Engtex Group (1)

Potential Beneficiary of Water Industry Restructuring

Publish date: Thu, 30 Oct 2014, 04:56 PM

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I have recently added more Engtex to my portfoilio. The restructuring of Selangor's water industry is still dragging on. However, I think it will be resolved soon and the State Government will kick start the pipe replacement programme of closed to RM10 billion. Non revenue water is too high and the state is facing potential water shortage. We simply cannot afford to wait any longer.

1. Principal Business Activities

The Engtex group is principally involved in the following business activities :-

(a) distribution and wholesale of pipe, valve, fittings, building & construction materials and steel products. Specialised in water supply, sewerage system, telecommunication, construction and infrastructure industries.

(b) manufacturing of ductile pipes, valves, fittings, wire mesh, etc.

(c) property development - the group has amassed quite a good size of land bank. But contribution from this division is still small

(d) hospitality industry - the group recently ventured into ownership of hotels. Contribution not significant at this stage.

(Engtex share price)

(Engtex-Wa price)

2. Relevent Financial Information

Based on 198 mil shares outstanding and share price of RM1.94, market cap is approximately RM386 mil.

The group has net assets of RM399 mil, cash of RM61 mil and borrowings of RM438 mil. This translates into net gearing of closed to 1 time. At first look, gearing is relatively high. However, the bulk of it is trade related facilities (RM284 mil are bills payable), which is common for manufacturing companies that needs to purchase raw materials for processing. 

Based on FYE 31 December 2013 net profit of RM51 mil (EPS of 27 sen), PE multiple is at undemanding 7.6 times. Price to book ratio is approximately 0.97 times.

3. Historical Profitability

One of the reasons Engtex attracted my attention was its ability to deliver earnings consistently over the years, even during severe economic downturn in 2008. In my opinion, the Group must have positioned itself very well and have certain competitive advantages that insulate it from adversities. 

								6 months
(RM mil)	FY2007	FY2008	FY2009	FY2010	FY2011	FY2012	FY2013	June 2014
Revenue	566	752	600	680	794	920	1090	591
Net profit	18.4	30.4	22.8	34.2	34.8	29.2	51.8	25.4

4. Selangor Water Industry Restructuring

As we all know, the water restructuring saga has been dragging on for a long time. However, one week ago, the new Menteri Besar said that he is willing to endorse the restructuring scheme :

(The Star, 23 October 2014)

Selangor Mentri Besar Azmin Ali wants to see an efficient and quality water supply in the state and has no intention of revoking the agreement between the federal and state governments.

“I am not going to revoke it. I want the exercise to be completed as soon as possible so the people can have enough water in the future,” he said.

I echo his sentiment that the State should conclude the deal as soon as possible. This issue has been allowed to drag on for too long and is starting to negatively affect the livelihood of ordinary people, manufacturing, property development and many other industries.  

The State needs to complete the acquisition of the assets of the various concessionaires and move on to the next stage - reducing non revenue water through replacement of old pipes and other old facilities. When that happens, companies that supply pipes and other components will benefit.

Engtex's Managing Director spoke to the press recently about the billion dollar opportunities associated with the restructuring of the industry :-

(The Sun, 3 March 2014) 

Water pipe manufacturer Engtex Group Bhd, seen as one of the major benefactors of a resolution in the water industry woes in Selangor, has allocated RM70 million as capital expenditure (capex) to expand its business operations in financial year ending Dec 31, 2014 (FY14), gearing up to go for mega infrastructure projects, said its founder and group managing director Datuk Ng Hook.

Ng said this will allow Engtex to better position itself to capture other mega infrastructure projects, be it Refinery and Petrochemical Integrated Development (RAPID) in Pengerang, Johor, Kuantan Port City, Rubber Research Institute of Malaysia (RRIM) and Mass Rapid Transit (MRT).

"We will (work) along with the turnkey contractors of these projects. However, with or without the mega infrastructure works, Engtex will continue to grow because business will operate as usual," he told SunBiz in an interview.

Currently, the factory utilisation rate of its ductile iron pipe plant in Gebeng Industrial Estate, Pahang stands at about 33% while its mild steel pipe plant at Serendah, Selangor reach about 60%.

The federal and state government signed a memorandum of understanding to facilitate the restructuring of the state's water industry and allow for the construction of Langat 2 water treatment plant last Thursday.

A one-stop centre to provide total supply-chain solution for water supply and sewerage system, Ng said, Engtex is poised to get a slice of pie in the Langat 2 water treatment plant project, as well as the long-overdue replacement of the aging water pipelines throughout the country.

"There is an urgency to solve this problem. I am optimistic that both the federal government and state government will be very kind to resolve it by this year," he said.

According to the Asian Green City Index, water system leakages in major Asian cities whereby Kuala Lumpur recorded 37% of leakage, far above the average of 22.2%.

Ng said treated water is lost through non-revenue water, from broken and leaking aged asbestos cement pipes, which should be replaced by ductile iron pipes and mild steel pipes.

Malaysia has 44,000 km of old asbestos cement pipes that require replacement, which would potentially fetch a value of about RM10 billion.

"Assuming that half of the asbestos cement pipes needs to be replaced by the mild steel pipes and ductile iron pipes, we are looking at RM5 billion market," said Ng.

The remaining RM5 billion, he said, may be allocated to other pipes such as high-density polyethylene (HDPE) pipe, polyvinyl chloride(PVC) pipe, UPVC (unplasticized PVC) pipe and clay pipe, which Engtex does not produce itself, but still can be involved in through its wholesale and distribution division

5. Bonus Issue

On 26 September 2014, Engtex announced a bonus issue. Shareholders will get one bonus share for every two shares held. The bonus issue is targeted to be completed by fourth quarter of 2014.

For illustration purpose, a shareholder who hold two shares at RM1.95 today will end up with three shares at RM1.30 post bonus issue.

6. Warrants

Engtex-Wa has exercise price of RM1.25 and expires in October 2017 (exactly three years from now).

Existing conversion premium is approximately 7.6%. Very reasonable for an instrument that still has three years to go.

Based on today's price of RM0.85, Engtex-Wa will trade at RM0.57 post bonus issue. Exercise price will be adjusted downwards to RM0.83 (does not contravene Company's Act as par value is RM0.50).

Warrant holders will be entitled to 1 warrant for every 2 warrants held.

7. Concluding Remarks

(a) I believe that the State government will very soon conclude the deal to restructure the State's water industry. The issue has been allowed to drag on for too long and is beginning to adversely affect economic development and people's livelihood. It is advisable to resolve the issue and move on.

(b) I chose Engtex for exposure to water industry because it is trading at low PE multiple of only 7.6 times despite consistent profit track record and good industry prospects. I think the company is well run. Even without the water industry restructuring, it deserves to trade at at least 10 times PE multiple. Based on historical EPS of 27 sen, fair value is easily RM2.70. With additional profit from pipe replacement, etc going forward, it is not inconceivable that it could one day touch RM3.00 or RM3.50. 

(c) Instead of mother share, I prefer Engtex-Wa. If Engtex indeed goes to RM2.70, Engtex-Wa should trade at at least RM1.45. An upside of 70%. The Warrants still has three more years to go and has low conversion premium. So it is quite safe.

(d) I believe the positive effect of the bonus issue has not been fully priced in. Engtex should attract more interest when the bonus issue is implemented in November 2014.

Have a nice day.