Water Utilities - Hydraulic Revolution
- We keep our OVERWEIGHT rating on the water sector as companies in our coverage universe have strong book-to-bill ratios and solid balance sheets to bid for new projects.
- With China facing slowing growth and high debt levels, we believe its Central Government may continue to push for more infrastructure spending to support the economy. As such, we expect to see faster adoption and quicker approval of PPP projects in the water sector in 2017.
- Our Top Pick for the sector is SIIC Environment.
Policies still favour the sector.
- Despite slower project acquisitions witnessed in 2016, we think the outlook for the sector remains promising in 2017. The Chinese Government is still putting the sector at the forefront of attention.
- Throughout 2016, China has aggressively advocated the adoption of the public- private partnership (PPP) model – especially for mature environment-related industries such as wastewater treatment (WWT). This would help to ease the financial burden for the industry players, thereby allowing them to bid for larger projects.
- Moreover, the Central Government has also mapped out a pipeline of 4,800 projects with a total investment value of CNY430bn to improve water quality.
- In 2017, we also expect to see a system in place that would incentivise local governments to complete water remediation projects on schedule.
Building gargantuan projects and leaders.
- We also expect the Chinese Government to increasingly tie low-return projects (such as water reclamation and pipe works) with better-yielding WWT projects in the PPP model. This means that the future growth of companies may be benchmarked against project investment scale rather than growth in treatment capacity. We believe this move would further consolidate the industry, as only the big state-owned enterprises (SOEs) with strong ability to control their cost structure would be able to take on these huge projects. While this may potentially result in large SOEs bidding down prices, we do not expect to see more than 1ppt of IRR erosion for the stocks under our coverage.
Paying out dividends to signal strong operating cash flow.
- More Singapore-listed water stocks are paying out dividends, or are at least considering doing so in the near term, despite the capital-intensive nature of the sector. While the amount may be insubstantial, we view this positively as it demonstrates the cash flow-generating ability of the companies’ operations. So far, for FY15, Everbright Water has declared a 35-cent (SG) DPS (12% payout ratio) while Citic Envirotech declared a 36-cent (SG) DPS (11% payout ratio).
- We believe SIIC would also start to pay out dividends after its dual-listing in Hong Kong is completed.
Strong balance sheet and book-to-bill ratio.
- Maintain OVERWEIGHT on the sector as we estimate that both China Everbright Water and SIIC Environment still have book-to-bill ratios of more than 1x. We expect to see continued strong construction revenues from both companies in 2017.
- Potential catalysts would be faster-than-expected project wins. In this respect, both companies have net gearing levels of about 0.5x, which holds them in good position to gear up for more project acquisitions