We believe that the outlook for regulation of the Chinese water sector remains positive and would caution against read-across from current proposals for gas regulation in Chongqing, as substantial differences exist between the two industries. Valuations in excess of HK$10/share are sustainable for China Water Affairs Group (CWA), in our view.
The National People’s Congress Standing Committee of Chongqing is currently proposing a cancellation of the network connection fee paid to gas companies. We are unaware of any intention on the part of the authorities to extend the policy regarding connection charges to other industries such as water. CWA has not been contacted with regard to its connection charges in Chongqing. In 2018, connection charges accounted for c 18% of CWA’s total revenues.
It is important to be aware that the recent economic policy document (943 June 2018) from the NDRC advocated the establishment of a price-adjustment mechanism that reflects the cost of water, so that the residential water price is no longer below cost level and prices in the non-residential section of the market allow for a reasonable profit level. The fact that many state-owned enterprises operate at a loss in the water sector also affords CWA a degree of regulatory protection, in our view. An analysis of returns (Bloomberg, 3 October 2018) also shows that gas companies earn returns in excess of those achieved by CWA (CWA’s returns are between 18% and 52% lower than the gas companies’ on average over the past five years).