20160603-招商证券_香港_-中国水务-00855.HK-Key_beneficiary_of_China_Water_Reform_11页_1mb_1mb

Summary of China Water Affairs (855 HK) Report

Core Content

China Water Affairs (CWA) is a leading tap water supplier in China, operating under the unique Transfer-Own-Operated (TOO) model, which differentiates it from peers who typically use the Build-Operate-Transfer (BOT) model. CWA's business spans tap water supply, raw water supply, and sewage treatment, with tap water accounting for 77% of its revenue in 2015. The company has a project portfolio of 65 projects across 40 cities, with a designed daily capacity of 6.2 million tons, and is projected to increase this to 8.7 million tons in the next 1-2 years.

CWA is a key beneficiary of China's water reform, which includes a progressive water tariff scheme, government support for public-private partnerships (PPPs), and a focus on improving water quality. The company's earnings are expected to grow by 36% in FY16E and 19% in FY17E, with a consensus P/E of 15x and 13x, respectively, which is approximately 10% lower than the average P/E of other Hong Kong-listed wastewater treatment companies.

Main Points

• TOO Model: CWA operates under the Transfer-Own-Operated (TOO) model, which allows it to own and operate facilities independently, avoiding the one-off non-cash construction revenue that affects profitability.

• Monopoly and Margins: CWA enjoys monopoly advantages in certain areas, with a gross margin of 40%-60% for pipeline connection services, due to its position as the primary water supplier in many regions.

• Water Tariff Trends: China's water tariff is among the lowest globally, accounting for less than 1% of average disposable income, and is expected to rise gradually as the government encourages water conservation and improves water quality.

• Capacity Expansion: CWA has expanded its water supply capacity through aggressive acquisitions, including the 2015 purchase of Goldtrust and a 2016 acquisition in Jiangxi. These expansions are expected to boost its capacity by 33% in the long term.

• Non-Core Business Disposal: CWA is actively selling non-core assets, such as property and concrete businesses, to unlock value and fund future expansion. This strategy is expected to reduce valuation discount and improve earnings visibility.

• Share Buybacks: CWA has initiated share buybacks, signaling management's confidence in the company's future performance and stock valuation.

• Financials: CWA reported adjusted profit growth of 31.8% in FY15, with a net profit of HK$371 million. The company has a high net gearing of 91% and a significant cash balance of HK$2.6 billion in 1H16, which supports its M&A activities.

Key Information

• Revenue Growth: CWA's revenue grew by 4.1% YoY in FY15, reaching HK$2,859 million, with a 20.8% growth in 1H16.

• Earnings Growth: Analysts forecast a 36% YoY adjusted profit growth for FY16E and 19% YoY for FY17E.

• Valuation: CWA is trading at 15x/13x P/E for FY16E/17E, which is lower than the sector average.

• Shareholding Structure: The top shareholders include Duan Chuan Liang (30.9%), ORIX Corporation (19.5%), and Tsui Chi Kin (5.7%).

• Market Cap: CWA has a market cap of HK$6.095 billion and an average daily trading volume of 2.27 million shares.

• Share Buybacks: CWA has repurchased 8.16 million shares at an average price of HK$3.90 since April 2016, indicating confidence in the stock's undervaluation.

• Financial Ratios: CWA has a high total debt/equity ratio (91.0% in 2015), with a net debt/equity ratio of 91.0% in 1H16. Its operating margin has increased from 28.2% in 2013 to 38.8% in 1H16.

Investment Outlook

• Ratings: CWA is rated as a "BUY" based on its potential for earnings growth and strategic advantages in the water sector.

• Key Risks: Potential lower-than-expected water tariff increases, slower M&A activity, and higher financing costs could affect earnings growth.

• Funding Sources: CWA has secured financing from the Asian Development Bank (ADB) and the International Finance Corporation (IFC), which supports its expansion plans and M&A activities.

Conclusion

CWA is well-positioned to benefit from the ongoing water industry reform in China, with a strong track record of growth through capacity expansion and tariff increases. The disposal of non-core businesses and share buybacks indicate a strategic move to focus on core operations and improve financial health. Despite the risks, the company's unique business model and government support make it a compelling investment opportunity.