China Water Affairs Group (CWA) is well positioned to take advantage of the favourable trends that we expect in the Chinese water and sewage market. CWA’s portfolio of water assets, experienced team, stable financial position and impressive track record should enable the company to continue to grow returns for shareholders.
CWA’s recent FY18 results extended the company’s impressive track record. In the period 2013–18, CWA achieved CAGR in EPS of 29.6% and DPS of 35.7%. In the same period, the revenues and segmental profits of the key water business (more than 85% of group profits) grew at a CAGR of 31.5% and 33.3%, respectively. The operating margin for the core water business has remained in the range of c 36– 42% since 2011, and in 2018 was 38%. Over a longer 10-year period, CWA has posted CAGR of 32.8% in revenues and 39.8% in operating profits. Despite the strong growth, CWA has preserved its financial strength with total liabilities/total assets at c 61% in 2018 (2013–18 range: 55–65%).
We believe CWA is capable of achieving further growth in the forecast period. Politics and regulation require further improvements to the Chinese water and sewage infrastructure and, as the recent opinion on changes to the price change mechanism (No. 943) issued by the National Development and Reform Commission (NDRC) acknowledges, tariffs should be reflective of costs and not force operators to supply the domestic water market at a loss. However, even at current tariff levels, CWA has turned previously lossmaking state-owned enterprises into profit through efficiency improvements. Profitability will be further enhanced once tariff rises are implemented. With a government committed to involving private capital in system improvements, CWA, with its track record of success, experienced management team, sound financial footing and diversified portfolio of water assets, is well placed to take advantage of the expected transformation.
Following the recent NDRC announcement, we have revised our forecasts (FY19e EPS HK$0.815 vs HK$0.762 previously), taking a more optimistic view on the scope for tariff increases and we also revise our minority interest charge. Blended peer group multiples indicate a valuation for CWA of c HK$10.7/share. Applying only peer group P/E multiples, CWA’s valuation would rise to HK$11.7/share (FY19) and HK$12.4/share (FY20). The two-year PEG ratio is c 0.9x (at HK$11/share).