ENGTEX’s 1HFY23 results disappointed. Its 1HFY23 net profit plunged 84% YoY on lower demand and margin contraction. On a brighter note, we see value in its large-diameter mild steel (MS) pipes and ductile iron (DI) pipes used in water projects. We cut our FY23F and FY24F earnings by 45% and 35%, respectively, but maintain our TP of RM0.58 and MARKET PERFORM call.

Below expectations. Its 1HFY23 core net profit of RM5m disappointed, coming in at only 25% and 13% of our full-year forecast and the full-year consensus estimate, respectively. The key variance against our forecast largely came from the softer demand and lower-than-expected margins for its generic steel products.

Results’ highlights. YoY, its 1HFY23 revenue eased 2% mainly due to lower demand and weaker prices for its steel products. Its core net profit plunged by a larger 84%, weighed down by the double-whammy of weaker ASP but higher inventory cost (i.e. hot rolled coil, wire rod and scrap metal).

Outlook. On the assumption of a stable economic outlook, we expect the demand for ENGTEX’s generic steel products to recover as it is poised to benefit from the revival of water projects nationwide as the new unity government settles in and starts to embark on the roll-out of public infrastructure projects to reduce NRW from 34% in 2020 to 25% by 2025, and 15% by 2049.

Forecasts. We cut our FY23F and FY24F net profit forecasts by 45% and 35%, respectively, to reflect a softer demand and lower margins for generic steel products which is still its key earnings driver.

Our TP remains at RM0.58, despite the change in our valuation basis to 0.3x P/B, at a 50% discount to 0.6x P/B for peer HIAPTEK given ENGTEX’s relatively smaller market capitalisation. We previously valued it at 7x FY24F PER, at a discount to 9x forward PER of HIAPTEK. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment thesis. 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. However, its generic steel products will continue to be a drag given their high-cost inventories, eating into the already thin margins. Maintain MARKET PERFORM.

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

Source: Kenanga Research - 25 Aug 2023