• Upgrade to Add from Hold, with a higher GGM-derived TP of RM0.82, based on 5.5% FY25F ROE, 8.8% cost of equity, and 3% long-term growth rate.

• Potential water tariff hike and more local infrastructure projects in FY24-25F may accelerate earnings growth, and are key rerating catalysts.

• We revise our EPS estimate down by 16.2% in FY23F on higher tax expense and up by 1.1-5.8% in FY24-25F on higher revenue and margins.

Worst Is Almost Over; Optimistic on Local Infrastructure Projects

The key catalyst for the water sector is the proposed water tariff hike to be tabled by the Cabinet, potentially by 30 Nov or early-2024, paving the way for larger and more structured capex allocations for pipe replacements beyond the annual c.RM1bn from Pengurusan Aset Air Berhad. If the tariff hikes materialise, it would accelerate water infrastructure upgrade projects, and Engtex, as one of the few domestic players capable of producing larger diameter ductile iron (DI) and mild steel (MS) pipes, as well as a supplier of other construction materials (e.g. wire mesh, steel bars), should be a key beneficiary, in our view.

Metal Pricing May Have Found a Floor; Iron Ore Prices Rebounding

Local steel (Fig 3) and pipe (Fig 4) prices have largely stabilised in the past four months, which may provide room for margin expansion (from 2022’s lows) and better earnings visibility. Of note, Chinese iron ore pricing has risen 23.8% (as of Oct 23) since May 23, potentially translating into higher local steel prices and providing a short-term boost to Engtex’s margins, given the estimated 2-3 months of raw material inventory kept on hand.

Higher Non-deductible Tax May Drag Profits in the Near Term

9M23 core net profit came in at RM8.6m (-77.9% yoy), below expectations at 59.7% of our FY23F estimate and 65.1% of Bloomberg consensus’. This was largely due to higher-thanexpected non-deductible tax expenses of RM2.1m (-21.6% yoy), which, coupled with a lower PBT of RM14.0m (-74.3% yoy), resulted in an effective tax rate of 36.4% (+11.7% pts yoy). Operationally, Engtex performed within expectations, with revenue of RM1.1bn (74.7% of our FY23F estimates) and EBITDA of RM48.3m (72.8% of our FY23F estimate).

Upgrade to Add With a Higher GGM-derived TP of RM0.82

We raise our FY24-25F core EPS by 1.1-5.8% (Fig 1) to account for the better operating environment, but lower our FY23F EPS (Fig 1) on higher tax expenses. We upgrade our recommendation to Add in view of the better operating environment and higher earnings outlook, with a GGM-derived TP of RM0.82, using a 5.5% FY25F ROE, 8.8% cost of equity, and 3% long-term growth rate. Our new TP translates into a CY25F P/E multiple of 7.5x, which is 0.5 s.d. below its historical mean. Key re-rating catalysts: 1) roll-out of local infrastructure and construction projects, and 2) stabilisation of metal prices translating into margin improvements. Key downside risks: 1) further delays in water tariff hikes, 2) slowerthan-expected rollout of construction projects, and 3) significant volatility in metal prices, all of which could negatively impact Engtex’s earnings growth.

Source: CGS-CIMB Research - 27 Nov 2023