China Everbright Water - Management confident on growth; Reiterate Buy

Management confident on project wins in 2H15; Buy as one of the top picks
CEW management is very confident to win over 1mt/d of new projects in 2015. This should relieve the investorso concern on the slow progress in project win in 1H15 with only 40kt/d secured. Share price has dropped 22% since 1 July among the market turmoil, and underperformed peers by 7-12ppt. We reiterate our Buy rating and CEW remains one of our top picks in the sector.

Guidance reiterated: over 1mt/d new projects in 2015; over 10mt/d in 3-5 years
At the analyst briefing, the management conveyed strong confidence to secure over 1mt/d of new designed capacity in 2015 (vs. DBe 0.5mt/d), as their effort in 1H15 will be reflected in 2H15 and 2016. Management reiterated their target to achieve over 10mt/d of designed capacity in 3-5 yearso time and become one of the three largest water companies in China. Management does not view such capacity target as aggressive, which could be revised up depending on actual progress. CEW has recently secured a BOT project with 50kt/d capacity expansion in Jinan city in Shandong. It is also following more than 50 projects/deals at the moment.

Growth from both organic and M&As; may accept lower return for large M&As
Management explained that the growth will come from M&A, TOT and BOT with a balanced mix. Large M&As are most effective in building up scale, albeit the return could be lower given the acquisition premium. CEW can accept minimum equity IRR of 8% for large M&As (compared to over 10% for its existing projects). Municipal wastewater treatment will remain CEWos core business, while new areas of interest include industrial water treatment, water supply and modern public toilets in scenic areas/cities under quasi-BOT model.

Prefer debt financing to finance capex; average borrowing cost to come down
CEW has the flexibility for both debt and equity financing, with only c.10% net debt to equity ratio by end-1H15 and the parent CEI holding 74.4% stake. However, management prefers debt over equity to fund the capex. CEW will continue to refinance HanKoreos expensive borrowings and reduce its average borrowing cost to c.5.5% by the year-end and to 4.5-5% in the longer term.

VAT rule impact; communication with the local governments has started
Management expects less than 5% earnings impact in 2015 from VAT rule change. It has started communicating with the local governments on tariff hikes and some projects should be able to pass on the impact within this year.


Technical Analysis
Daily Chart
DCF-based target price of S$1.32, implying over 70% upside; 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) 

Read Related Report
China Everbright Water - Expect a better 2H
Thursday, 6 August 2015
- DBS Group Research

Source : Deutsche Bank Markets Research

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