ENGTEX is likely to find a spot in the limelight following its best ever quarterly results in 2Q16, with earnings surging 41%, helped by margin expansion. In addition, it is also poised to benefit in the longer term from several upcoming water pipe replacement projects nationwide and acts as a good proxy to the local water-piping industry. Having said that, while we like the company for its market lead in the local water-piping industry and high involvement in government piping projects, we believe the positives are already priced in. Furthermore, we believe the superb 2Q16 profit margin may not be unsustainable. Hence, ENGTEX is a "Not Rated" with fair value of RM1.36/share.

Best proxy for the domestic piping scene, as it is one of the leading pipe players in the local industry. ENGTEX is also the exclusive pipe supplier for Pengurusan Aset Air Berhad (PAAB) in six states. It is one of the only two players in Malaysia manufacturing Ductile Iron (DI) pipes, able to produce DI pipes of up to 800mm in diameter, claiming to be one of the largest in ASEAN, while its Mild Steel (MS) pipes can go up to 3,000mm diameter. To further sustain competitive advantage, the group is seeking further capex investment of RM8m to increase its DI pipes diameter to 1,200mm, with another RM7m capex to increase MS pipe production capacity by 50% to 66k MT from the current 44k MT, running at 72.5% utilization rate in 1H16, all of which are to be completed by end of FY17.

Potential catalyst in NRW. With non-revenue water in Malaysia higher than most countries in the region at c.36%, we gather that about 3m MT (estimated 44,000 km, worth c.RM10b) of pipes needs to be replaced nationwide as the federal government targets for NRW to be reduced to 25% by 2020. Furthermore, the Selangor government has also allocated RM1b for pipe replacement program. Industry estimates are that there will be a total of eight packages up for tender within these two years (five in FY16, three in FY17), with the first order of RM25m already awarded to ENGTEX. With no official announcements or any time frame, we reckon the entire RM1b project will be fully completed within 5-8 years. All in all, we expect ENGTEX to be a major player and continuously involved in pipe-replacements program nationwide.

Best ever quarterly results in 2Q16. Despite relatively flattish revenue and volume sales, 2Q16 net profit surged 41% YoY/QoQ from RM14.7m in 2Q15/1Q16 to RM20.8m. The positive set of earnings was largely due to margin expansion, which was seen in: (i) MS pipes, with EBITDA margins from 15.7%/22.1% in 2Q15/1Q16 to 23.7%, and (ii) wire mesh, with EBITDA margins from 7.9%/6.2% to 16.53%. This was mainly attributed to an increasing price environment for hot-rolled coil and wire cod in 2Q16, which pushed ASP higher while raw material costs remained lower given its 3-month inventory lag time. However, moving forward, margins should normalize over the coming quarters on the back of sluggish price fluctuations for raw materials.

Current earnings momentum unlikely to repeat. Given the remarkable 2Q16, we project FY16 earnings to grow at 52% to RM61.4m. However, as current favourable margins begin to taper off beyond FY16, FY17 earnings are projected to decline by 16% to RM51.4m, which will still be higher than that of RM40.4m in FY15 through improved margins as ENGTEX should directly benefit from the absence of Megasteel’s monopoly over the hot rolled coil market, leading to lower raw material costs. Our projection implies volume growth of c.4%, based on the current order book of RM122m and tender book of RM297m, with lower overall revenue as we have excluded contributions from its property segment with no new launches in the pipe-line.

Not rated with fair value of RM1.36. We believe the positives are already priced-in as our fair value of RM1.36 is valued at 1SD above its 5-year mean at 8x FY17E PER which is fair for small cap stock. Also, the commendable 2Q16 results may not be unsustainable with margin expecting to taper off while gearing is not low at about 1x at the net level. Upside risks to our Not Rated call include a sustainable profit margin coupled with higher than expected volume growth.

Source: Kenanga Research - 6 Sep 2016