ENGTEX is poised for more water pipe orders following the recent water tariff hike which will translate to strengthened cash flows for water operators, allowing them to kick start their capex programmes. In addition, firming steel prices will also boost its overall margins. We raise our FY24F earnings forecast by 69%, lift our TP by 83% to RM1.41 (from RM0.77) and maintain our OUTPERFORM call.

We came away from a recent engagement with ENGTEX feeling upbeat on its prospects. The key takeaways are as follows:

1. As panel water pipe suppliers of Pengurusan Aset Air Bhd (PAAB), Ranhill SAJ, and Pengurusan Air Selangor (PAS), ENGTEX is poised for more orders ahead. This follows the recent announcement by National Water Services Commission (SPAN) of an average hike of RM0.25/m3 or ~42% hike in water tariffs effective 1 Feb 2024 for domestic users (see Exhibit 1).

The hike will translate to strengthened cash flows for these water operators, allowing them to kick start their capex programmes in water infrastructure including non-revenue water (NRW) reduction initiatives. Recall, the government targets to reduce the national NRW from 36% in 2021 to 15% by 2049. Also recall, it is estimated that 70%-75% of the current NRW is attributed to issues such as leaks, pipe bursts, and damaged fittings. Based on our estimate, a 1% drop in NRW would cost roughly RM800m. ENGTEX estimated that there are pipes spanning over 6,292km in urgent need for replacement in Selangor, translating to 350k MT of pipes with a cost of about RM1b.

2. ENGTEX revealed that as at Nov 2023, its order book stood at RM229m (DI pipes: RM30m, MS/pilling pipes: RM199m), while its tender book was at RM720m (DI pipes: RM63m, MS/pilling pipes: RM657m).

3. Meanwhile, it believes steel prices have bottomed out and should at least stabilise at current levels. This is consistent with an 11% rebound in hot-rolled coil (HRC) prices since the low in late-Oct 2023 (see Exhibit 2). Rising steel prices lift selling prices of ENGTEX’s steel product (as steel input cost has been locked in), resulting in margin expansion.

4. We understand that there are plans to divest its non-core assets. The proceeds could significantly reduce its current net debt and gearing of RM495m and 0.62x as at end-3QFY23, respectively, and hence lower its finance costs.

Forecasts. We maintain our FY23F earnings forecast but lift our FY24F earnings by 69% to reflect strong pipe orders and overall margins.

Valuations. Consequently, we raise our TP by 83% to RM1.41 as we recalibrate our PBV valuation basis to 0.8x (from 0.4x previously) to reflect sector valuation during the last upcycle in the water in 2014 triggered by the massive RM1b Langat 2 water treatment plant with a capacity of 1,130 million litres per day (MLD) following the completion of the PahangSelangor Raw Water Transfer project. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 5).

Investment case. 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 mild steel (MS) pipes and ductile iron (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 - 13 Feb 2024