ENGTEX is eyeing for water pipe supply contracts valued at north of RM600m, against its current outstanding order book of RM285m. On the other hand, it is not spared the impact from higher electricity tariff. Hence, while maintaining FY22F earnings, we trim FY23F earnings by 3% and consequently reduce our TP by 3% to RM0.75 (from RM0.77) but maintain our OUTPERFORM call.

We came away from a recent engagement with ENGTEX feeling positive about its water pipe business but cautious on its steel segment. The key takeaways are as follows:

1. ENGTEX is eyeing for water pipe supply contracts worth RM623m, comprising ductile iron (DI) pipes (RM54m), and mild steel (MS) and piling pipes (RM569m). We understand that the demand for DI pipes will come mainly from new water projects as well as pipe replacement programmes to address the high non-revenue water (NRW) numbers, particularly, in Selangor, Sabah and Sarawak. On the other hand, the demand for MS and piling pipes will come from Phase 2 of the Sungai Rasau Water Supply of Air Selangor, on the heels of Phase 1 of the same project.

We expect the government to continue to roll out pipe replacement projects under the 12th Malaysia Plan to bring the NRW down to 25% by 2025 from 34% in 2020. According to Malaysia Water Association (MWA), at present, the water distribution network in Malaysia consists of MS pipes (29.1%), asbestos-cement (AC) pipes (27.1%) and DI pipes (8.0%). We believe the AC pipes will eventually be phased out completely due to health concerns (studies have shown that severely deteriorated AC pipes release asbestos fibre into the water supply) while certain MS and DI pipes in the system have already exceeded their useful lives.

If secured, the new potential water supply contracts will boost ENGTEX’s outstanding order book, currently at RM285m comprising DI pipes worth RM29m coming largely from a two-year renewable contract with Pengurusan Air Selangor (PAS) and MS and pilling pipes worth RM265m coming largely from Sungai Rasau Water Supply (Phase 1).

2. ENGTEX is expected to face some margin compression in 1HFY23 driven by the steep hike in electricity cost i.e. 20 sen/kWh surcharge (from 3.7 sen/kWh previously). Historically, utilities cost make up 5%-10% of total production costs. On a brighter note, the labour shortage issue is easing with the arrival in phases of foreign workers. Thus far, ENGTEX has received c.100 out of 500 workers it applied for.

3. Having plunged 40% in 2HFY22, the company is hopeful that steel prices will improve gradually throughout the year underpinned by China’s reopening. We note that HRC steel prices have thus far rebounded 15% from recent lows.

Forecasts. While maintaining FY22F net profit, we cut FY23F net profit by 3% to reflect the higher electricity cost.

We reduce our TP by 3% to RM0.75 based on FY23F PER of 7x, at a discount to 9x forward PER of peer Hiap Teck Venture given the former’s slightly smaller size. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Overall, we continue to like ENGTEX for: (i) the huge potential in the water pipe replacement market locally, (ii) its dominant market position in both large-diameter MS pipes and DI pipes, and (iii) its strong earnings visibility underpinned by significant order backlogs and a strong pipeline of new projects. Maintain OUTPERFORM.

Risks to our call include: (i) volatility in input costs and end-product selling prices, and (ii) delay in the rollout of water infrastructure projects.

Source: Kenanga Research - 16 Jan 2023