We believe China Water Affairs Group’s (CWA) strong financial position (net debt/equity FY18 c 70%) and impressive track record of generating returns for shareholders should enable it to exploit the favourable market conditions and allow for a continuation of its strong growth profile. Following the recent acquisition of 29.5% of Kangda International, CWA’s market valuation appears undemanding compared to its peers despite its track record of delivering attractive returns for its shareholders.
CWA’s record of generating growth for its shareholders is impressive, with a CAGR in EPS and DPS of 30% and 36%, respectively in the period 2013–18. H119 results were broadly in line with our projections for FY19 and we expect CWA to achieve further strong growth in the period 2018–21 (CAGR for EPS of c 17% and DPS c 20%) through a mixture of volume increases, tariff increases and acquisitions. CWA plans, in due course, to separately list the Environmental Protection business, which could also create value for shareholders in the medium term.
The recent acquisition of 29.5% Kangda International Environmental Group (KIEG) for HK$1.2bn underlines CWA’s desire to expand in its core Chinese water market and crucially will help strengthen its position in the expanding waste water sector. The business was acquired at a c 15% discount to book value and, despite a c 60% premium to the market price prior to the announcement, a relatively modest P/E of 13.5x (historic earnings). As well as strategic benefits generated by the acquisition, CWA believes it can, over time, enhance earnings and reduce KIEG’s high level of indebtedness. The short-term financial impact of the acquisition (from FY20) is likely to be modest, with a contribution equivalent to c 3% of PBT.
Applying peer group average multiples would indicate a valuation of c HK$11.4 per share (up HK$0.9 per share since we last published in December 2018), for CWA, c HK$3 per share above the current share price. At HK$8.2 per share, CWA trades on a PEG ratio of only 0.6x versus 1.6x for its peers. Applying an undemanding PEG ratio of 1.0x would indicate a valuation of HK$13.0 per share. Our DCF points to a valuation of HK$11.9 per share.