20180123-招商证券_香港_-China_water_sector__Bottom_up_–_rerate_is_not_far_away_for_quality_players_47页_3mb

China Water Sector Summary

Core Content

The China water sector is evaluated with a cautiously positive outlook, focusing on the potential for quality players to be rerated due to improved financial positions and sustainable growth. The report highlights the importance of government investment, the maturing PPP model, and the need for operational efficiency and financial innovation.

Main Points

• Government Investment: The 13th Five-Year Plan (FYP) indicates increased government investment in the water sector, with a total of RMB564bn (up from RMB427bn in the 12th FYP). This supports the growth of wastewater treatment (WWT), sludge treatment, and water renovation work.
• Market Opportunities: Residential wastewater treatment, particularly in townships, is a key growth area. The government also emphasizes water renovation projects, such as black-and-malodorous water treatment and rainwater pipeline construction.
• PPP Model Maturation: The PPP model is becoming more established, allowing WWT operators to offload financial burdens and improve returns on equity (ROE). However, competition remains fierce, and small players may struggle without financial and operational advantages.
• Valuation: The sector is currently trading at a 2018E P/E of 10.6x, a 21% discount to its 3-year historical average of 13.5x. Quality players, especially BEW, are considered undervalued and have the potential for re-rating.
• Company Performance: BEW is highlighted as a top pick due to its asset-light strategy, SOE background, and strong track record. It is expected to deliver a recurrent EPS CAGR of 22% over 2018-19E and trade at a 2018E PEG of 0.6x, which is attractive compared to the sector average of 0.9x.
• CTEG Evaluation: CTEG is rated NEUTRAL due to its troubled past with short-sell reports and project delays. Its earnings growth is expected to rebound in 2018-19E, but it may take time to regain investor confidence.

Key Information

• BEW (371 HK):

  • Current Price: HK$5.99
  • Target Price: HK$7.80
  • Upside: 30.2%
  • 2018E P/E: 10.6x
  • 2018E ROE: 24.5%
  • 2018E PEG: 0.6x
  • Rating: BUY

• CTEG (1363 HK):

  • Current Price: HK$1.58
  • Target Price: HK$1.55
  • Upside: -1.9%
  • 2018E P/E: 12.9x
  • 2018E ROE: 16.1%
  • 2018E PEG: 0.85x
  • Rating: NEUTRAL

Investment Thesis

• Positive Factors:

  • Increasing government investment in the water sector.
  • Negative news is largely priced in.
  • Rerating potential for quality players with positive results, such as ROE enhancement through the PPP model.

• Cautious Factors:

  • Small players may struggle with intensified competition.
  • Risks include lower-than-expected government investment, delays in tariff adjustments, and high competition in PPP projects.

Catalysts and Risks

Near-term Catalysts:

1. Faster development of PPP funds
2. Upward revision of WWT discharge standards
3. Accelerating consolidation in the WWT market

Key Downside Risks:

1. Keen competition in PPP projects
2. Lower-than-guided government investment
3. Delays in tariff adjustment
4. Tightening environmental regulation in the industrial WWT market

Valuation and Earnings

• Sector Valuation:

  • 2018E P/E: 10.6x
  • 3-year historical average: 13.5x
  • PEG: 0.9x (excluding GD Investment)

• BEW Valuation:

  • 2018E PEG: 0.6x
  • Recurrent EPS CAGR (2018-19E): 22%
  • Expected to deliver higher earnings and ROE through PPP projects and improved financial performance.

• CTEG Valuation:

  • 2018E PEG: 0.85x
  • Earnings growth is expected to rebound, but it will take time to regain confidence.

Earnings Sensitivity

• BEW:

  • Higher earnings sensitivity to operational capacity and tariff.
  • Gross profit from operating water treatment services accounts for 56% of total gross profit.
  • A 25bp interest rate hike could impact earnings by 2.2ppts.

• CTEG:

  • Lower gross margins and higher administrative expenses are assumed in the forecasts.
  • Earnings are less sensitive to operational capacity and tariff.

Differences from Consensus

• BEW:
  • 2017-19E recurrent EPS estimates are 2-4% below consensus, mainly due to the dilutive effects of share options.
• CTEG:
  • 2017-19E recurrent EPS estimates are 5-9% below consensus, due to lower gross margins and higher administrative costs.

Conclusion

The report suggests that the China water sector is undervalued, with quality players like BEW having significant potential for re-rating. However, small players may struggle due to intense competition and lack of financial innovation. The maturing PPP model and government initiatives in water renovation provide growth opportunities, but risks such as competition and regulatory changes remain.