Trade Wise: Pipemakers set to regain traction

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AFTER almost a decade of delays, Malaysia’s crumbling water infrastructure is set to gain a new lease of life. With Selangor’s water restructuring scheme planned to be wrapped up this year and the federal government’s billion-ringgit allocation for water infrastructure works, stocks in the sector may again see investor interest after years of false starts.

The government and its water sector management arm Pengurusan Aset Air Bhd (PAAB) have committed to building new plants and fixing and replacing water pipelines. As a result, several public-listed pipemakers have been ramping up capacity in anticipation of new contracts, some of which had already been given out in 2014.

tw2_5chart_1048On Dec 22, JAKS Resources Bhd announced that it was awarded a RM55.3 million contract under Package 5 of the Langat 2 water treatment plant and water reticulation system project for the supply and installation of pipes. The company had, earlier in March, won a much larger RM399.31 million contract for the construction of a sewerage pipe network in Jinjang, Kepong.

Minister of Energy, Green Technology and Water Datuk Seri Maximus Ongkili said on Oct 30 that the government had allocated RM975.37 million to replace old and leaking pipes as part of its development budget for this year.

According to the 2014 Malaysia Water Industry Guide, there are about 43,390km of old asbestos cement pipes in the country that need to be replaced. As the estimated allocation to replace all the pipes is RM11 billion, it may take several years for a complete overhaul, based on the annual expenditure of the federal government.

Due to budget constraints and ongoing water infrastructure projects, the government’s allocation for pipe replacement is unlikely to exceed RM1 billion per year. However, given the small group of pipemakers with the necessary capability to undertake these projects, getting a slice of RM1 billion could easily translate into hundreds of millions of ringgit in revenue.

Another catalyst is the expected completion of Selangor’s water asset consolidation this year. The disposals of Puncak Niaga Sdn Bhd and Syarikat Bekalan Air Selangor Sdn Bhd by their parent company Puncak Niaga Holdings Bhd to Pengurusan Air Selangor Bhd by the first quarter (1Q2015) will jump-start the state’s much-needed water pipe replacement programme.

To recap, a planned RM700 million capex drive to install and replace pipes in Selangor grinded to a halt in 2008 following Pakatan Rakyat’s takeover of the state. A prolonged stalemate in negotiations between the state and federal governments ensued, which resulted in the deterioration of the state’s aging water network infrastructure.

Selangor’s non-revenue water (NRW), or water that is “lost” before reaching consumers, stands at 33%.

“We will need to replace all old pipes to reduce NRW. We need to think long term and cannot only repair leaking pipes,” said Selangor infrastructure executive councillor Zaidy Abdul Taib during a Nov 26 state assembly sitting.

The two main types of pipes used for water and sewerage networks are ductile iron (DI) and mild steel (MS). Engtex Group Bhd and YLI Holdings Bhd make up a duopoly in the DI pipe segment in Malaysia as they are the only companies with the specialised capability to manufacture them.

The MS pipe segment, on the other hand, is fairly competitive with more than 18 players including Engtex, YLI and JAKS. It is worth noting that the margins for DI pipes are higher than for MS pipes as the former utilise local scrap as feedstock, compared with the pricier hot roll coil for the latter.

The construction of the Langat 2 plant will entail demand for large-diameter MS pipes (for the channelling of raw water to the plant) and small-diameter DI pipes (for distribution to households). Given the plant’s tight completion deadline in 2017, more contracts related to pipe supply and installations are expected to be handed out by PAAB this year.

A chunk of the industry is dominated by public-listed pipemakers that have the capability to undertake major contracts and manufacture large amounts of pipes. A look at five public-listed pipe manufacturers indicates that their stocks are undervalued relative to their asset worth.

For example, Engtex is trading at a modest six times earnings despite reporting increasing profits over the past several financial years. The company is also on track to report its best revenue and net profit for the financial year ended Dec 31, 2014 — and this without being a recipient of any major pipe replacement contract from a state government.

Similarly, JAKS seems to be an equally attractive investment proposition, especially after winning its first Langat 2 contract.

A prevailing theme among the pipemakers’ stocks is that many of them are trading far below net asset value (NAV). At present prices, Engtex is trading at a 50% discount to its NAV per share of RM2.19 while Choo Bee Metal Industries Bhd is trading at about RM1.70 as opposed to its NAV per share of RM3.90.

The degree of liabilities and business interests outside the pipe industry may explain the erratic share price performances of the companies in 2014. (Note that Engtex has interest in property development while JAKS has a thermal power plant joint-venture project in Vietnam.) Some have been consistently profitable while others have reported mediocre earnings mainly due to major contracts drying up over the past few years.

Nevertheless, 2015 could mark a major turning point for the industry with both state and federal governments determined to move ahead with major water infrastructure projects and pipe replacement. The current share prices and NAV of the companies suggest minimal downside risk while at the same time, they are set to be competing for contracts worth billions of ringgit over the next few years.

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This article first appeared in The Edge Malaysia Weekly, on January 5 - 11, 2015.