in 4Q2018 amid the moderating demand from Europe. The lower prices could also mean that Engtex’s margins could be pressured.

Its property development segment will remain downbeat in 2019 in view of the prolonged sluggish property market environment in Malaysia. Meanwhile, we also reckon that Engtex’s hospitality division could continue to drag the segment performance in 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 34.2% and 10.7% to RM23.3 mln and RM34.2 mln for 2019 and 2020 respectively to account for the lower margins from the manufacturing segment, arising from the additional costs from the two new manufacturing plants. 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 as the concrete project timeline has yet to be determined.

We maintain our SELL recommendation on Engtex with a lower target price of RM0.60 (from RM0.80) 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 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 its 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 - 28 Feb 2019