ENGTEX’s FY23 results disappointed, weighed down by high-cost steel inventory. It is poised for a much stronger FY24 following the recent water tariff hike, which will bolster cash flows of water operators, enabling them to kick start their water projects including pipe replacement. We maintain our forecasts, TP of RM1.41 and OUTPERFORM call.

Below expectations. Its FY23 core net profit of RM10m missed our forecast and the consensus estimate by 14% and 15%, respectively.

The variance against our forecast came largely from higher-than- expected raw material and production costs.

YoY, its FY23 revenue grew marginally by 2%, we believe, due to the recovery in demand for selective steel products. However, its core net profit plunged 69%, weighed down by high-cost inventory (i.e. hot rolled coil, wire rod and scrap metal) amid falling steel prices.

QoQ, similarly, its 4QFY23 core net profit plummeted by 53% on a flattish topline primarily due to high raw material cost.

Outlook. The sentiment towards water-related stocks has improved following 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 (of which some have not been adjusted in the past four decades). 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. We believe a pick-up in pipe replacement orders will be kicking in by 2HFY24 and accelerate into FY25. Also helping is the stabilisation of product prices as steel price bottom out (see chart on next page).

ENGTEX, a water pipe maker, will benefit from spending to reduce the national non-revenue water (NRW) from 36% in 2021 to 15% by 2049. It is estimated that 70%-75% of current NRW is attributed to leaks, pipe bursts, and damaged fittings.

Forecasts. We maintain our FY24F earnings forecasts while introducing our FY25F numbers.

Valuations. We also maintain our TP of RM1.41 based on 0.8x FY24F PBV, which is in line with sector valuation during the last upcycle in 2014 triggered by the massive RM1b Langat 2 water treatment plant with a capacity of 1,130m litres per day (MLD) following the completion of the Pahang-Selangor 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 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, (ii) rising input costs; and (iii) the delay in the roll-out of water infrastructure projects.

Source: Kenanga Research - 1 Mar 2024