China Everbright Water - Not yet making a splash
- More competitive landscape, project delays despite favourable government policies.
- Lower valuations at 11-14x FY17/18 P/E, but prefer to await more project wins.
- Retain Hold rating with a lower DCF-based TP (7% WACC).
Construction remains key driver
- CEWL is a municipal wastewater treatment (WWT) company with geographical focus in the Chinese provinces of Jiangsu and Shandong, where it has a track record and provincial governments are financially sound.
- As of Sep 16, it had a total design capacity of 5mt/d, vs. operating capacity of 4.5mt/d. Its 9M16 core net profit was within expectations while construction activities remain its key revenue driver.
Financing and FX risks
- As of end-Sep 16, its Rmb-denominated borrowings accounted for 62% of total debt, while 38% were in HK$ and US$. 9M16’s average cost of debt fell to 4.1%, vs. 9M15’s 4.8%. Net gearing remained decent at 43% as of end-Sep 16.
- 3Q16 saw one-off FX expenses of HK$7m arising from the liquidation of US$-pegged borrowings, of which US$73m have been fully repaid by end-Jul 16.
No lack of funding, for now
- CEWL announced on 31 Oct 16 its proposed issuance of Rmb-denominated corporate bonds of up to Rmb2.5bn. Based on its triple-A credit rating, management thinks the interest costs could be in the range of 2.9-3.5%. This bond issuance will not only help to minimise FX exposure from those offshore loans and retire those more expensive borrowings, but also provide capital for future projects.
- Other banking facilities include Rmb5bn from China Development Bank, Rmb1.8bn from other foreign and domestic banks, amounting to a total of Rmb9.3bn.
Staying ahead of rising competition via expansion into sponge city
- Intensifying competition in the WWT segment is one of the reasons for CEWL’s shift towards sponge city projects and PPP formats. Sponge city projects are typically larger in scale which also encompass WWT capacity, but are more technically challenging in terms of overall design and development. Such characteristics act as natural hurdles against smaller companies with less established track records.
- Construction for Zhenjiang Sponge City has been delayed due to more stringent standards imposed by local governments. CEWL is hopeful that progress could be expedited in 4Q16 for completion targeted by end-2017.
Dalian Dongda drags…
- While the acquisition of Dalian Dongda was finalised in Nov 15, it continues to weigh on CEWL in the following ways:
- slow collection of receivables;
- average tariff increment still not up to management’s expectations due to slower-than-expected upgrading progress. Dalian’s average water tariff is Rmb0.8/ton, and c.60% of assets is in Grade 1B/2;
- Liaoning province’s 2016 GDP growth rate has been sub-par.
- Our FY17-18F EPS estimates fall by 4% to account for higher effective tax rate.
- Our DCF-derived target price falls to S$0.54 (7% WACC) as we assume a slower ramp-up of treatment income, and on rollover to end-FY17.
- While valuations have tapered off to 14x/11x FY17/18 P/E, we keep our Hold rating, pending stronger traction in receivables collection and visibility in acquisition pipeline.