Initiation Report 7 August 2017 Engtex Bhd Beneficiary of nationwide piping projects

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1 JF APEX SECURITIES BERHAD (47680-X) Initiation Report 7 August 2017 Engtex Bhd Beneficiary of nationwide piping projects BUY KLCI points Share Price RM1.27 Target Price RM1.60 Expected share price return 26% Expected dividend return 0.8% Expected total return 26.8% Stock Data Bursa / Bloomberg code 5056 / ENGT MK Market / Board Main / Industrial Issued shares (m) Market cap RM453.9m Par value RM week price Range RM Beta (against KLCI) m Average Daily Volume 1.97m 3-m Average Daily Value^ RM2.66m Share Performance 1m 3m 12m Absolute (%) Relative (%-pts) Major Shareholders % DATO NG HOOK MANULIFE ASSET MANAGEMENT 5.21 CRYSTAL IMAGE SDN BHD 4.80 Estimated free float Source: Bloomberg Lee Cherng Wee , ext. 759 leecw@jfapex.com.my This report is also accessible at Investment Highlights More than 30 years experience - Engtex is the largest distributor of non-oil & gas pipes, valves and fittings (PVF), plumbing materials, building & construction materials, general hardware products and steel related products. With over 30 years of experience, Engtex has a wide distribution network around the country. Leadership position - During the same period, Engtex also established itself as a dominant pipe manufacturer catering to the water and sewerage sectors. Engtex also ventured into production of wire mesh to cater for the construction and infrastructure sectors and is currently among the top 3 wire mesh manufacturers in Malaysia. Benefit from govt. infra spending - Being a leading integrated pipeline systems provider and supplier, Engtex is a beneficiary of nationwide piping projects from both public and private sectors. Earnings growth would come from water & sewerage projects on the back of the ongoing expenditure on infrastructure undertaken by the federal government under 11MP and state governments. More contracts from Langat 2? Under the Langat 2 water treatment plant project, Engtex has secured RM127m worth of piping contracts from Phase 1 & 2 and is looking to bid for more jobs from Phase 3 & 4. New water treatment plants - The Selangor government announced its plan to build two water treatment plants with a combined cost of RM800m to be completed in end-2017 and Pipe replacement - Apart from new piping projects, there is also potential for pipe replacement in line with the government s target to reduce NRW to 25% by 2020 by replacing burst pipes. Steady orderbook - Engtex s orderbook currently stands at RM175m to be delivered in 3 to 4 months. The company is bidding for another RM340m worth of jobs from all around the country as well as the Asean region. Flat property earnings not a concern - With the Amanja serviced apartments to be fully completed later this year, earnings contribution from the property division is expected to be flat until new property launches. On the hospitality side, start-up costs of a third new hotel would weigh on the division s earnings. However, we are not overly concerned as property and hospitality contribute only 3.7% of 1Q17 revenue. The lion share of group s earnings is contributed by the Manufacturing Please read carefully the important disclosures at end of this publication

2 and Wholesale & Distribution arms that mainly cater for sectors such as Water & sewerage, Infrastructure and Construction. Background Overall, we expect 2017 and 2018 net profit to grow 5.3% and 18.7% on the back of revenue growth of 2.2% and 7.9% respectively. Cash proceeds from warrants - Engtex has 133m warrants which will expire in October Conversion of the warrants could raise RM110m to reduce borrowing, expand production and fund upcoming property development. Valuation & Recommendation We are initiating coverage on Engtex with a BUY call at a target price of RM1.60 based on FY18F EPS with forward PER of 10.2 times, based on industry peer average. This translates into a potential upside of 26% against its current share price. Engtex was founded by managing director Dato Ng Hook in 1983 when it started off as a hardware shop in Jalan Ipoh, Kuala Lumpur. Over the past 30 years, Engtex has grown into the largest distributor of non-oil & gas pipes, valves and fittings (PVF), plumbing materials, steel and hardware products. During the same period, Engtex also established itself as a dominant pipe manufacturer catering to the water and sewerage sectors. Being a leading player in the pipe industry, Engtex, then, ventured into production of wire mesh to cater for the construction and infrastructure sectors and is currently among the top 3 wire mesh manufacturers in Malaysia. In 2002, Engtex was listed on Bursa Malaysia and commenced ductile iron (DI) pipe manufacturing. Business units Engtex has four business divisions, namely 1) Manufacturing; 2) Wholesale & Distribution; 3) Property Development and 4) Hospitality. 1) Manufacturing Under the Manufacturing division, Engtex s main products are ductile iron (DI) pipes, mild steel (MS) pipes and wire mesh. These three products contribute about 80% of 1Q17 revenue with the balance coming from other products such as valves, fittings, manhole covers, hydrants, industrial casting products, and other steel products. 2

3 Engtex is one of the few local players that could manufacture large diameter pipes and is able to produce MS pipes up to 3-metre diameter. The company is also the larger of the two DI pipe producers in Malaysia and among the top 3 manufacturers of wire mesh and hard drawn wire. Ductile iron pipes (DI pipes) Mild steel (MS) pipes Wire mesh Valves & fittings In recent years, Engtex has embarked on capacity expansion and has established production plants all around Malaysia to serve customers nationwide and tap into the Singaporean and East Malaysian markets. Production plants and capacity Tonnes WIRE MESH per year Ijok Kuala Selangor 96,000 Seberang Perai Penang 12,000 Gebeng Kuantan 36,000 Johor Bahru Johor 36,000 Bukit Minyak Penang 12,000 Kota Kinabalu Sabah 18, ,000 DI PIPES Gebeng Kuantan 60,000 MS PIPES Serendah Selangor 66,000 3

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5 2) Wholesale & Distribution Engtex is the largest distributor of non-oil & gas pipes, valves and fittings (PVF), plumbing materials, building & construction materials, general hardware products and steel related products. The company positions itself as the leading one-stop pipeline system provider in Malaysia by offering an extensive and comprehensive product mix of more than 150 product categories and 5,000 product items. With over 30 years of experience, Engtex has the advantage of wide distribution network around the country and enjoys cost leadership from its bulk purchases that it could afford discounts to customers. Inhouse brands make up 40% of product range while the balance is sourced from over 300 local and foreign suppliers. The company operates from its warehouses in Sg Buloh, Selangor and Seberang Perai, Penang. It currently has over 4,000 active customers in various industries such as water supply, sewerage system, telecommunication, construction and infrastructure. 3) Property development Engtex has completed two developments in Selayang with only one ongoing development in Bandar Sri Damansara which is 69% completion and would wrap up in Currently, unbilled sales stand at RM31.1m. Going forward, Engtex has earmarked its landbank in Gambang, Pahang for potential development of affordable housing for government servants under the Perumahan Penjawat Awam 1Malaysa (PPA1M) scheme, and Kuang, Selangor (along Guthrie Corridor Expressway) for residential property development. LAND UNBILLED UNSOLD AREA GDV TAKE UP SALES STOCK LOCATION PROJECT (acres) TYPE (RM 'm) RATE (RM 'm) (RM 'm) DURATION Selayang Tiara Residence 3.9 Link houses 83 78% Completed Selayang Emerald Avenue 3.6 SOHO % Completed Shop offices % Duplex % Sri Amanja 1.84 Amani % Damansara Baris % % completed Tiara Residence, Selayang

6 Amanja, Bandar Sri Damansara Emerald Avenue, Selayang 4) Hospitality Engtex is currently operating two hotels, namely 144-room Ibis Style, in Bandar Sri Damansara and 72- room Avenue J near Central Market, Kuala Lumpur. Both hotels have occupancy rates of 61.3% and 13.2% respectively in 1Q17. The management is planning to open a new hotel at its Emerald Avenue development by end of this year. Avenue J at Central Market, KL Ibis Style, Sri Damansara 6

7 Financial Highlights The lion share of earnings is contributed by the Manufacturing and Wholesale & Distribution arms that mainly cater for sectors such as Water & sewerage, Infrastructure and Construction. Revenue crossed RM1b mark in 2013 and since has stayed above the level, achieving a 5-year CAGR of 3.9% thanks to higher demand of Wire Mesh and MS pipes. In 2016, the slowdown in construction and property development led to revenue declined by 7.5% YoY to RM1.07b following the decline in market demand for metal-related trading products and manufactured steel products as well as lower contribution from its property development & hospitality division. 7

8 Despite lower sales in 2016, EBITDA and net earnings increased 23% YoY and 47% YoY respectively due to recovery in steel prices and effective utilization of resources including the sourcing of trading products and raw materials locally and abroad. EBITDA improved at a 5-year CAGR of 16.7% and net profit grew at a 5-year CAGR of 19.3%. Margins shielded from commodity and forex fluctuations - On fluctuations in raw material price and foreign currency, Engtex has the ability to pass them on to customers as its contracts are short term in nature and materials are ordered in advance. Wire rod accounts for 89% of wire mesh production cost while hot-rolled coil/steel plate makes up 76% of MS pipe cost. For DI pipes, scrap metal consists of 56% of cost but it is sourced locally, thus is without forex exposure. Overall, EBITDA margin improved steadily to 12% in 2016 from single digit growth rate previously following economies of scale from its production lines. Cash proceeds from warrants - Engtex has 133m warrants which will expire in October Conversion of the warrants could raise RM110m to reduce borrowing, expand production and fund upcoming property development. As such, net gearing of 0.9x is expected to decrease to 0.5x with proceeds from warrants conversion. Management is also looking at disposal of non-core assets such as residential properties and small plots of land. Over the years, Engtex has been paying annual dividend of around 1 sen/share translating into a yield of 0.8%. There could be potential for higher dividend following the warrants conversion. 8

9 Hot rolled coil price on New York Mercantile Exchange (USD/tonne) Hot rolled coil price on Shanghai Futures Exchange (CNY/tonne) China Weekly Steel Wire Rod 6.5mm Export Price (USD/tonne) Steel Price Index Wire Rods (CNY/tonne) Source: Bloomberg Potential catalysts Being a leading integrated pipeline systems manufacturer and supplier, Engtex can ride on nationwide piping projects from both public and private sectors. The company can benefit directly through supplying pipe products directly to the project or indirectly by selling to contractors. Under the 11 th Malaysia Plan ( ), the government has allocated development expenditure of RM260b with half of it going to infrastructure. The government has set the following targets: Reduce wastage and non-revenue water (NRW) to 25% 9

10 Achieve 99% clean and treated water Increase coverage of sewerage connected services to rural areas Develop new treatment plants with focus to states with lower water supply reserve margins Rationalise 3,000 small inefficient sewage treatment plants by constructing regional centralized plants with larger capacities Among potential projects that Engtex can benefit from are: Langat 2: Under the Langat 2 water treatment plant project, Engtex has secured RM127m worth of piping contracts from Phase 1 & 2 and is looking to bid for more jobs from Phase 3 & 4. New water treatment plants: The Selangor government announced its plan to build two water treatment plants in Jenderam Hilir, Semenyih and Labohan Dagang, Kuala Langat with a combined cost of RM800m to be completed in end-2017 and 2019 respectively. Pipe replacement: Apart from new piping projects, there is also potential for pipe replacement in line with the government s target to reduce NRW to 25% by 2020 by replacing burst pipes. The management estimates about 43,890km (about 3m metric tonne) of AC pipes that need to be replaced with value of about RM10b, out of which 6,423km (350k metric tonne) will be in Selangor with a value of RM1b. Pengurusan Air Selangor Sdn Bhd (PAS) has called for the first tender of the pipe replacement project. 10

11 Earnings Outlook Earnings growth could come from the water & sewerage and on the back of the ongoing expenditure on infrastructure by the government under 11MP and state governments. Engtex s orderbook currently stands at RM175m (RM35m: DI pipes + RM140m: MS pipes) to be delivered in 3 to 4 months. The company is bidding for another RM340m worth of jobs (RM70m: DI pipes + RM270m: MS pipes) from all around the country as well as the Asean region. Overall, we expect 2017 and 2018 net profit to grow 5.3% and 18.7% with revenue growing 2.2% and 7.9% respectively on the back of higher demand for MS pipes and wire mesh as well as lower tax rate assumption. With the Amanja serviced apartments to be fully completed later this year, Engtex will have no property development project in the immediate pipeline. As such, earnings contribution from the property division is expected to be flat until new launches. The company has earmarked two landbanks for development in Gambang, Pahang and Kuang, Selangor. On the hospitality side, start-up costs of a third new hotel would weigh on the division s earnings. However, we are not concerned as property and hospitality contribute only 3.7% of 1Q17 revenue. SWOT Analysis Strengths - Over 30 years experience and nationwide network in distributing hardware products - Leading manufacturer of MS & DI pipes and wire mesh - One-stop centre for pipe products and solutions - Non-core assets (residential properties and small plots of land) available for disposal Opportunities - Beneficiary of infrastructure expenditure under 11MP - New piping projects and water treatment plants such as Langat 2 - Government s pipe replacement projects to reduce NRW - Has landbank for future property development Weaknesses - Property earnings expected to be flat with no new launches at the moment - Hospitality division is still trying to breakeven and opening its new hotel later this year could face start-up costs - Low dividend yield as a result of high gearing and expansion but situation could improve with proceeds from warrants conversion Threats - Prolonged slowdown in construction and property sector could lower demand for pipes and wire mesh - Risk in replenishing orderbook if the company fails to secure new contracts - Execution risks which could result in delay in project delivery - Regulatory risks such as change in rules on steel import and anti-dumping which could affect supply Recommendation We are initiating coverage on Engtex with a BUY call at a target price of RM1.60 based on FY18F EPS with forward PER of 10.2 times based on industry peer average. This translates into a potential upside of 26% against its current share price. Company Market PE(x) P/B(x) ROE Div. 4-Aug-17 Cap. (RM'm) Current Est Est (%) Yield (%) ANN JOO RESOURCES BHD 3.0 1, CHIN HIN GROUP BHD JAKS RESOURCES BHD HIAP TECK VENTURE BHD PANTECH GROUP HOLDINGS BHD CHOO BEE METAL INDUS BHD YLI HOLDINGS BHD Source: Bloomberg, JF Apex 11

12 Income Statement (RM million) Year end Dec F 2018F Wholesale & Distribution Manufacturing Property Dev & Hospitality TOTAL REVENUE , , , , , ,184.1 Cost of Goods Sold (804.7) (934.8) (1,014.3) (992.3) (875.0) (900.1) (971.0) Gross Margin Depreciation (13.8) (15.0) (15.1) (16.6) (19.1) (20.0) (20.9) Other Operating Income Other Operating Expenses (2.1) (3.1) (2.0) (1.5) (6.4) (3.3) (3.6) Sales, General &Administration Cost (49.4) (56.5) (70.4) (70.8) (72.7) (71.4) (77.0) Operating Profit Interest Expense (12.3) (14.8) (18.4) (22.9) (22.9) (23.6) (19.8) Interest Income Profit before Tax Tax (11.1) (16.3) (18.3) (20.0) (25.4) (21.6) (25.4) Profit after Tax Minority Interest (1.7) (3.7) (2.3) (2.2) (2.4) (2.4) (2.4) Profit after Tax and Minority Interest Dividends (2.8) (2.8) (3.4) (3.0) (2.3) (3.2) (5.3) Retained Profit for the Year

13 Balance Sheet (RM million) Assets F 2018F Cash and Deposits Trade Receivables (Debtors): Inventory Property Development Cost Assets held for sale Current Tax Assets Total Current Assets ,050.5 Property, Plant and Equipment Investment properties Deferred Tax Assets Accumulated depreciation (96.2) (107.7) (116.9) (132.7) (150.3) (156.4) (159.9) Total Non-Current Assets Total Assets , , , , ,476.8 Liabilities F 2018F Short Term Bank Loans Trade Creditors (Receivables) Current Tax Liabilities Total Current Liabilities Long Term Bank Loans Tax/Deferred Taxation Total Non-Current Liabilities Share Capital Share Premium Translation Reserve (0.0) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) Treasury Shares (8.7) (9.9) (0.0) (1.1) (1.2) (1.2) (1.2) Minority interest Retained Earnings Shareholders' Funds Total Liabilities and Equity , , , , ,

14 Ratios Year end Dec F 2018F EBITDA (RM m) EPS (sen) PER DPS (sen) Dividend yield 0.5% 0.5% 0.6% 0.5% 0.4% 0.5% 0.9% Divided payout ratio 9.2% 5.1% 7.5% 7.0% 3.7% 5.0% 7.0% Tax rate 26.5% 22.9% 28.5% 32.0% 29.2% 25.0% 25.0% Sales growth % 8.1% -1.5% -7.5% 2.2% 7.9% EBITDA growth % -3.8% 7.3% 22.9% -0.4% 7.9% Net profit growth % -15.0% -7.7% 47.1% 5.3% 18.7% Gross Profit Margin 13% 14% 14% 15% 19% 18% 18% Operating Profit Margin 5.8% 8% 7% 7% 10% 10% 10% EBITDA margin 7.6% 9.3% 8.3% 9.0% 12.0% 11.7% 11.7% PBT Margin 4.6% 7% 5% 5% 8% 8% 9% Net profit margin 3.2% 4.7% 3.7% 3.5% 5.5% 5.7% 6.2% Return on Capital Employed (ROCE) 14.7% 18.5% 14.2% 13.0% 15.6% 12.5% 12.5% Return on Invested Capital (ROIC) 10.6% 13.8% 11.1% 11.3% 13.1% 11.1% 11.3% Return on Assets (ROA) 6.9% 9.1% 7.3% 7.3% 8.7% 7.8% 8.0% Return on Equity (ROE) 9.5% 14.6% 10.4% 8.8% 11.2% 9.0% 9.7% Asset Turnover Asset Leverage Inventory Days Trade Receivables (Debtor) Days Creditors Days Current Ratio Quick Ratio (Acid Test) Working Capital (RM m) Gross Gearing Net Gearing NTA per share Price to NTA

15 JF APEX SECURITIES BERHAD CONTACT LIST JF APEX SECURITIES BHD Head Office: 6 th Floor, Menara Apex Off Jalan Semenyih Bukit Mewah Kajang Selangor Darul Ehsan Malaysia General Line: (603) Facsimile: (603) PJ Office: 15 th Floor, Menara Choy Fook On No. 1B, Jalan Yong Shook Lin Petaling Jaya Selangor Darul Ehsan Malaysia General Line: (603) Facsimile: (603) DEALING TEAM Head Office: Kong Ming Ming (ext 3237) Shirley Chang (ext 3211) Norisam Bojo (ext 3233) Institutional Dealing Team: Lim Teck Seng Fathul Rahman Buyong (ext 741) Ahmad Mansor (ext 744) Zairul Azman (ext 746) PJ Office: Mervyn Wong (ext 363) Azfar Bin Abdul Aziz (Ext 822) Tan Heng Cheong (Ext 111) RESEARCH TEAM Head Office: Lee Chung Cheng (ext 758) Lee Cherng Wee (ext 759) Low Zy Jing (ext 754) Nazhatul Shaza binti Shukor (ext 755) Nursuhaiza Binti Hashim (ext 752) JF APEX SECURITIES - RESEARCH RECOMMENDATION FRAMEWORK STOCK RECOMMENDATIONS BUY : The stock s total returns* are expected to exceed 10% within the next 12 months. HOLD : The stock s total returns* are expected to be within +10% to 10% within the next 12 months. SELL : The stock s total returns* are expected to be below -10% within the next 12 months. TRADING BUY : The stock s total returns* are expected to exceed 10% within the next 3 months. TRADING SELL : The stock s total returns* are expected to be below -10% within the next 3 months. SECTOR RECOMMENDATIONS OVERWEIGHT : The industry as defined by the analyst is expected to exceed 10% within the next 12 months. MARKETWEIGHT : The industry as defined by the analyst is expected to be within +10% to 10% within the next 12 months. UNDERWEIGHT : The industry as defined by the analyst, is expected to be below -10% within the next 12 months. *capital gain + dividend yield JF APEX SECURITIES BERHAD DISCLAIMER Disclaimer: The report is for internal and private circulation only and shall not be reproduced either in part or otherwise without the prior written consent of JF Apex Securities Berhad. The opinions and information contained herein are based on available data believed to be reliable. It is not to be construed as an offer, invitation or solicitation to buy or sell the securities covered by this report. Opinions, estimates and projections in this report constitute the current judgment of the author. They do not necessarily reflect the opinion of JF Apex Securities Berhad and are subject to change without notice. JF Apex Securities Berhad has no obligation to update, modify or amend this report or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. JF Apex Securities Berhad does not warrant the accuracy of anything stated herein in any manner whatsoever and no reliance upon such statement by anyone shall give rise to any claim whatsoever against JF Apex Securities Berhad. JF Apex Securities Berhad may from time to time have an interest in the company mentioned by this report. This report may not be reproduced, copied or circulated without the prior written approval of JF Apex Securities Berhad. This report is also accessible at Published & Printed By: JF Apex Securities Berhad (47680-X) (A Participating Organisation of Bursa Malaysia Securities Berhad) 15