China Water Sector - Renewed interest on more attractive valuation

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■ Investors are more cautious on valuation and risk

■ Interest will grow again when valuation is more attractive

■ SOE players are preferred choice

Reiterate our BUY rating on our top picks: CITIC Envirotech (CEL SP), CT Environmental Group (1363 HK), Kangda (6136 HK)

Valuation not cheap
During our marketing trips in Hong Kong and Singapore, we felt interest towards the sector from investors in both markets has subsided, compared with last year. With lower risk appetite, almost all investors we met during the marketing trip believed the valuation of the sector is not cheap, although they all agreed that the government is still supportive to the sector. Nevertheless, we believe investors’ interest in the sector will be renewed on more attractive valuation when adjusted PE is closer to the historical average (currently slightly below +1SD).

More risk adverse
Contrary to our previous marketing trip where investors mainly focused in the growth drivers and re-rating catalysts, more discussions on downside risk and potential de-rating factors were made this time. Nevertheless, we do not expect any major de-rating factors in the short term as the environment is still too bad for the government to ignore. Some investors wondered whether the reduction in VAT rebate will continue which we believe is highly likely though the progress should be gradual. The downtrend in IRR requirement by listed companies from >10% to 8-10% has also raised the concern on market competition.

Prefer SOE backed players
Investors have become sceptical towards non SOE backed counters after the incident of Sound Global (967 HK), as reflected in their preference to SOE backed stocks, particularly the two large players, i.e. China Everbright Int’l (257 HK) and Beijing Enterprises Water (371 HK).

With regard to one of our top picks CITIC Envirotech (CEL SP) (previous known as United Envirotech (UENV SP)) which is also an SOE player, Hong Kong investors showed stronger interest but two major concerns are the low trading liquidity and high A/R days. Investors were more receptive to CT Environmental Group (1363 HK) amongst non SOE counters, given its Build – Own – Operate business model has less distortion and its exposure to industrial sector offers higher return. While investors agreed with our view that Kangda (6136 HK) has high growth potential, they were concerned on its short listing history and non SOE background. (Read Report)

Source : DBS Group Research

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