China Water Affairs Group’s (CWA’s) reported 59% half-on-half (h-o-h) increase in revenue and 62% operating profit improvement were flattered by HK$1,336m non-cash revenues and a HK$248m non-cash operating profit contribution from a property revaluation. Excluding non-cash effects, h-o-h operating profit increased by 30%. City Water Supply (CWS), CWA’s most significant business unit, grew revenue at an underlying rate of 25% h-o-h (70% reported; see Exhibit 3) and operating profit surprised on the upside. We increase our estimates to take account of the improved operating performance and work through various non-cash items in FY17e. Our 1.3% increase in FY18e EBITDA, together with improved cash generation, has the effect of increasing our fair value per share by 9.6% to HK$7.12 from HK$6.52.
CWA delivered a strong set of H117 numbers showing an exceptionally robust performance in its CWS business. After stripping out a HK$248m fair value gain in the Property division, CWA’s 30% h-o-h EBIT increase was predominantly driven by the CWS unit.
We increase our FY18e group EBITDA forecast by 1.3%, which is driven by a superior FY18e CWS segment EBIT (HK$2,073m vs HK$2,004m previously). Superficially, we increase FY17e forecasts significantly (16.2% increase in EBITDA), although this is mainly due to the Property fair value adjustment. Once this is stripped out, the underlying EBITDA increase is 4.4%. CWA did not release a figure for capex over the first half but we reduce our FY17e forecast substantially from HK$1,901m to HK$1,082m to reflect the absence of M&A in the first half. Consequently our FY17e net debt to EBITDA improves from 2.6x to 2.0x.
Our EV/EBITDA multiple-based, sum-of-the-parts valuation model implies a fair value per share of HK$7.12, which is a 9.6% increase on our previous fair value estimate. This is partly driven by the 2.4% increase in our CWS EBIT forecast for FY18, but mostly (HK$0.52 out of HK$0.60) due to our reduction in M&A capex converting into a lower net debt estimate, which expands the equity component of our forecast enterprise value. Peer-based multiples concur with the thesis that CWA trades at a significant discount to fair value as the company is 34% undervalued in comparison to its peers on a one-year forward EV/EBITDA.