Better-than-expected growth in profitability in FY18, a higher than forecast DPS and a favourable market outlook are clearly positive for China Water Affairs (CWA). We forecast continuing growth over the next few years and have raised our valuation to HK$10 per share. At that price, CWA would trade on a forward-looking P/E multiple of 13.1x, a c 15% discount to our group of selected peers.
CWA posted continuing year-on-year growth in group revenue (HK$7,580m +32.8%), recurring operating profit (HK$2,718m +37.5%) and EPS (71.8c +29.6%). The growth reported exceeded our expectations for both revenue (HK$7,069m), and EPS (64.9c). The performance was aided by tariff hikes, acquisitions and an improvement in the cost to income ratio. The core water business (c 82% of group revenues) saw revenues and operating profits increase by 25.1% (to HK$6,204m) and 30.1% (to HK$2,401.9m) respectively. The DPS was increased to 23.0c (Edison FY18e 19.6c) and represented c 32% of basic EPS. As CWA continues to expand the scope of its operations, net debt rose to HK$7,801m, but the balance sheet remains healthy and the ratio of total liabilities to total assets reduced from 65% to 61%, helped by the recovery of HK$833m from the sale of non-core assets.
CWA has achieved five-year CAGR of 33.3% in core water profits and the outlook continues to appear promising. CWA’s strong market position should allow it to take advantage of the incremental privatisation of the Chinese water system as China seeks to address regional water imbalances, integrate urban and rural water supply and improve water quality. Targeted acquisitions, funded by organic cash flow and an increased pace of non-core disposals, tariff increases, capacity expansions and the strategic co-operation agreement with Toray in the high-margin drinking water market should provide for growth at CWA.
We have revised our forecast and valuation on the back of the strong FY18 results. We now forecast EPS of 88.2c for 2020 (previously 83.0c) and expect a CAGR in EBIT of c 14% for the period 2018-21 (c 27% CAGR 2013-18). We have also reassessed our valuation, which increases from HK$8.0 per share to HK$10.0 per share. At that price, CWA trades on an FY19e P/E of 13.1x (a discount to a group of 10 Chinese and international peers at c 15.1x) and a PEG ratio of c 1.3x (c 1.4x for peer group).