Initiating with Buy; top pick in the sector
We initiate coverage of China Everbright Water (CEW) with a Buy. CEW is well positioned to become one of the leading water companies in China, supported by its SOE background, low funding cost and synergy with its parent CEI. We expect CEW to accelerate expansion after completion of the reverse takeover of HanKore as a separately listed vehicle in Dec 2014. It offers the highest earnings growth and therefore deserves a higher valuation multiple than peers.
Strong growth outlook; synergy with its parent CEI
We expect CEW to deliver a 43% EPS CAGR in 2015-17E after a temporary slowdown in 2015 with the impact from the reverse takeover (RTO). CEW aims to grow its designed capacity to over 10mt/d in 3-5 years. We conservatively assume 0.5mt/d new project wins in 2015 to allow for a transitional period after the RTO, followed by a 1.5mt/d p.a. addition to achieve total designed capacity of c.10mt/d in five years. CEW’s parent CEI is known for its strong track record in the environmental sector. As CEI’s water platform, CEW should benefit from CEI’s reputation and synergy in sourcing new projects. There is still room for CEW to leverage up (from c.11% net debt to equity currently) to fund capex.
Under-researched; more attractive risk-reward than peers
CEW has underperformed peers by 25ppt YTD. Its valuation multiple appears high for 2015 due to the temporary impact of the RTO, but it looks attractive in 2017 considering its strongest growth rate. We think the market expectation is relatively conservative, as CEW is still building up its track record. There is significant potential for it to beat expectations. Every 1mt/d of extra capacity would imply an over 20% boost to the near-term earnings. Listing in Hong Kong in the future looks to be a realistic possibility, which would help improve the liquidity and re-rating of the stock.
DCF-based target price of S$1.32; key risks
Our DCF valuation (WACC 6.2%) incorporates long-term growth and is not affected by the mismatch between reported earnings and cash flows under concession accounting.
Risks: lower-than-expected project wins, EPS dilution from potential equity placement, and receivable risks from local governments. (Read Report)
Source : Deutsche Bank Markets Research