We initiate coverage of SIIC Environment (SIIC) with a Buy. The company has the potential to become one of the leading water companies in China due to its SOE background and low funding costs. SIIC is under-researched, with its valuation at a discount to that of its peers. This is likely to change with a potential dual listing in Hong Kong. A potential asset injection could also be a positive catalyst. Our target price implies more than 30% upside potential.
Strong earnings growth ahead from capacity growth
SIIC is the environmental platform of Shanghai Industrial Holdings (SIHL, 0363.HK, NR). We expect SIIC to deliver an earnings CAGR of 35% over 2015- 17, driven mainly by a c.30% CAGR in operational capacity, assuming the company matches the upper level of the company’s guidance of 1-1.5mt/d p.a. SIIC may further expand its waste-to-energy business through M&A or enter other environmental areas, which could imply upside to our earnings estimates. Its conservative balance sheet leaves significant scope for SIIC to leverage up (from a 34% net debt/equity ratio by end-2014) to fund capex.
Trading at discount to peers; HK listing and asset injection potential catalysts
SIIC’s earnings growth is higher than that of BEWG and CEI, but the stock is trading at a discount of more than 10% on 2015E adjusted EV/EBIT. SIIC is considering a dual listing in Hong Kong, which could help improve its trading liquidity and narrow the valuation gap. Its parent has a 45% stake in General Water (with c.6mt/d designed capacity) and the remaining 16.8% stake in Longjiang, which could be injected into SIIC. This could be a positive catalyst, if priced attractively.
DCF-based target price of S$0.28; Buy; 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; receivable risks from local governments. (Read Report)
Source : Deutsche Bank Markets Research