20180705-招商证券_香港_-China_Waste_Treatment__Treasure_hunt_in_the_wastes_45页_3mb_3mb

China Waste Treatment Sector Summary

Core Content

The China waste treatment sector, particularly the waste-to-energy (WTE) segment, is positioned for mid-term growth driven by urbanization, pollution concerns, and insufficient treatment capacity. Despite market concerns over negative operating cash flow and the sustainability of capacity expansion, the sector has underperformed the Hang Seng Index (HSI) and Hang Seng China Enterprises Index (HSCEI) by 2-11% YTD and 2-20% in 12-month basis. However, the sector is currently trading at a historical low of 9.1x blended forward P/E, 26% below its 3-year historical average of 12.3x, suggesting potential for re-rating.

The government's push for incineration as the preferred MSW treatment method has led to a significant increase in capacity. From 235ktpd in 2015 to 591ktpd in 2020, the incineration treatment capacity is expected to grow at a CAGR of 20%, outpacing other methods. This shift is expected to drive the WTE market to be worth RMB157bn during 2017-20E.

Main Viewpoints

• Growth Drivers: Urbanization, rising pollution concerns, and insufficient waste treatment capacity are the main factors driving growth in the WTE sector.
• Sector Performance: The WTE sector has underperformed the HSI and HSCEI, but this is attributed to concerns over cash flow and capacity sustainability.
• Valuation Discount: WTE is currently undervalued compared to its historical average, presenting a buying opportunity.
• Earnings Quality: WTE operators have better earnings quality than waste-water treatment (WWT) operators, with cash-basis profits accounting for >68% of total net profit in 2017.
• Market Leadership: CEI is highlighted as the top pick in the environmental sector due to its flexibility, technology know-how, management expertise, and SOE background.

Key Information

• CEI (257 HK):

  • Rating: BUY
  • Current Price: HK$10.18
  • Target Price: HK$13.00
  • Upside: 27.7%
  • 2019E PEG: 0.45x (9% premium to sector average)
  • Expected recurrent EPS CAGR: 19% over 2017-2018
  • Cash-basis operation profit: >68% of total net profit in 2017

• Canvest (1381 HK):

  • Rating: BUY
  • Current Price: HK$4.15
  • Target Price: HK$4.90
  • Upside: 18.1%
  • 2019E PEG: 0.57x
  • Cash-basis operation profit: 72% of total net profit in 2017 (highest among peers)

• Market Outlook:

  • MSW generation is expected to grow steadily due to urbanization and rising living standards.
  • WTE operators are expected to maintain robust growth with a CAGR of 20.3% during the 13th FYP.
  • The WTE market is highly competitive, with the top 5 operators holding 40% of the market share.

• Opportunities and Risks:

  • Opportunities: Accelerating M&A, higher-than-expected demand, and technology breakthroughs.
  • Risks: Increased competition, downward pressure on power generation tariffs, stricter emission standards, and reduced government investment guidance.

Investment Thesis

• WTE operators are expected to benefit from the government's push for incineration and the growing MSW issue.
• CEI is preferred due to its strong growth profile, better earnings quality, and ability to capture fast-growing opportunities in the environmental sector.
• Canvest is also a strong contender due to its niche position in Guangdong and strategic partnerships.

Valuation and Performance

• WTE vs WWT: WTE operators have better earnings quality and are expected to trade at a premium to WWT operators.
• Sector Valuation: WTE is currently undervalued, with a blended forward P/E of 9.1x, significantly lower than the sector average.
• Performance Metrics:
  • CEI: 2019E PEG of 0.45x, 19% recurrent EPS CAGR
  • Canvest: 2019E PEG of 0.57x, high operating efficiency
  • Sector Average: 9.7x P/E, 17.2% 3-year EPS CAGR

Specialized Waste Treatment

• Biomass to Energy: Robust development with a CAGR of 20% over 2012-2016. However, securing feedstock is a key success factor.
• Hazardous Waste Treatment (HWT): Expected to grow due to favorable policies, but faces challenges such as high CAPEX and fragmented market.

Conclusion

The WTE sector in China is poised for growth and re-rating due to its strong fundamentals, government support, and improved earnings quality. CEI and Canvest are the top picks, with CEI showing stronger growth potential and better valuation metrics. While the sector presents opportunities, investors should be mindful of the risks associated with increased competition, regulatory changes, and potential reductions in government investment.