China Everbright Water - CIMB Research 2016-08-08: Lukewarm quarter dampened by higher costs

China Everbright Water - CIMB Research 2016-08-08: Lukewarm quarter dampened by higher costs CHINA EVERBRIGHT WATER LIMITED U9E.SI

China Everbright Water - Lukewarm quarter dampened by higher costs

  • 1H16 revenue was above our/consensus estimates (+40% yoy) due to greater mix of construction activities. Gross margin fell from 46.8% in 1H15 to 35% in 1H16.
  • 1H16 core net profit was below expectations, taking hits from higher admin and deferred tax expenses and forming only 41% of our full-year forecast.
  • Net gearing was 40.3% at end-1H16 with lower average borrowing costs of 3.5% (1H15: 7.8%).
  • We project pipeline to drive construction momentum, as well as higher water tariffs.
  • Downgrade to Hold with lower TP as we factor in higher construction mix.

1H16 topline growth offset by lower gross margin and higher taxes 

  • 1H16 revenue rose 40.1% yoy to HK$1.3bn, thanks to construction activities comprising a larger component of 53% (1H15: 36%). However, this caused overall gross margin to contract from 46.8% in 1H15 to 35.0% in 1H16 because construction gross margin is typically 20-30% versus treatment gross margin of at least 50%. 
  • We expect strong construction momentum to continue, given its backlog of 0.08mt/d WWT (Rmb283m) projects and Rmb1.75bn projects due to commence in 2H16.

Higher admin and tax expenses were one-off 

  • 1H16 core net profit of HK$181m was below our/Bloomberg consensus expectations. 
  • Apart from lower gross margin, the unexpected increase in deferred tax expenses (arising from non-recurring, non-tax deductible items) had negative impact on bottomline. 
  • Admin costs rose 56% yoy in 1H16 partly due to HK$23.3m FX losses from some US$-denominated borrowings (already repaid in Jul 16). 
  • We note that Dalian Dongda (acquired in Nov 15) contributed HK$37m to 1H16 net profit.

Decent financial scorecard 

  • CEWL’s total borrowings surged from HK$1.8bn at end-Jun 15 to HK$5.6bn at end-Jun 16 but finance costs rose by a smaller extent, as more expensive debt was replaced (average borrowing costs fell from 7.8% to 3.5%). 
  • Net gearing at end-Jun 16 was acceptable at 40.3%, with 56% Rmb debt. 
  • Management stated credit collection from local governments tightened from five months in 1H15 to four in 1H16. 
  • Service concession receivables likely to keep rising on the back of more construction.

Management remains optimistic on business prospects 

  • In 1H16, CEWL delivered project wins of 0.455mt/d in terms of designed capacity, with total capex of Rmb2.1bn. Management is confident of meeting its FY16 target of 1.5mt/d new water assets and could expand its options to more sponge city and sludge treatment projects. Upward tariff revision for more projects is underway, as exemplified by recent tariff hike for the Suzhou project from Rmb1.9/tonne to Rmb2.2/tonne. Average tariff for Dongda projects is 30-40% below CEWL’s existing projects.

Downgrade from Add to Hold 

  • We revise our FY16-18 assumptions to factor in higher construction mix and lower gross margins, as well as higher effective tax rate in FY16. Hence, our FY16-18F EPS drops by 2-16%, leading to lower DCF-based target price of S$0.67 (WACC: 7%). 
  • We downgrade CEWL to Hold, given the lack of catalysts in the near term and expected slow ramp-up in treatment income. 
  • Upside risks to our call are earnings-accretive M&A and better operational efficiency, while downside risk is deteriorating receivables.

NGOH Yi Sin CIMB Research | Roy CHEN CFA CIMB Research | Keith LI CIMB Research | http://research.itradecimb.com/ 2016-08-08
CIMB Research SGX Stock Analyst Report HOLD Downgrade ADD 0.67 Down 0.810