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Equity Research Summary: China Water Affairs Group Limited (855 HK)

Core Content

China Water Affairs Group Limited (CWA) is a leading operator in China's water industry, offering a unique integrated business model that spans raw water supply, tap water supply, and sewage treatment. The company has grown significantly through acquisitions over the past decade, and is currently positioned to benefit from favorable government policies and increasing water demand.

Main Points

• Company Overview: CWA supplies city water and sewage treatment through its subsidiaries, with a total daily capacity of approximately 6.55 million tonnes.
• Market Position: CWA is the only HKEx-listed company with a highly profitable tap water supply business model, providing a competitive edge in the industry.
• Policies: The Chinese government has introduced supportive policies, including increased investment budgets and reduced VAT, to stimulate the water supply and wastewater treatment sectors. These policies aim to improve water usage efficiency and attract private sector participation.
• Business Model: CWA operates primarily under the TOO (Transfer-Own-Operate) model, which allows it to own both concession rights and water supply assets, leading to more stable and recurring cash flows compared to peers using the BOT (Build-Operate-Transfer) model.
• Growth Drivers: CWA's growth is driven by two main factors: (1) capacity expansion through acquisitions, including Goldtrust Water, and (2) water price hikes, which are expected to increase revenue and earnings at a CAGR of 29%.
• Valuation: The current share price is HK$3.75, with a target price of HK$5.8, representing a 55% upside. This is based on a 25x core FY16E PE and 2.1x forward PB.
• Investment Potential: CWA is trading at a 30% discount to the sector average, and the company has a significant land bank that could be redeveloped into residential and commercial properties, adding further value.

Key Information

• Recent Acquisition: CWA acquired Goldtrust Water for US$109.7 million in June 2015, increasing its daily capacity by 650,000 tonnes.
• Capacity Expansion: The acquisition and organic growth are expected to increase daily capacity to 6.55 million tonnes in FY16E, up 32% from previous levels.
• Revenue Growth: CWA's revenue is projected to grow at a CAGR of 24% in water supply and sewage treatment, with the potential to reach 1.363 billion tonnes by FY18E.
• Profitability: CWA's core net profit is expected to grow at a CAGR of 25.7%, with a strong margin profile due to its integrated operations and fee collection model.
• Tariff Increases: Water tariffs in China are increasing at an average of 8%–10% annually, which is expected to drive CWA's revenue growth.
• Land Bank: CWA holds a significant land bank from the relocation of old water supply plants, which can be redeveloped into high-value properties.
• Competitive Landscape: CWA's integrated business model and regional exclusivity give it a distinct advantage over peers, which often focus on sewage treatment under the BOT model.

Financial Highlights

Investment Risks

• Regulatory Risk: Changes in government policy could impact the investment returns and growth trajectory of the water supply industry.
• Economic Risk: While CWA's business model is relatively immune to economic cycles, macroeconomic downturns could still affect overall demand for water services.
• Operational Risk: The company's reliance on fee collection from end users could be affected by payment defaults or regulatory changes.
• Competition Risk: Although CWA has a strong market position, increased competition in the sewage treatment sector could impact margins.

Management and Shareholding

• Chairman: Duan Chuan-Liang holds 25.1% of the shares.
• Management Commitment: Goldtrust's founders have shown commitment by subscribing to CWA shares, indicating confidence in the company's future.
• Shareholding Structure: The company's major shareholder is the Chairman, with a significant stake that provides stability and control.

Conclusion

CWA is well positioned to benefit from the growing demand for water services in China, supported by favorable government policies and its unique integrated business model. The company's recent acquisition of Goldtrust Water, combined with expected water price hikes, is anticipated to drive strong revenue and earnings growth. With a target price of HK$5.8 and a 55% upside, CWA is considered a strong investment opportunity in the water sector.