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China Everbright Water - DBS Research 2016-08-09: Short term hiccups

China Everbright Water - DBS Vickers 2016-08-09: Short term hiccups CHINA EVERBRIGHT WATER LIMITED U9E.SI

China Everbright Water - Short term hiccups

  • 1HFY16 net profit dropped 14%, below expectation.
  • Expect net profit to rebound on margin improvement.
  • Revise down FY16 and FY17 earnings by 17% and 9% respectively.
  • Maintain BUY with TP lowering to S$0.66. 


Target to become a top three player. 

  • We have a BUY rating on China Everbright Water (CEW) as it has a solid plan to become a top three player through capacity expansion, diversification along the value chain and technology enhancement. 
  • Although 1HFY16 interim results suffered a profit decline, we reckon it is only a short term hiccup and it would ride on the robust growth of the China water market again.


Rebound in profitability. 

  • 1H16 net profit was down 14% to HK$180.6m, which was below our expectation on margin squeeze of 11.8ppts to 35%. However, we expect involvement of in-house engineering company will increase along with acceleration of construction work for Zhenjiang Sponge City PPP projects and other waste water treatment plants, which would lift up gross margin of construction services by 2-3ppts. 
  • In addition, we estimate gross margin of operating services to rebound 2-3ppts on tariff hike, technical upgrade and lower maintenance expenses. We project overall gross margin to reach 37.6% in FY16 and 38.7% in FY17. 
  • Coupled with reduction in forex loss, we estimate net profit to climb 10% and 42% in FY16 and FY17 respectively.


Growth through scale and diversification. 

  • After adding 455k tons of daily capacity, CEW’s project portfolio reached c.5m tons per day in 1HFY16, on track to reach its target of 1-2m tons/day for the year. We expect more business development to be announced (including both M&A and securing projects from local governments) in the coming months. 
  • We also expect CEW to diversify into new segments, such as water supply, recycled water, integrated watershed management, construction of sponge cities, etc. In fact, the recent acquisition of the Zhenjiang sponge city project is a major step forward for CEW in diversifying its revenue stream and stepping into the provision of more comprehensive environmental services.

Valuation

  • Our TP of S$0.66 is based on 26x 12-month rolling adjusted PE where earnings are adjusted to reflect only operational projects, i.e. profit from construction revenue is stripped out.

Key Risks to Our View

  • We have assumed CEW to add at least 1m tons of capacity through acquisitions. Delay in M&A would result in slower-than-expected earnings growth.




Patricia YEUNG DBS Vickers | Tony WU CFA DBS Vickers | http://www.dbsvickers.com/ 2016-08-09
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 0.66 Down 0.690


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