9M18 core PATAMI of RM16.9m (-52% YoY) missed expectations, accounting for only 56.1% and 53.7% of our and consensus full-year forecasts. Key deviations include time-lag in passing on higher procurement and raw material costs in trading and manufacturing divisions, and slower demand in the property and hospitality segment. We cut our FY18-20 core PATAMI forecasts by 38.4-45.2% after factoring the slower demand of manufactured steel products on the back of softer construction and property environment moving forward. Downgrade to SELL (from Hold) lower SOP-derived TP of RM0.80 from RM1.14.

Missed expectations. 3Q18 core PATAMI of RM0.7m (QoQ: -88.5%; YoY: -93.3%), took 9M18 core PATAMI to RM16.9m (-52%). The results came in below expectations, accounting for only 56.1% and 53.7% of our and consensus full-year forecasts.

Deviations. The weaker-than-expected performance was due mainly to (i) higher than-expected procurement cost in the trading divisions, (ii) higher-than-expected raw material cost in the manufacturing division, (iii) slower-than-expected utilisation rate in ERW and rolling mill and (iv) weaker performance at the property division.

QoQ/YoY. Despite registering stronger revenue in 3Q18 (boosted by increased demand during tax holiday period), core PATAMI shrunk 88.5% QoQ and 93.3% YoY to RM0.7m in 3Q18 on the back higher procurement cost in trading division, coupled with higher material cost in the manufacturing division. In addition, the two newly setup manufacturing plants (ERW and rolling mill) located in Melaka and Pahang were still in the gestation period, contributed to a slower utilisation rate.

YTD. 9M18 core PATAMI fell 52% to RM16.9m due the time-lag in passing on the procurement cost and raw material cost in the trading and manufacturing division, respectively and the start-up cost in the new manufacturing plants. Also, hospitality and property division continued to incur losses due to challenging property market.

Outlook. The slowdown of construction and property projects may persist over the near term with the lack of new mega projects and subdued demand for properties. However, the breakthrough of the Selangor’s water restructuring exercise could spur stockists’ optimism on pipes demand in FY19. Although there is no budget allocation on NRW during Budget 2019, the newly appointed Pengurusan Aset Air Berhad (PAAB) chairman could revisit the water supply services industries in supporting government initiatives to bring down the NRW level throughout Malaysia in the coming years, which may translate to potential pipe replacement demand.

Forecast. We cut our FY18-20 core PATAMI forecasts by 42.5%, 45.2% and 38.4% respectively after taking into account the tepid outlook for construction while the property division may remain sluggish at least over the near term, which may contribute towards a slowdown in the market demand for manufactured steel products (41% of FY17 revenue).

Downgrade to SELL with lower TP of RM0.80. We downgrade Engtex to SELL (from Hold) and lower our SOP-derived TP by 29.8% to RM0.80 (from previously RM1.14) on the back of subdued construction outlook and softer property environment, translating towards weaker demand on manufactured steel products. Moreover the catalyst from the pipe replacement may not be immediate and near term results are likely to remain weak. Our SOP-derived TP is based on 9x PE on end-FY19 (after rolling over our valuation horizon from mid-FY19) core PATAMI from WDD and MD and 1.0x book value of FY17 property segment.

Source: Hong Leong Investment Bank Research - 23 Nov 2018