CITIC Envirotech Ltd - DBS Research 2016-10-27: Awaiting improvement in deal flow

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CITIC ENVIROTECH LTD. U19.SI

CITIC Envirotech Ltd - Awaiting improvement in deal flow

• Q3 results boosted by engineering revenue.
• Awaiting China Reform Fund to open door for more opportunities.
• FY17 earnings estimates revised down by 12%.
• Maintain HOLD with TP of S$1.20.

Slow deal flow. 

• While CITIC Envirotech (CEL) has a strong competitive edge (including strong backing from parent and strong technical knowhow in membranes), the deal flow has been slower than expected giving rise to lower earnings visibility. Thus, we maintain our HOLD rating until we see the new shareholder can improve the momentum in its order backlog.

Robust growth in engineering revenue. 

• Q3FY16 net profit jumped 66% to S$23.1m, underpinned by 
  1. 200% growth in engineering revenue; 
  2. 22% growth in treatment services (operating capacity estimated to climb from >2m tons to 2.8m tons per day); and 
  3. 35% growth in membrane sales. 
• CEL still has 1.7m tons of non operating capacity, which we estimate can lead to 7% growth in engineering revenue in FY17. Upon the completion of construction, we estimate operating capacity to climb further to 3.6-3.9m tons, resulting in 15-27% growth in treatment service in FY17 and FY18. 
• In addition, production capacity of membrane has just been doubled. Gradual ramp up of the new capacity will maintain membrane sales growth at 20-25% going forward.

New shareholder opens the door to more business opportunities. 

• Our major concern on CEL is its slow deal flow. 
• On a positive note, China Reform Puissance has recently acquired the entire 269m shares from KKR (@S$1.45/sh) and become the second largest shareholder of CEL with a 23.85% stake. China Reform Puissance is an investment vehicle set up by China Reform Fund (CRF) and Puissance Capital. 
• CRF is sponsored by a stated-owned asset management corporation under the direct supervision of the central government. Thus, we are hopeful that this new shareholder can open the door to more business opportunities for CEL, and accelerate the company’s development.

Valuation

• We have revised down our FY17 earnings estimate by 12% to reflect the potential dividend payment from perpetual capital securities. As competition in the water sector is getting fierce, we have lowered our target PE from 25x to 20x for treatment services and membrane sales.
• Our new TP is set at S$1.20, based on 12x, 20x and 20x 12-month rolling PE (adjusted for construction revenue) for EPC, treatment services and membrane sales respectively. 
• Maintain HOLD.  

Key Risks to Our View

• Delay in construction progress of EPC projects could hurt top line growth.
• Further depreciation of Reminbi will also hurt earnings growth.

Patricia YEUNG DBS Vickers | http://www.dbsvickers.com/ 2016-10-27

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 1.20 Down 1.550