ENGTEX’s 1HFY24 results disappointed. This was no thanks to weak sales in 2QFY24 compounded by higher-cost inventory that reared its ugly head again in the quarter. We cut our FY24F earnings by 31% but still expecting a stronger showing in 2HFY24 as the recent water tariff hikes allow water operators to kick start the long overdue water projects including pipe replacement. The sentiment towards water-related stocks has improved, and we keep our TP of RM0.81 which commensurate with previous up- cycle valuations, and leave our OUTPERFORM call unchanged.

Below expectations. Its 1HFY24 core net profit of RM11m disappointed, coming in at only 28% and 26% 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 higher- than-expected input costs in 2QFY24.

YoY, its 1HFY24 revenue was flattish, fell by 3% primarily attributed to the weakening market demand for its steel products. Nonetheless, its core net profit soared more than doubled driven by stronger margins from depleting high-cost inventory with inventory impairments having reduced to RM1.9m versus RM3.2m last year due to the declining steel prices.

QoQ, its 2QFY24 core net profit dipped by 83% on lower sales volume and margin pressure suffered from rising input costs (HRC, CRC, etc), though this has subsequently normalised.

Outlook. The sentiment towards water-related stocks has improved following the 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 4QFY24 and accelerate into FY25 as the tendering and funding process among Pengurusan Aset Air Bhd (PAAB), water operators, and contractors typically takes at least six months to be finalised. Also, the recent surge in the number of data centres setting up in Malaysia will further push the government to address water infrastructure issues, as reliable water supply is crucial for cooling these facilities. ENGTEX, a water pipe maker, will benefit from investments 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.

In the immediate term, stabilisation of product prices such as steel prices bottoming out (Exhibit 1) should provide stability to the group’s earnings. Recall, fluctuations in steel prices (CRC, HRC, etc) can significantly impact its profitability due to its large revenue base.

Forecasts. Despite ASPs likely to hold, our 31% earnings cut is to reflect the higher steel prices in FY24 though it has since eased further in 3Q24. However, we maintain our FY25F numbers.

Valuations. We maintain our TP of RM0.81 based on 0.8x FY24F PBV, in line with sector valuation during the last upcycle in 2014 which was triggered by the massive RM1b Langat 2 water treatment plant with a capacity of 1,130m litres per day following the completion of the Pahang-Selangor Raw Water Transfer project. There is no adjustment to our TP for ESG on 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 - 23 Aug 2024