Is Engtex an investment opportunity?

Value Investing Case Study 69-1: A fundamental analysis of Engtex Group Berhad  to see whether it is a value trap or an investment opportunity.  

Engtex Group Berhad (Engtex or the Group) started as a humble hardware shop in 1983. It has since grown with a reach that spans wholesale, manufacturing, property development, and even hospitality. 

This Group's journey from retail beginnings to becoming a leading one-stop solution provider for pipes, valves, and fittings is remarkable.

Yet, despite their meteoric rise, the story isn't all smooth sailing. The Group's profits have been as volatile as the steel prices they depend on, raising questions about long-term sustainability. 

In this article, we dig deep into the numbers, uncovering a company's triumphs, challenges, and uncertain future in a tough industry. 

My analysis shows that the performance of the Group is nothing to shout about. Given the lack of a margin of safety, this is not an investment opportunity.

Should you still buy it? Well, read my Disclaimer.

AI is posed to disrupt the work of investment analysts. To get a better understanding of the AI capability I also provided a comparative analysis by 2 fundamental investing AI that I have been exploring – FinChat.io and Stock Market GPT.

Contents

• Company background

• Operating performance

• Financial position

• Valuation

• Conclusion

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Company background

The Group began in 1983 as a hardware retail shop but has grown into an integrated wholesale and distribution center. It is today a leading one-stop solution provider for plumbing materials, iron and steel products, and building/construction materials.

In 1995, the Group expanded into manufacturing ductile iron and mild steel products, as well as operating a steel service center. 

The Group reports its performance under 4 segments:

• Wholesale & distribution. This includes wholesale and distribution of pipes, valves, fittings, plumbing materials, general hardware products, and construction materials.

• Manufacturing covering the manufacturing and sale of steel and ductile iron pipes and fittings, valves, manhole covers, hydrants, industrial casting products, and other related products.

• Property development covering property development and investment activities.

• Hospitality. This includes the provision of rooms, food and beverage, laundry service fees, and other hospitality services.

As can be seen from Chart 1, the Wholesale & distribution and Manufacturing segments are the 2 bigger revenue and profit contributors. I would classify Engtex as operating in the steel sector.

Chart 1: Segment Profile

Steel prices are cyclical as illustrated in Chart 2 and you should not be surprised to find that the Group performance is linked to steel prices. You can see the cyclical revenue and profit patterns of the Group from Chart 1. 

There is a 51% correlation between Engtex’s revenue and the hot roll steel prices over the past 12 years. Not exactly significant. 

Chart 2: Steel prices

Operating performance

To get a sense of where the business is heading, I looked at the topline, bottom-line, and capital efficiency trends from 2012 to 2023. Refer to the left part of Chart 3.

While revenue had a continuous uptrend since 2012 growing at 4.3 % CAGR from 2012 to 2023, PAT was volatile. 

• The sharp decline in profit in 2019 was “exacerbated by the high procurement and operating costs for all its business segments.” You can see from Chart 1 that the Manufacturing segment incurred a loss for the year.

• The profit spike in 2021 was due to the “increase in market demand and higher selling prices…in tandem with the increase in the global and domestic metal prices.” 

• The decline in profits in 2023 was because “domestic steel prices retraced amid the weak economic environment and absence of large infrastructure projects rollout during 2023”

The right part of Chart 3 illustrates the impact of volatile steel prices on the gross profit margins. For example, there was an increase in the gross profit margin to 17.4 % in 2021 compared to 12.9 % in 2020.

While the gross profit margin was volatile, the more troubling sign was the declining trend for gross profitability (gross profits/total assets). This suggests a declining capital efficiency. Refer to the left part of Chart 3.

Chart 3: Performance Index and Margins

The disappointing picture was that there was declining operating and capital efficiencies. 

• Operating efficiencies. Refer to the left part of Chart 4. The performance of the various metrics got worse from 2012 to 2023. This was reinforced by the narrowing gap between the gross profit margin and SGA margin as shown in the right part of Chart 3. 

• Capital efficiencies. Refer to the right part of Chart 4. In addition to the declining gross profitability, capital turnover (revenue/total capital employed) declined. The cash conversion cycle also got worse ie a longer cash conversion cycle in 2023 compared to 2012.

Chart 4: Operating and capital efficiencies

Given the volatile profits, returns were also volatile and declining. Refer to the left part of Chart 5. From 2012 to 2023, ROIC averaged 5% while ROE averaged 7%

Given the current WACC of 9%, I would conclude that the Group did not create any shareholders’ value over the past 12 years. 

Referring to the right part of Chart 5, you can see that there is also no discernible trend for the contribution margin. The chart also illustrates a key feature of Engtex – fixed cost is a small component of the total cost. In 2023, it accounted for 8 % of the total cost. This cost structure meant that as revenue ramps up, there will be a big impact on profits.

Chart 5: Returns and Operating Profit 

Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.

• Fixed cost = SGA, Depreciation & Amortization and Others.
• Variable cost = Cost of Sales – Depreciation & Amortization.
• Contribution = Revenue – Variable Cost.
• Contribution margin = Contribution/Revenue.

AI Comparisons 1 FinChat could not provide an explanation for the volatile PAT and growth potential citing lack of data. Stock Market GPT answers were not to the point. FinChat stated the following:  The financial data suggests that Engtex Group Berhad has experienced volatility in its profitability over the past decade. The low profit margins, EBITDA margins, and returns on assets and equity, coupled with the high debt-to-equity ratio, indicate that the company's operational and financial performance has been under pressure during this period.  Engtex Group Berhad's growth potential appears to be mixed. While the company has struggled with negative growth in the recent past, the analysts' estimates suggest the possibility of a turnaround in the near future and stronger long-term growth prospects. However, the company's ability to execute its strategies and maintain its competitive position in the industry will be critical factors in determining its growth trajectory going forward.  The AI comments suggest that while currently the AI could identify the trends, it had yet to tap into the Management and Discussions Part of the Annual Reports to find the explanations.

AI Comparisons 1

FinChat could not provide an explanation for the volatile PAT and growth potential citing lack of data. Stock Market GPT answers were not to the point.

FinChat stated the following: 

The financial data suggests that Engtex Group Berhad has experienced volatility in its profitability over the past decade. The low profit margins, EBITDA margins, and returns on assets and equity, coupled with the high debt-to-equity ratio, indicate that the company's operational and financial performance has been under pressure during this period. 

Engtex Group Berhad's growth potential appears to be mixed. While the company has struggled with negative growth in the recent past, the analysts' estimates suggest the possibility of a turnaround in the near future and stronger long-term growth prospects. However, the company's ability to execute its strategies and maintain its competitive position in the industry will be critical factors in determining its growth trajectory going forward. 

The AI comments suggest that while currently the AI could identify the trends, it had yet to tap into the Management and Discussions Part of the Annual Reports to find the explanations.

Peer comparison

I compared Engtex's performance with several Bursa steel companies. You can see from Table 1 that Engtex is among the smaller companies in the peer group. However. it achieved the best revenue growth over the past 12 years.

Table 1: Peer revenue

Engtex was also among the top performers when it came to return on capital and EBIT margin. Refer to Chart 6.

Chart 6: Bursa Peer Comparisons

Summary

What are the key takeaways from the above analyses of the operating performance?

• This is a steel company whose performance is affected by steel prices.

• This is not a growth company as revenue only grew at about the GDP growth rate.

• Returns were volatile and declining over the past 12 years.

• There are no signs of improving capital and operating efficiency. 

• Engtex is among the better performers compared to its peers.

AI Comparisons 2 When asked how it would rate Engtex fundamentals, FinChat responded as follows: “Engtex has some strengths in terms of revenue growth and long-term EPS growth. However, the declining net income, low operating margin, and volatility in earnings are areas of concern. The company may have potential for long-term growth, but it also faces significant short-term challenges." Strengths: Moderate revenue growth. Positive long-term EPS growth. Weaknesses: Declining net income and EPS in the short term. Low operating margin. Volatility in earnings. When compared to its peers in the steel industry, Engtex shows moderate revenue growth but lags in net income and EPS growth. Its operating margin is also lower than some of its peers.  Stock Market GPT concluded as follows: "Engtex Group Berhad's performance appears to be weaker compared to its Bursa steel peers in terms of profitability, growth, valuation, financial strength, and shareholder returns. While the company may have the potential for a turnaround, it currently lags behind its industry counterparts in key financial metrics." Note: I chose the same peers for the peer comparison In broad terms both the AI and I have similar conclusions although it looks as if we relied on data of different periods.

AI Comparisons 2

When asked how it would rate Engtex fundamentals, FinChat responded as follows:

“Engtex has some strengths in terms of revenue growth and long-term EPS growth. However, the declining net income, low operating margin, and volatility in earnings are areas of concern. The company may have potential for long-term growth, but it also faces significant short-term challenges."

Strengths:

• Moderate revenue growth.

• Positive long-term EPS growth.

Weaknesses:

• Declining net income and EPS in the short term.

• Low operating margin.

• Volatility in earnings.

When compared to its peers in the steel industry, Engtex shows moderate revenue growth but lags in net income and EPS growth. Its operating margin is also lower than some of its peers. 

Stock Market GPT concluded as follows:

"Engtex Group Berhad's performance appears to be weaker compared to its Bursa steel peers in terms of profitability, growth, valuation, financial strength, and shareholder returns. While the company may have the potential for a turnaround, it currently lags behind its industry counterparts in key financial metrics."

Note: I chose the same peers for the peer comparison

In broad terms both the AI and I have similar conclusions although it looks as if we relied on data of different periods.

Financial position

In assessing the financial position of a company, I first consider the overall picture via the capital allocation plan and the Reinvestment rate. Thereafter I zoomed in on profitability, efficiency, liquidity, and leverage.

On such a basis, I would rate Engtex's financial standing as below average. My rationale is as follows:

Engtex capital allocation track record has been poor. Refer to Table 2. The cash flow from operations was not sufficient to fund its CAPEX and acquisitions. 

Over the past 12 years, it had an average Reinvestment rate (Reinvestment/NOPAT) of 42%. This seems to be an average rate. I defined Reinvestment = CAPEX & acquisitions – Depreciation & amortization + increase in Net Working Capital.

Table 2: Sources and Uses of Funds 2012 to 2023

I have already mentioned that its profits and efficiencies are nothing to should about. This is summarized in the top part of Table 3.

In the context of liquidity, the results in Table 3 show that it did not do too well. This is supported by the following:

• Over the past 12 years, there were 4 years with negative cash flow from operations.

• Over the past 12 years, it generated RM 368 million cash flow from operations compared to its PAT of RM 445 million. This is a poor cash flow conversion ratio.

Table 3: Financial Position

The main positive points were:

• As of the end of June 2024, it had RM 103 million cash, equal to 7 % of its total assets.

• Its average Debt Equity ratio over the past 3 years was less than 1. 

• But its interest coverage is borderline.

AI Comparisons 3 When asked how it would rate Engtex's financial position, FinChat responded as follows: Overall, while Engtex Group Berhad has adequate liquidity and a manageable level of debt, the declining profitability and interest coverage ratios are areas of concern. Liquidity: The current ratio is above 1, indicating adequate liquidity, but the quick ratio below 1 suggests potential liquidity concerns. Solvency: The debt-to-equity ratio is below 1, indicating a manageable level of debt, but the declining interest coverage ratio is a concern. Profitability: Both ROA and ROE have declined significantly, indicating weakened profitability. Stock Market GPT answered as follows: Overall, Engtex Group Berhad's financial position can be characterized as moderately weak. The company's high debt levels, low profitability, and inefficient utilization of assets suggest a relatively fragile financial standing. While the company maintains adequate liquidity, the high leverage and limited operating cash flow may constrain its financial flexibility and ability to invest in growth opportunities. Investors should carefully consider these financial factors when evaluating the company's long-term sustainability and investment potential. The AI and I looked at different metrics to come to similar conclusions. I am sure that the AI could be specified to look for the same set of metrics.

AI Comparisons 3

When asked how it would rate Engtex's financial position, FinChat responded as follows:

Overall, while Engtex Group Berhad has adequate liquidity and a manageable level of debt, the declining profitability and interest coverage ratios are areas of concern.

• Liquidity: The current ratio is above 1, indicating adequate liquidity, but the quick ratio below 1 suggests potential liquidity concerns.

• Solvency: The debt-to-equity ratio is below 1, indicating a manageable level of debt, but the declining interest coverage ratio is a concern.

• Profitability: Both ROA and ROE have declined significantly, indicating weakened profitability.

Stock Market GPT answered as follows:

Overall, Engtex Group Berhad's financial position can be characterized as moderately weak. The company's high debt levels, low profitability, and inefficient utilization of assets suggest a relatively fragile financial standing. While the company maintains adequate liquidity, the high leverage and limited operating cash flow may constrain its financial flexibility and ability to invest in growth opportunities. Investors should carefully consider these financial factors when evaluating the company's long-term sustainability and investment potential.

The AI and I looked at different metrics to come to similar conclusions. I am sure that the AI could be specified to look for the same set of metrics. 

Valuation

I looked at several valuation metrics to assess whether there is a margin of safety. Refer to Table 4. You can see that there are only margins of safety under the Asset Value.

Table 4: Valuation metrics

Notes

a) EV / EBITDA. A ratio less than 6 is considered cheap.

b) Free cash flow/market price.

Because of the low revenue growth, it is better to estimate the Earnings value based on the Earnings Power Value (EPV). You can see that the EPV is significantly lower than the Asset Value. This is clearly illustrated in Chart 7.

According to Professor Bruce Greenwald, this suggests underutilization of the assets. You should not be surprised as we have declining returns and the Group did not create shareholders value.

The key is whether the Group can turn around its performance and deliver better returns.

Note: The intrinsic value assuming a 4% perpetual growth rate resulted in an intrinsic value of negative RM 0.15 per share. This negative value arose because the low returns led to a low value for the Firm. 

Chart 7: Valuation 

AI Comparisons 4 When I asked the FinChat what is the EPV of Engtex Group Berhad based on the DCF, it responded as follows: The Unlevered Discounted Cash Flow (DCF) model for Engtex Group Berhad (ENGTEX) provides the following intrinsic value estimate and key assumptions: Intrinsic Value Estimate: -0.89 (-245.73%) Valuation Summary Sum of Discounted Cash Flows: -MYR 46.49M. Discounted Terminal Value: MYR 704.05M (using an exit multiple EV/FCF of -141.22). Net Debt: MYR 514.27M. Total Equity Value: MYR 143.29M. Share Price Estimate: MYR 0.18 (compared to the current share price of MYR 0.61, indicating a -70.03% upside/downside) The DCF model suggests that the intrinsic value of Engtex is significantly lower than its current market price Note: The AI projected the performance over the next 5 years to arrive at the valuation. The differences between the values computed by the AI and I are probably due to the different assumptions and valuation models. The interesting point is that we both agree that there is no margin of safety. On the other hand Stock Market GPT stated that it did not have the data to do the valuation.

AI Comparisons 4

When I asked the FinChat what is the EPV of Engtex Group Berhad based on the DCF, it responded as follows:

The Unlevered Discounted Cash Flow (DCF) model for Engtex Group Berhad (ENGTEX) provides the following intrinsic value estimate and key assumptions:

Intrinsic Value Estimate: -0.89 (-245.73%)

Valuation Summary

• Sum of Discounted Cash Flows: -MYR 46.49M.

• Discounted Terminal Value: MYR 704.05M (using an exit multiple EV/FCF of -141.22).

• Net Debt: MYR 514.27M.

• Total Equity Value: MYR 143.29M.

• Share Price Estimate: MYR 0.18 (compared to the current share price of MYR 0.61, indicating a -70.03% upside/downside)

The DCF model suggests that the intrinsic value of Engtex is significantly lower than its current market price

Note: The AI projected the performance over the next 5 years to arrive at the valuation.

The differences between the values computed by the AI and I are probably due to the different assumptions and valuation models. The interesting point is that we both agree that there is no margin of safety.

On the other hand Stock Market GPT stated that it did not have the data to do the valuation.

Intrinsic valuation model

I valued Engtex using a single-stage Free Cash Flow to the Firm model.

Value to the firm = FCFF X (1 + g) / (WACC – g).

FCFF = EBIT(1 – t) X (1 – Reinvestment rate).

EBIT = Revenue X Gross profit margin – SGA. 

g = 0 under the EPV.

The reinvestment rate was = 0 based on the fundamental growth equation.

Table 5 illustrates the calculation for the EPV

There are 4 key parameters in my model. 

• Revenue. I assumed this to be the 2023 revenue.

• Contribution margin. I assumed the average 2012 to 2024 margin to represent the performance over the cycle.

• Capital turnover (Revenue/TCE). I assumed the average 2012 to 2024 value to represent the performance over the cycle.

• WACC. Based on the first-page result of a Google search for the term “Engtex Contracts WACC” as shown in Table 6. 

Table 5: Sample calculation

Table 6: Estimating the WACC

Case Notes AI is set to disrupt the work of investment analysts in several significant ways 1. Data Processing and Analysis Speed and Efficiency: AI can process and analyze vast amounts of financial data faster than humans, identifying trends, patterns, and anomalies that might be missed by human analysts. Predictive Analytics: Machine learning models can predict market movements, asset prices, and company performance with increasing accuracy, using historical data, news sentiment, and even social media trends. 2. Automation of Routine Tasks Report Generation: AI can automate the creation of reports, such as earnings summaries, market overviews, and investment recommendations, freeing up analysts to focus on more strategic tasks. Risk Assessment: AI can continuously monitor portfolios and market conditions, automatically flagging or even adjusting positions in response to changes in risk. 3. Enhanced Decision-Making Augmented Intelligence: AI can assist analysts in decision-making by providing data-driven recommendations, back-testing strategies, and running simulations, which enhances human judgment and reduces the risk of errors. Portfolio Optimization: Advanced AI algorithms can optimize portfolios by balancing risk and return more effectively than traditional methods. To be relevant in the AI age, analysts have to provide insights that the AI will have difficulty in doing. This is meant to go behind the numbers and focus on strategies, and management capabilities. Investing sites will have to address this. In this context, Seeking Alpha recently ruled that its contributors cannot use AI to produce reports. I am not sure that this is the correct way to go.  It is not an issue yet as my comparison has shown that there is still some way to go before the AI can generate reliable analysis. But a day will come when the AI can generate reliable reports. Why would anyone read articles from investing sites unless they provide perspectives that the AI cannot Investing sites like Seeking Alpha* will then have to find another business model.

Case Notes

AI is set to disrupt the work of investment analysts in several significant ways

1. Data Processing and Analysis

• Speed and Efficiency: AI can process and analyze vast amounts of financial data faster than humans, identifying trends, patterns, and anomalies that might be missed by human analysts.

• Predictive Analytics: Machine learning models can predict market movements, asset prices, and company performance with increasing accuracy, using historical data, news sentiment, and even social media trends.

2. Automation of Routine Tasks

• Report Generation: AI can automate the creation of reports, such as earnings summaries, market overviews, and investment recommendations, freeing up analysts to focus on more strategic tasks.

• Risk Assessment: AI can continuously monitor portfolios and market conditions, automatically flagging or even adjusting positions in response to changes in risk.

3. Enhanced Decision-Making

• Augmented Intelligence: AI can assist analysts in decision-making by providing data-driven recommendations, back-testing strategies, and running simulations, which enhances human judgment and reduces the risk of errors.

• Portfolio Optimization: Advanced AI algorithms can optimize portfolios by balancing risk and return more effectively than traditional methods.

To be relevant in the AI age, analysts have to provide insights that the AI will have difficulty in doing. This is meant to go behind the numbers and focus on strategies, and management capabilities.

Investing sites will have to address this. In this context, Seeking Alpha recently ruled that its contributors cannot use AI to produce reports. I am not sure that this is the correct way to go. 

It is not an issue yet as my comparison has shown that there is still some way to go before the AI can generate reliable analysis. But a day will come when the AI can generate reliable reports. Why would anyone read articles from investing sites unless they provide perspectives that the AI cannot

Investing sites like Seeking Alpha* will then have to find another business model.

Risks and limitations

The reason for the low EPV is because of the low returns. You may think that the Group’s return was pulled down by the Property Development and Hospitality segments. While true as can be seen from Table 7, these 2 segments only used up 8% of the net assets. 

So even if their returns can be improved, the impact on the Group is small. To improve the returns, we need the Wholesale & distribution, and Manufacturing segments to have significantly better returns.

Table 7: Segment return

It is interesting to note that the market is pricing Engtex greater than the EPV. Is the market suggesting that the Group performance is expected to improve significantly?

Historically, the profit boost followed steel price increases. But steel prices are cyclical and any price increase would be followed eventually by a price decline. By using the past decade's averages, I have accounted for this.

The market cannot anticipate the long-term impact of price increases. Is the market then expecting improvements in efficiencies? But I have shown that there have not been signs of this.

I would think that the market has overpriced the company.

AI Comparisons 5 I asked ChatGPT to comment on the risks and limitations of my analysis after giving it a copy of the article. This is how the AI thinks about the risk and limitations Your analysis of Engtex is comprehensive, but like any investment analysis, it has inherent risks and limitations. Here are the key risks and limitations of your analysis: 1. Dependence on Historical Data Assumption of Historical Trends: Your analysis heavily relies on historical data to project future performance. While past trends can offer insights, they may not fully account for future market conditions, changes in the competitive landscape, or macroeconomic shifts. Cyclicality and Predictive Limitations: The steel industry is cyclical, and while you've accounted for past cycles, the timing and magnitude of future cycles are unpredictable. A significant deviation from historical patterns could render some of your assumptions invalid. 2. Valuation Model Sensitivity Assumptions in Valuation Models: The intrinsic value derived from your valuation models (e.g., DCF, EPV) is highly sensitive to key assumptions like WACC, growth rates, and margin projections. Small changes in these inputs can lead to significant variations in the estimated value, introducing potential inaccuracies. Asset Valuation Risks: The asset value provides the only margin of safety, but this assumes that the company can effectively unlock or realize the value of its assets. If market conditions or operational challenges prevent this, the asset value could be overstated. 3. Lack of Forward-Looking Insights Management Strategy and Future Plans: While your analysis covers past performance and current standing, it may not fully account for future strategic initiatives or changes in management that could impact Engtex's performance. The potential for operational turnaround or strategic shifts is difficult to quantify without insights into management’s future plans. External Factors: The analysis might underweight the impact of future external factors such as regulatory changes, technological advancements, or shifts in global trade policies that could affect the steel industry and Engtex's operations specifically. 4. Limited Peer Comparison Peer Group Selection: The peer comparison provides a relative performance benchmark, but the selection of peers and the metrics used for comparison could influence the results. Different peers or additional metrics might present a different competitive landscape. Industry-Specific Risks: While Engtex performs relatively well against peers, the broader steel industry may face challenges that impact all players, including Engtex. A strong relative position doesn’t eliminate sector-wide risks. 5. Overemphasis on Financial Metrics Neglect of Qualitative Factors: The analysis is primarily quantitative, focusing on financial metrics and historical performance. Qualitative factors, such as management quality, corporate governance, company culture, and industry positioning, are harder to quantify but can significantly influence long-term performance. Market Sentiment and Behavioral Factors: The analysis may not fully account for market sentiment, investor behavior, or other non-fundamental factors that can drive stock prices in the short term, potentially leading to mispricing. 6. Risk of Overlooking Subtle Trends Declining Efficiencies: While you identified a decline in operating and capital efficiencies, there might be underlying factors driving these trends that aren’t fully explored. These could include issues with supply chain management, product mix shifts, or changes in customer demand that require a deeper dive. Long-Term Strategic Risks: The analysis might not fully capture longer-term risks related to shifts in the global steel market, such as the rise of alternative materials, changes in environmental regulations, or new technological developments that could disrupt traditional steel manufacturing. 7. Macro-Economic Dependencies Global Economic Conditions: The steel industry is highly sensitive to global economic conditions, including GDP growth, infrastructure spending, and commodity prices. A sudden economic downturn or slowdown in key markets (e.g., China) could adversely affect Engtex, and these macro risks might not be fully captured in your analysis. Currency and Interest Rate Risks: Fluctuations in exchange rates or changes in interest rates can impact Engtex’s cost structure, profitability, and debt servicing ability, particularly if the company has significant foreign currency exposure or floating-rate debt. 8. Execution Risk Management’s Ability to Turn Around Performance: Your analysis assumes that historical inefficiencies and poor performance trends will continue unless proven otherwise. However, there’s always a risk (or opportunity) that management could successfully execute a turnaround strategy that significantly alters the company’s trajectory, which may not be fully anticipated in your analysis. Conclusion Your analysis is robust, but it must be interpreted with an understanding of its limitations. The risks mentioned above could influence the accuracy of your conclusions and should be considered when making an investment decision. Engtex's future performance may deviate from your projections due to unforeseen factors, and as such, ongoing monitoring and adjustments to the analysis would be prudent. While I don’t disagree with ChatGPT comments, they are general and could be applied for all the other analysis that I do.

AI Comparisons 5

I asked ChatGPT to comment on the risks and limitations of my analysis after giving it a copy of the article. This is how the AI thinks about the risk and limitations

Your analysis of Engtex is comprehensive, but like any investment analysis, it has inherent risks and limitations. Here are the key risks and limitations of your analysis:

1. Dependence on Historical Data

• Assumption of Historical Trends: Your analysis heavily relies on historical data to project future performance. While past trends can offer insights, they may not fully account for future market conditions, changes in the competitive landscape, or macroeconomic shifts.

• Cyclicality and Predictive Limitations: The steel industry is cyclical, and while you've accounted for past cycles, the timing and magnitude of future cycles are unpredictable. A significant deviation from historical patterns could render some of your assumptions invalid.

2. Valuation Model Sensitivity

• Assumptions in Valuation Models: The intrinsic value derived from your valuation models (e.g., DCF, EPV) is highly sensitive to key assumptions like WACC, growth rates, and margin projections. Small changes in these inputs can lead to significant variations in the estimated value, introducing potential inaccuracies.

• Asset Valuation Risks: The asset value provides the only margin of safety, but this assumes that the company can effectively unlock or realize the value of its assets. If market conditions or operational challenges prevent this, the asset value could be overstated.

3. Lack of Forward-Looking Insights

• Management Strategy and Future Plans: While your analysis covers past performance and current standing, it may not fully account for future strategic initiatives or changes in management that could impact Engtex's performance. The potential for operational turnaround or strategic shifts is difficult to quantify without insights into management’s future plans.

• External Factors: The analysis might underweight the impact of future external factors such as regulatory changes, technological advancements, or shifts in global trade policies that could affect the steel industry and Engtex's operations specifically.

4. Limited Peer Comparison

• Peer Group Selection: The peer comparison provides a relative performance benchmark, but the selection of peers and the metrics used for comparison could influence the results. Different peers or additional metrics might present a different competitive landscape.

• Industry-Specific Risks: While Engtex performs relatively well against peers, the broader steel industry may face challenges that impact all players, including Engtex. A strong relative position doesn’t eliminate sector-wide risks.

5. Overemphasis on Financial Metrics

• Neglect of Qualitative Factors: The analysis is primarily quantitative, focusing on financial metrics and historical performance. Qualitative factors, such as management quality, corporate governance, company culture, and industry positioning, are harder to quantify but can significantly influence long-term performance.

• Market Sentiment and Behavioral Factors: The analysis may not fully account for market sentiment, investor behavior, or other non-fundamental factors that can drive stock prices in the short term, potentially leading to mispricing.

6. Risk of Overlooking Subtle Trends

• Declining Efficiencies: While you identified a decline in operating and capital efficiencies, there might be underlying factors driving these trends that aren’t fully explored. These could include issues with supply chain management, product mix shifts, or changes in customer demand that require a deeper dive.

• Long-Term Strategic Risks: The analysis might not fully capture longer-term risks related to shifts in the global steel market, such as the rise of alternative materials, changes in environmental regulations, or new technological developments that could disrupt traditional steel manufacturing.

7. Macro-Economic Dependencies

• Global Economic Conditions: The steel industry is highly sensitive to global economic conditions, including GDP growth, infrastructure spending, and commodity prices. A sudden economic downturn or slowdown in key markets (e.g., China) could adversely affect Engtex, and these macro risks might not be fully captured in your analysis.

• Currency and Interest Rate Risks: Fluctuations in exchange rates or changes in interest rates can impact Engtex’s cost structure, profitability, and debt servicing ability, particularly if the company has significant foreign currency exposure or floating-rate debt.

8. Execution Risk

• Management’s Ability to Turn Around Performance: Your analysis assumes that historical inefficiencies and poor performance trends will continue unless proven otherwise. However, there’s always a risk (or opportunity) that management could successfully execute a turnaround strategy that significantly alters the company’s trajectory, which may not be fully anticipated in your analysis.

Conclusion

Your analysis is robust, but it must be interpreted with an understanding of its limitations. The risks mentioned above could influence the accuracy of your conclusions and should be considered when making an investment decision. Engtex's future performance may deviate from your projections due to unforeseen factors, and as such, ongoing monitoring and adjustments to the analysis would be prudent.

While I don’t disagree with ChatGPT comments, they are general and could be applied for all the other analysis that I do.

Conclusion

Engtex's performance over the past decade is nothing to shout about:

• Revenue growth was about the GDP growth rate.

• Returns were declining and lower than the cost of funds suggesting that shareholders' value was not created.

• There were no signs of improving efficiencies.

• I would rate its financial position as average.

But it did better than its steel peers. This suggests that the sector is a tough one to make money.

From a valuation perspective, the margin of safety comes from only the Asset Value.

Looking at the EPV, I would not consider Engtex an investment opportunity. 

Investment Thesis

Engtex's performance over the past decade has been underwhelming, with declining returns and no clear signs of efficiency improvements. The company's valuation suggests it is overpriced relative to its earnings potential 

Engtex has some strengths, particularly in its relative performance within the steel sector. But the overall outlook is cautious. There is limited upside unless there is a significant turnaround in its operations or market conditions. You may want to wait for clearer signs of operational improvements or a more favourable market environment before considering Engtex as an investment opportunity.

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If the above article was useful, you can find more insights on how to make money in my e-book. The e-book is now available from Amazon, Kobo and Google Play. PS: If you are in Malaysia or Singapore, the e-book can only be download from Kobo and Google Play.

If the above article was useful, you can find more insights on how to make money in my e-book. The e-book is now available from Amazon, Kobo and Google Play.

PS: If you are in Malaysia or Singapore, the e-book can only be download from Kobo and Google Play. 

Disclaimer & Disclosure

I am not an investment adviser, security analyst, or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

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