Engtex Group Bhd (Nov 23, 90 sen)

Downgrade to sell with a lower sum-of-parts (SoP)-derived target price (TP) of 80 sen: Engtex Group Bhd’s third quarter ended Sept 30, 2018 (3QFY18) core profit after tax and minority interests (Patmi) of RM700,000 (quarter-on quarter [q-o-q]: -88.5%; year-on-year [y-o-y]: -93.3%), took cumulative nine months ended Sept 30, 2018 (9MFY18) core Patmi to RM16.9 million (-52%). 

The results came in below expectations, accounting for only 56.1% and 53.7% of our and consensus full-year forecasts.

The weaker-than-expected performance was due mainly to: i) higher-than-expected procurement cost in the trading divisions; ii) higher-than-expected raw material cost in the manufacturing division; iii) slower-than-expected utilisation rate in electrical resistance welding (ERW) pipes and rolling mill; and iv) weaker performance in the property division. 

Despite registering stronger revenue in 3QFY18, which was boosted by increased demand during the tax holiday period, core Patmi shrank 88.5% q-o-q and 93.3% y-o-y to RM700,000 in 3QFY18 on the back of higher procurement cost in the trading division, coupled with higher material cost in the manufacturing division. 

In addition, the two newly set-up manufacturing plants (ERW and rolling mill) located in Melaka and Pahang were still in the gestation period, and thus contributed to a slower utilisation rate.

Year to date, 9MFY18 core Patmi fell 52% to RM16.9 million due the time lag in passing on the procurement cost and raw material cost in the trading and manufacturing divisions respectively and the start-up cost in the new manufacturing plants. 

In addition, the hospitality and property divisions continued to incur losses due to the challenging property market. 

The slowdown of construction and property projects may persist over the near term with the lack of new megaprojects and subdued demand for properties. However, the breakthrough of Selangor’s water restructuring exercise could spur stockists’ optimism on pipe demand in FY19. 

Although there is no budget allocation for non-revenue water (NRW) during Budget 2019, the newly appointed Pengurusan Aset Air Bhd chairman could revisit the water supply services industries in supporting government initiatives to bring down the NRW level throughout Malaysia in the coming years, which may translate into potential pipe replacement demand.

We cut our FY18 to FY20 core Patmi forecasts by 42.5%, 45.2% and 38.4% respectively after taking into account the tepid outlook for construction, while the property division may remain sluggish at least over the near term, which may contribute towards a slowdown in the market demand for manufactured steel products (41% of  FY17 revenue).

We downgrade Engtex to “sell” (from “hold”) and lower SoP-derived TP by 29.8% to 80 sen (from previously RM1.14) on the back of subdued construction outlook and softer property environment, translating into weaker demand on manufactured steel products. 

Moreover, the catalyst from the pipe replacement may not be immediate and near-term results are likely to remain weak. — Hong Leong Investment Bank Research, Nov 23

This article first appeared in The Edge Financial Daily, on Nov 26, 2018.

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