China Water Affairs (CWA) delivered a CAGR of 24.7% in top-line growth and a CAGR of 23.4% in EBITDA in FY12-17. We expect its growth story to continue with volume/price increases in the Chinese market and the opportunity to acquire underperforming assets from local governments. We forecast revenue to increase 25% in FY18 and 20% in FY19 (vs consensus of 19% and 14%, respectively), on the back of a 50% increase in capex in FY17 under service concession contracts. Its net debt of HK$6.2bn and net debt to equity ratio of 70% are at a historical high. The management of capex spending and the pace of acquisitions will be a delicate balancing act against the level of leverage. We reduce our fair value by 6% from HK$7.12/share to HK$6.71/share based on sum-of-parts EV/EBITDA valuation as we lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively (given CWA’s reported FY17 sales were 9% below our previous estimates).
CWA posted 20% growth in revenue and 34% growth in EBITDA in FY17. Operating cash flows increased by 25% y-o-y to HK$1,454m. Meanwhile, capex increased 50% to HK$1,910m, mainly on water supply capacity expansion under service concession agreements as the sole water supplier in different regions. Net debt increased by 48% to HK$6.2bn, bringing CWA’s net debt to equity ratio from 50% in FY16 to 70% in FY17, a level comparable to HK-listed peers.
CWA took a breather from asset purchases, with cash outflows for acquisitions down from HK$972m in FY16 to HK$286m in FY17. As the central government is pushing local governments to improve the efficiency of existing infrastructure, CWA intends to speed up acquisitions in central, eastern and southern China.
We derive our fair value with a sum-of-parts EV/EBITDA valuation and lower our fair value by 6% from HK$7.12/share to HK$6.71/share (primarily as a result of our 6% and 7% downward revision of FY18e and FY19e revenue forecasts, respectively). Our net debt calculations are based on management’s guidance regarding the likely recovery of HK$860m loan to China City Infrastructure Group in FY18e and combined capex and acquisitions at c HK$2bn over the next three years.