ENGTEX's 9MFY24 results came in below expectations as we expect upcoming quarters to face margin pressures from rising input cost while ASPs remain flat. Nonetheless, we are more inclined to look beyond FY24, expecting increased water pipe orders as water tariff hikes enable operators to kick start long overdue projects. While we keep revenue unchanged, we cut our FY24F and FY25F earnings by a respective 61% and 25% to reflect margin impact, and keep our TP of RM0.81, after rolling forward the valuation base year. OUTPERFORM is maintained.

Below expectations. Its 9MFY24 core net profit of RM12.8m fell short, coming in at only 47% and 44% of our full-year forecast and the full- year consensus estimate, respectively. The key variance against our forecast came largely from weaker-than-expected margins as China's stimulus package fell short of the anticipated impact on steel prices, which remains at 9% below expectation.

YoY, its 9MFY24 revenue declined marginally by 2% due to weak ASPs. Its core net profit fell 14% weighed down by higher operating costs but partially offset by an improved GP margin as reduced steel price volatility resulted in more manageable inventory costs.

QoQ, its 3QFY24 dipped into losses due to weak margins as ENGTEX carried high-cost COGS (arising from the surge in input costs such as HRC, CRC, etc) during a period when steel prices fell gradually, eroding its margins.

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 accelerated in 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 the cooling function of such 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.

Several mega infrastructure projects are set to be rolled out, including:

(i) Sungai Perak Raw Water Transfer Scheme to Penang (SPRWTS), (ii) Langat 2 water treatment plant, and (iii) Sungai Rasau phase 2.

Based on our estimates, the total value of the water pipe components for these projects is approximately RM1.1b.

Forecasts. Given the generally low-base margins, our cut of 1-2 ppts in margins lead to a FY24F and FY25F earnings forecasts cut of 61% and 25%, respectively. This is to reflect compressed margins for its generic steel products, which remain the primary earnings driver, despite our optimistic outlook on water piping demand and without changing revenue assumptions. Recall, fluctuations in steel prices (CRC, HRC, etc) can significantly impact its profitability due to its large revenue base.

Valuations. However, we maintain our TP of RM0.81 as we roll forward our valuation base year to FY25F based on 0.8x 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 - 22 Nov 2024