Engtex’s 1H19 core loss of RM0.8m missed consensus and our estimates. Key deviations were mainly due to (i) softer-than-expected demand in trading and manufactured steel products such as MS pipes and wire mesh, (ii) higher-than expected procurement cost of raw materials (i.e. steel billets and wire rods) for manufacturing division and (iii) weak property demand and lower AOR in hospitality division. We slash our FY19-21 core PATAMI forecasts by 33.4%- 49.6%. Maintain SELL with lower SOP-derived TP of RM0.48 from RM0.61. Our SOP-derived TP is based on 9x PE on end-FY19 core PATAMI from WDD and MD and 1.0x book value for the property segment.

Another disappointing quarter. Engtex registered core net loss of RM0.9m in 2Q19 (vs. a core net profit of RM6.3m in 2Q18 and RM0.1m in 1Q19), bringing 1H19 core net loss to RM0.8m. The results missed consensus and our estimates largely due to softer-than-expected market demand for trading and manufactured steel products (especially in MS pipes and wire mesh), higher-than-expected procurement cost in raw materials (steel billets and wire rods) for manufacturing division as well as weak property market.

QoQ. 2Q19 performance turned into a core net loss of RM0.9m (vs. a core net profit of RM0.1m in 1Q19) mainly due to (i) soft demand in the trading and manufactured steel products (i.e. MS pipes and wire mesh), (ii) higher-than-expected procurement cost of raw materials (i.e. steel billets and wire rods) in manufacturing division, (iii) slower delivery during Raya festive in 2Q19 and (iv) weak property demand and lower average occupancy rate (AOR) in the hospitality division.

YoY. 2Q19 core net loss of RM0.9m (vs. RM6.3m in 2Q18) was dragged by soft demand in metal-related trading products, higher procurement cost in the manufacturing division. Besides, both the property and hospitality divisions remained challenging (still loss making) amidst sluggish property environment.

YTD. 1H19 turned into a core net loss of RM0.8m (from a core net profit of RM16.2m in 1H18), mainly due to slower replenishing activities amongst stockist, and lower demand for MS pipes and wire mesh amid the longer-than-expected slowdown in construction and infrastructure activities.

Outlook. Management has highlighted that it has shifted the procurement strategy (changed from sourcing its major feedstock from overseas to local in smaller purchases) starting 2Q19 and may only see a normalised effect by 4Q19 on its cost structure. Meanwhile, we believe both the wholesale & distribution (WDD) and manufacturing (MD) divisions would only recover when construction and infrastructure activities pick up more meaningfully, which would likely to happen sometime by 2H20 onwards.

Forecast. We slash our FY19-21 core PATAMI forecasts by 33.4-49.6% to RM5.2m, RM6.4m and RM10.1m, respectively, reflecting lower EBITDA margin and utilisation rate assumptions at manufacturing division on the back of slower-than-expected recovery in construction and properties activities.

Maintain SELL, TP: RM0.48. Following the downward revision in our core net profit forecasts, we lower our SOP-derived TP by 21.3% to RM0.48 (from RM0.61). Our SOP-derived TP is based on 9x FY20 core PATAMI at WDD and MD division and 1.0x book value for the property segment. In our view, a rerating on the stock would only be warranted should construction activities pick up (which would happen sometime by 2H20 onwards).

Source: Hong Leong Investment Bank Research - 23 Aug 2019