CITIC Envirotech - A water expert, not just a builder

■ CEL reported 1H15 EPS in line with our 9M15 forecasts, but below consensus.

■ Weaker-than-expected engineering income resulted in a 32.7% yoy fall in overall sales. This was aggravated by higher labour costs and financing charges.

■ Excluding one-off items in 1Q15 and 1Q14, 1H15 core EPS dipped slightly by 7.9%.

■ FY16-17F capex cut to S$250m pa on slower expansion due to smaller project wins.

We remain optimistic of the industry outlook and CEL’s technological expertise in WWT. Maintain Add with lower target price of S$1.80 (DCF-based, WACC:6%).

Topline miss due to lumpy engineering revenue
2Q15 revenue of S$70.9m fell 32.7% yoy, largely due to a 62.9% yoy decrease in engineering revenue, slightly offset by higher membrane sales (+96.3% yoy) and treatment income (+28.9% yoy). Gross margin improved from 29.2% to 37.6% due to a higher proportion of membrane sales which typically command higher margins. Net gearing as of 2Q15 was c.45.6%, signaling potential for further leverage to boost ROE.

Bottom line impacted by higher labour and finance costs
Employee benefit expenses for 2Q15 rose from S$4.9m to S$7.7m on the back of additional staff strength to operate new treatment plants and manufacturing facilities for membrane products. The newly issued bond of S$225m and bank borrowings resulted in higher financing charges. Excluding the one-off fees of S$6.5m in 1Q15 and a onetime gain of S$14.2m on AFS disposal, 1H15 core EPS dropped slightly by 7.9%.

Outlook remains positive
In addition to China’s 13th 5-year plan, CITIC Limited (its key stakeholder) has also announced on 24 Jun 15 it would invest more than Rmb700b to support China’s “One Belt, One Road” initiative. Given its strong presence in industrial wastewater treatment (WWT) and membrane technology, there will be more opportunities for CEL to partake in water infrastructure development projects along the trade routes.

Slow but steady flow of project wins
Despite intensifying industry competitiveness, CEL continues to secure project wins, which should, in our view, drive future earnings. In Aug 15, they obtained 3 WWT and water supply BOT projects of total contract value of Rmb263m. In Oct 15, CEL also won a EPC contract (Rmb400m) to construct a WWT plant using their proprietary membrane bioreactor technology in Gansu Province, China.


Technical Analysis
Daily Chart
Maintain Add with a lower target price of S$1.80
While 2Q15 core net profit fell 16.5% yoy, we are not overly concerned about near-term earnings volatility due to the lumpy and low-margin nature of the engineering business. On account of the gradual ramp-up via the route of JVs/ PPPs, we have adjusted our annual capex assumptions from S$300m to approximately S$250m, and lowered our FY15-17 forecasts for engineering income and membrane sales. Hence, our DCFderived target price falls to S$1.80 (WACC:6%). We maintain our Add recommendation. (Read Report)

Read Related Reports
1) CITIC Envirotech - QoQ improvement in Sep quarter‏ by OCBC Investment Research, published on 30 October 2015

2) CITIC Envirotech Ltd - Paving way for a rebound by DBS Group Research, published on 29 October 2015

Source : CIMB Research

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