Results Highlights

• Engtex’s 1Q2019 profit slumped 98.8% Y.o.Y to RM118,000, dragged down by: (i) soft demand that contributed to lower utilisation rates and increases in procurement cost for certain metal and steel products that bit into the manufacturing and wholesale & distribution segments’ margins, (ii) higher operating cost for the completed property development projects in Kepong and Selayang, and (iii) hospitality segment remaining in the red. Revenue for the quarter fell 8.0% Y.o.Y to RM274.2 mln.

• The reported earnings fell short of our expectations, amounting to only 0.5% of our previous estimated net profit of RM22.7 mln. The reported revenue also came below our expectations, accounting to 21.4% of our last full year revenue forecast of RM1.30 bln.

• In 1Q2019, the group’s wholesale and distribution segment’s pretax profit fell 32.6% Y.o.Y to RM6.1 mln due to higher procurement cost in certain metal related trading products. The manufacturing segment’s pretax loss stood at RM1.0 mln vs. a pretax profit of RM8.6 mln in the previous corresponding period on additional operating cost from two new manufacturing plants located in Melaka and Pahang. Both the property development and hospitality segments remain in the red on the weak property market, coupled with intense competition in hotel room rates.

• In 1Q2019, Engtex’s gearing level fell to 0.6x (from 0.8x recorded in 4Q2018) as the expansion of its two new manufacturing plants were completed in 2018.

Prospects

On the group’s expansion plans, the installation and commissioning works are being carried out to add a new casting, annealing and parts of finishing facility to produce larger diameter ductile iron (DI) pipes from 800 mm currently to up to 1200 mm will be completed in 2Q2019. Engtex hopes to capitalise on the allocation of RM1.3 bln under the 11th Malaysia Plan to be spent over the next three years to tackle the Non-Revenue Water issue. The upgrading of the DI pipe diameter places the group in a good position to undertake the on-going pipe replacement programme in Selangor and seven other states undertaken by PAAB, FELDA and on the Pan Borneo Highway.

Hot-rolled coil prices continues to trend lower, averaging at US$701.46 (-15.9% Q.o.Q) in 1Q2019 (see Appendix 1) whilst wire rod prices that peaked in end-October 2018 saw continuous weakness, declining 7.6% Q.o.Q to an average of US$609.03 per tonne in 1Q2019 amid the prolonged trade tension between the U.S. and China. The lower prices could also mean that Engtex’s margins will be pressured further.

Elsewhere, a total of over RM100.0 mln worth of unsold stocks, from the three property projects – Tiara Residence, Emerald Avenue and Amanja will be recognised upon completion of sales. Moving forward, there will be no future launches from its 131.3 ac. landbank, in view of the tepid property market sentiment. Elsewhere, we continue to see the hospitality segment, comprising of three hotels in Selangor, remaining in the red, pressured by the competitive room rates.

Valuation and Recommendation

With the reported earnings coming below our forecast, we slashed our earnings estimates by 73.3% and 61.6% to RM6.0 mln and RM12.7 mln for 2019 and 2020 respectively to account for the lower margins from both the manufacturing and wholesale & distribution segments, arising from the additional costs from the two new manufacturing plants, coupled with higher procurement costs.

We reckon that Engtex’s earnings will be choppy, premised to the volatile metal and steel prices over the foreseeable future, 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, whilst both the property development and hospitality segment is expected to remain in the red for the remainder of the year.

We maintain our SELL recommendation on Engtex with a lower target price of RM0.48 (from RM0.60) amid the cut in its margins and the challenging operating environment. Our target price was derived from ascribing an unchanged target PER of 8.0x to our revised 2019 earnings forecast of its manufacturing and wholesale & distribution businesses, in line with its historical PER. 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, while 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 - 27 May 2019