Capital Environment Initiation of Coverage

Transcription

1 9 August 2017 Capital Environment Initiation of Coverage Emerging player in solid waste treatment Capital Environment Holdings Limited ( CEHL ) is a leading solid waste management operator in China with a strong brand. It has 39 projects on hand with attributable daily capacity of about 17.6k tons, of which about 2.7k tons are currently in operation. We expect the company is going to experience a high growth period in FY17-19E, as the operating capacity is expected to grow at a CAGR of 73.5%, which we believe will result in its earnings taking off in FY18. We initiate a BUY on CEHL with a target price of HKD0.40, based on 15.0x FY18 forward PE valuation, implying a 33% upside potential. 74.2% CAGR revenue growth from domestic projects Having a strong foothold in the waste-to-energy business, CEHL has expanded its service coverage to the more profitable hazardous waste and organic waste treatment business. Supported by its accelerated progress of domestic projects and substantial increment in daily operating capacity, we expect the domestic segment would fuel a CAGR of 74.2% in revenue to about RMB3.2bn, constituting about 56% of FY19E s revenue. Strong brand to acquire high quality assets CEHL has built up a strong brand and reputation in aspects of both technical expertise and extensive network backed by its parent Beijing Capital Group. It has advanced waste treatment technologies and its parent has maintained a decent track record in environmental projects operation, which is favorable for acquiring new projects and high quality assets. Last year, CEHL acquired a 51% interest in the largest urban waste operator BCG NZ from its parent, which is expected to contribute some RMB182mn in profit in FY18E. Should CEHL consider acquiring the remaining 49% stake in the future, it would further deliver an additional profit of about RMB175mn, representing 52% of its attributable profit in FY18E. CLEAN & GREEN BUY Recommendation Ticker 3989 HK Quam's Rating BUY Last Close HK$0.30 Target Price HK$0.40 Previous Target N/A Up/(Down)side 33% Previous Rating Initial Coverage Share Information 52-week range (HK$) ADT (3M) (HK$ mn) 2.06 Market Cap. (HK$ mn) 4,288.4 Shares outstanding ( mn) 14,294.7 Free float 31.6% SH-HK Stock Connect No SZ-HK Stock Connect No Major Shareholders Beijing Capital Group Co. Ltd 66.9% Share Price Performance Well-financed expansion plan Anticipating the incremental capacity costs of about RMB300k/ton, its annual Capex is estimated to be about RMB1.2bn. With PPP model adopted in the projects and strong support from its parent, CEHL is capable of financing its robust business expansion plan at a low funding cost of around 5%. We expect that CEHL will further increase its net gearing to about 105% by FY18E, after which the Capex required could be well financed by its internal resources. Source: Bloomberg Risk Factors Execution of expansion plan; delay in greenfield projects construction; change in government policies; devaluation of the NZD. Key Financials Fiscal Year Ended 31 Dec (RMB mn) FY15* FY16 FY17E FY18E FY19E Revenue 2,639 2,708 3,604 4,874 5,707 Growth (%) 2.6% 33.1% 35.2% 17.1% Operating profit ,173 Growth (%) -10.7% 64.9% 58.7% 24.0% Attributable profit Growth (%) -72.2% 158.8% 194.3% 43.0% CAGR FY17-19E 121.7% EPS (RMB fen) Li Yiming, Eric P/E (x) P/B (x) : Dividend Yield (%) N/A N/A N/A N/A N/A : eric.li@quamgroup.com 1

2 Table of Contents 1. Investment Highlights Valuation and Comparables Business Overview Accelerated contribution from domestic segments Strong brand for acquiring new projects Well-funded business expansion plan Sound synergy from BCG NZ Industry Outlook Solid waste industry starting to drive revenue Waste-to-energy sector in China Expanding demand on solid waste treatment Financial Analysis Revenue breakdown Profitability Financial position Operating efficiency Company Background Key milestones Strong support from Beijing Capital Group Shareholding structure Financial statements Appendix: The existing solid waste treatment projects Capital Environment (3989 HK) 2

3 1. Investment Highlights 74.2% CAGR revenue growth from domestic market CEHL has secured 39 domestic projects with attributable daily capacity of about 17.6k tons, of which about 2.7k tons are currently in operation. It has implemented its mature business model as well as technical expertise in its core waste-to-energy treatment business, which delivers stable income streams from both government subsidies and electricity sales during the long concession period. Riding on the two successful waste-to-energy projects, CEHL has been accelerating the construction progress of other committed projects, attempting to replicate its success nationwide. Looking ahead, we expect a CAGR of 74.2% in revenue contributed from domestic projects in FY17-19E, supported by a 73.5% YoY growth of attributable daily operating capacity during the period, reaching about 13.9k tons by FY19E. Stable profit contribution from BCG NZ CEHL acquired a 51% interest in the largest urban waste management operator in New Zealand ( BCG NZ ) from its parent company Beijing Capital Group in 2016, where BCG NZ retains over 30% of market shares. BCG NZ has optimized its business and we expect it will contribute to an attributable profit of about RMB182mn in FY18E. It does not only deliver stable profit to the company, but also brings in practical experience in project operation and integration. Previously, Beijing Capital acquired the entire interests of TPI NZ at consideration of about NZD950mn and renamed it to BCG NZ. If CEHL were to consider acquisition of the remaining 49% interest in BCG NZ from its parent, a RMB175mn profit increment is expected, representing 52% of its attributable in FY18E. Lucrative GPM from new treatment technologies In addition to its waste-to energy treatment business, CEHL also introduced two new treatment technologies with higher GPM in its service coverage, which will further improve its overall profitability. The hazardous waste treatment and anaerobic treatment technology is capable of achieving an excellent gross profit margin of about 60% and 25% respectively with high treatment tariff. We anticipate revenue contribution from anaerobic and hazardous waste treatment would commence in FY17-18E. Going forward, we expect anaerobic and hazardous waste treatment attributable daily capacity would reach about 3,688 tons and 1,608 tons respectively by FY21E, representing a CAGR of 17% and 59% respectively during the period. Capital Environment (3989 HK) 3

4 Strong brand to acquire high quality assets CEHL has built up its strong brand nationwide in the aspects of waste treatment technology as well as extensive network backed by its parent company Beijing Capital Group. Supported by its comprehensive solid waste treatment technologies, CEHL is capable of providing services for all kinds of solid waste while controlling the operating costs with advanced incineration technology from Japan. Given the reputation and extensive network of Beijing Capital Group, which has already achieved success in wastewater treatment business, CEHL could further expand its business via acquiring high quality projects and assets on a larger scale. Well-financed expansion plan with healthy financial position Anticipating an incremental capacity costs of about RMB300k/ton, we expect CEHL s annual Capex would be about RMB1.2bn given its robust expansion plan of reaching 21.9k tons by FY21E. With the PPP models implemented in the projects as well as strong support from its parent company, CEHL is capable of fulfilling the Capex requirements with finance costs as low as around 5% during the period. It is estimated that the company will further increase its net gearing to 105% by FY18E, after which its Capex could be supported by its internal resources. Key risks (1) The execution of business expansion plan; (2) Delay in construction of domestic projects; (3) Change in government policies; (4) Devaluation in NZD. Capital Environment (3989 HK) 4

5 2. Valuation and Comparables We initiate a BUY on CEHL with a target price of HKD0.40, based on 15.0x 2018 forward P/E on a fully diluted basis, implying a 33% upside potential. Anticipating high revenue growth from waste-to-energy, anaerobic and hazardous waste treatment, our target price represents about 10.4x FY19 forward PE. Our target valuation is acquired from a comparable approach with other solid waste operators in China. The companies in the sector are currently trading between 6.9 and 14.2x FY18 consensus P/E with an average of 11.0x PE. Compared with the peers, CEHL is presenting a high growth potential in both its revenue and profit given its accelerated progress of its domestic projects, as well as its ability in acquiring new projects leveraging its strong brand and extensive network. The company is expected to achieve a substantial growth in attributable profit to RMB478mn in FY19, representing a CAGR of about 122% in FY17-19E. Hence, considering the overall business expansion plan, profitability improvement and expected earnings growth, we believe that CEHL should deserve a relatively higher valuation of 15.0x FY18 forward P/E. Figure 1. Valuation of CEHL Company Ticker Closing Price (HKD) FY18E EPS (HKD) FY18E P/E (x) FY17E-19E EPS (CAGR) Capital Environment % Peer Group China EB Int l % New Universe Environment % Dongjiang Environment % Dynagreen Environment % Canvest Environment % Peers range Source: Bloomberg, Quam Securities Capital Environment (3989 HK) 5

6 Figure 2. Peer Comparison Table Last Price Market Cap P/E Trailing 12 mth Hist Current Next P/B Div Yield T/O Net Profit EV / EBITDA GPM Net Margin EPS Growth ROE ROA Company Name Ticker (HK$) (HK$'bn) (x) (x) (x) (x) (%) ('mn) ('mn) (x) (%) (%) (%) (%) (%) Currency CAPITAL ENV 3989 HK , (76.0) HKD Peer Group CHINA EVERBR INT 257 HK ,971 2, HKD NEW UNIVERSE ENV 436 HK HKD DONGJIANG ENV-H 895 HK , CNY DYNAGREEN ENVI-H 1330 HK , CNY CANVEST ENV 1381 HK , HKD Simple Average Source: Bloomberg Capital Environment (3989 HK) 6

7 Revenue (RMB million) 3. Business Overview 3.1 Accelerated contribution from domestic segments CEHL is the solid waste treatment listed platform of Beijing Capital Group. It is primarily engaged in a wide range of waste management services in China, including waste collection and transfer, waste-to-energy, landfill, anaerobic treatment for organic waste, hazardous waste treatment and dismantling services of electrical appliances. It acquired a 51% interest in BCG NZ from its parent in Sep Currently, the urban waste treatment accounts for about 78% of its total revenue. Looking ahead, the company will kick start its domestic expansion plan in the wasteto-energy segment. We expect that the company would achieve a substantial revenue growth with a CAGR of 74.2% in the domestic segment in FY17-19E, reaching about RMB3.2bn by FY19E, or 56% of its total revenue. Figure 3. Revenue breakdown of CEHL 5,000 4,500 4,400 4,000 3,796 3,500 3,205 3,000 2,500 2,000 1,960 2,101 2,248 2,491 2,383 2,502 2,602 2,706 1,500 1,356 1, * E 2018E 2019E 2020E 2021E BCG NZ Domestic Projects. Data in FY15 is restated. Furthermore, we believe there is a chance that the remaining 49% interest in BCG NZ currently held by the parent group could be injected in the future. In FY18E, the projected attributable profit of BCG NZ is about RMB182mn. Thus, the remaining stake could provide an additional RMB175mn profit to the company, representing 52% of FY18E s attributable profit. Capital Environment (3989 HK) 7

8 Figure 4. Segment revenue contribution in FY17E and FY18E Collection and transfer, 1.1% Waste-to-energy treatment, 6.1% Anaerobic, 0.6% FY17E revenue segment contribution Dismantling, 8.0% Others, 0.2% Landfill, 0.9% BCG NZ, 62.4% Collection and transfer, 1.7% Waste-to-energy treatment, 12.9% FY18E revenue segment contribution Hazardous, 9.6% Dismantling, Others, 0.1% 6.2% Landfill, 0.7% BCG NZ, 48.9% Construction, 20.8% Anaerobic, 1.3% Construction, 18.5% CEHL has formulated a robust business plan for its domestic projects. A total of 31 waste treatment projects are expected to be in operation by FY19 compared to the current five. The waste-to-energy treatment sector, the company s core revenue driver, is expected to triple its current size to about 6,000 tons in operating capacity by FY18. The anaerobic treatment and hazardous waste treatment business would complete construction and a combined 2,300 tons of capacity would go into operation in FY19. Going forward, we expect the company s aggregate daily operating capacity would achieve a CAGR of 45% in FY17-19E, reaching about 21.9k tons by FY21E. Figure 5. Forecast of daily operating capacity of CEHL s domestic projects Segments Current FY17E FY18E FY19E FY20E FY21E Anaerobic / 400 tons 1,200 tons 1,600 tons 2,000 tons 2,400 tons Waste-to-energy 1,800 tons 2,766 tons 6,000 tons 8,000 tons 10,000 tons 12,000 tons Collection and transfer 724 tons 724 tons 1,500 tons 2,400 tons 3,600 tons 4,800 tons Landfill 874 tons 874 tons 1,000 tons 1,200 tons 1,400 tons 1,600 tons Hazardous Waste / / 400 tons 700 tons 900 tons 1,100 tons Total 3,398 tons 4,764 tons 10,100 tons 13,900 tons 17,900 tons 21,900 tons Dismantling 3.2mn units 3.2mn units 3.2mn units 3.2mn units 3.2mn units 3.2mn units Capital Environment (3989 HK) 8

9 Utilizing the three common solid waste treatment technologies, namely landfill, waste-to-energy and anaerobic treatment, CEHL is capable of providing waste management services for all kinds of solid waste, including urban waste and industrial hazardous waste. The company targets at providing comprehensive solutions that minimize the waste size, while controlling the energy consumption, operating costs and repeated pollution. Compared with traditional solid waste treatment operators, CEHL aims to extend its services by integrating waste collection, transfer and treatment, which would maximize its operating efficiency and market share. Figure 6. CEHL s major business segments and capacity Compared to the traditional landfill method, waste-to-energy treatment substantially reduces the size of leftovers and delivers additional income from power generation. Anaerobic treatment for organic waste, including kitchen waste, minimizes the repeated post-treatment pollution. Incorporating these methods into its solutions, CEHL is capable of handling all kinds of solid waste and building up its brand to acquire new projects. Capital Environment (3989 HK) 9

10 Figure 7. Solid waste treatment solutions Treatment Method Energy Consumption Reduction of waste size Operating cost Repeated pollution Landfill Low Minor (10%) Low High Waste-to-energy High Substantial (80-90%) High High Anaerobic Medium Standard (50-60%) Medium Low Source: Company data Waste-to-energy business to drive revenue With mature business model and booming demand ahead, CEHL strategically places its focus on waste-to-energy projects that bring in stable profit from both government subsidies and electricity sales. The Build-Own-Transfer (BOT) model has been widely adopted in its wasteto-energy business, in which the company is eligible for stable subsidy income during the long concession period of about 30 years upon completion of construction. Government subsidy for its existing waste-to-energy projects stands at a wide range of RMB per ton, varying among different locations, while power tariff remains high at RMB0.65/kWh for the initial 280kWh per ton of waste. Going forward, government subsidies would be further adjusted upward in line with the inflation of its operating costs. Looking ahead, CEHL would gradually improve the gross profit margin of the waste-to-energy business to about 20% with the scale up of operating capacity. Figure 8. Revenue streams of waste-to-energy treatment Income Source Government subsidy Power tariff (State Grid) Source: Company data Initial 280kWh/ton From 281kWh/ton Pricing standard Price range from RMB65-146/ton RMB0.65/kWh In line with coal-fired power tariff As of Jul 2017, CEHL has signed 15 waste-to-energy projects with total daily treatment capacity of about 13.65k tons, in which two projects with capacity of 1.8k tons are currently in operation. The company has optimized its operation of the Quanling waste-to-energy project located in Nanchang, Jiangxi, where it controls the operating costs with advanced waste incineration technology from Japan. The company aims at further replicating its successful formula in other sites. Looking ahead, CEHL would continue to expand its waste-to-energy business. We expect the attributable capacity would achieve a CAGR of 27% in FY17-21E, reaching about 25.6k ton by FY21E. Capital Environment (3989 HK) 10

11 Figure 9. Waste-to-energy daily capacity projection Segments FY16 FY17E FY18E FY19E FY20E FY21E Attributable operating capacity 1,787 tons 2,766 tons 6,000 tons 8,000 tons 10,000 tons 12,000 tons Attributable greenfield capacity 5,916 tons 8,837 tons 9,103 tons 10,603 tons 12,103 tons 13,603 tons Attributable capacity 7,703 tons 11,603 tons 15,103 tons 18,603 tons 22,103 tons 25,605 tons Total capacity 9,750 tons 13,650 tons 17,150 tons 20,650 tons 24,150 tons 27,650 tons Figure 10. The Quanling waste-to-energy plant in Nanchang, Jiangxi Anaerobic and hazardous waste treatment boosted overall GPM CEHL has a total of 7 projects in the more profitable anaerobic treatment for organic waste and hazardous waste treatment businesses. Organic waste commonly include kitchen food waste, paper products, garden waste, etc. Similar to waste-to-energy projects, CEHL would collect government subsidies at a price range of RMB /ton for its existing anaerobic treatment projects depending on location. In the industrial areas with urgent demand for hazardous waste treatment such as Jiangsu and Shandong, the treatment tariff stands at a high level at about RMB 3,200/ton. Looking ahead, gross profit margin for hazardous waste treatment and anaerobic treatment could reach about 60% and 25% respectively, which could become new revenue drivers in the coming two years. Capital Environment (3989 HK) 11

12 Figure 11. Government subsidies of anaerobic and hazardous waste treatment Income Source Anaerobic Treatment Hazardous waste treatment Source: Company data Pricing standard Price range of RMB /ton Price range at about RMB 3,200/ton CEHL is currently participating in four anaerobic waste treatment projects with attributable daily capacity of about 1,688 tons, where the first 400 tons is expected to commence operation as early as this year. Looking ahead, CEHL would continue to expand the segment size with a CAGR of about 17% in daily attributable capacity in FY17-21E, reaching about 3,688 tons by FY21E. Figure 12. Anaerobic treatment daily capacity projection Segments FY16 FY17E FY18E FY19E FY20E FY21E Attributable operating capacity / 400 tons 1,200 tons 1,600 tons 2,000 tons 2,400 tons Attributable greenfield capacity 1,688 tons 1,288 tons 988 tons 1,088 tons 1,188 tons 1,288 tons Attributable capacity 1,688 tons 1,688 tons 2,188 tons 2,688 tons 3,188 tons 3,688 tons Total capacity 2,490 tons 2,490 tons 2,990 tons 3,490 tons 3,990 tons 4,490 tons CEHL has engaged in three hazardous waste treatment projects, which are currently at initial stage. As one of the strategic move of the company, an incremental daily capacity of about 300 tons per annum is expected in the coming five years, in which the first batch with daily capacity of about 400 tons would start operation in FY18E. We expect CEHL s attributable daily capacity would increase with a CAGR of about 59% in FY17-21E, reaching about 1,608 tons by FY21E. Figure 13. Hazardous waste treatment daily capacity projection Segments FY16 FY17E FY18E FY19E FY20E FY21E Attributable operating capacity / / 400 tons 700 tons 900 tons 1,100 tons Attributable greenfield capacity 158 tons 408 tons 308 tons 308 tons 408 tons 508 tons Attributable capacity 158 tons 408 tons 708 tons 1,008 tons 1,308 tons 1,608 tons Total capacity 158 tons 408 tons 708 tons 1,008 tons 1,308 tons 1,608 tons Capital Environment (3989 HK) 12

13 Integrated project incorporating waste collection and transfer Compared with traditional waste management operators, CEHL is looking to integrate the upstream waste collection and transfer business into its waste-to-energy projects, which could effectively control its operating costs, receive additional subsidies and increase market shares. CEHL currently owns 11 waste collection and transfer projects with total capacity of about 3k tons, of which six of them are integrated with waste-toenergy projects. CEHL would be eligible for additional government subsidies within the range of RMB /ton for its existing projects. Figure 14. Government subsidies of anaerobic and hazardous waste treatment Income Source Waste collection and transfer Source: Company data Pricing standard Price range of RMB /ton CEHL is anticipated to expand its waste collection and transfer business rapidly in the coming five years. Based on the existing 11 projects, we expect its revenue will start to contribute from FY17 with its first batch of projects put into operation. By FY21E, CEHL would further enlarge its attributable capacity to about 9k tons at a CAGR of about 45% in FY17-21E. Figure 15. Waste collection and transfer daily capacity projection Segments FY16 FY17E FY18E FY19E FY20E FY21E Attributable operating capacity / 724 tons 1,500 tons 2,400 tons 3,600 tons 4,800 tons Attributable greenfield capacity 1,386 tons 2,262 tons 2,986 tons 3,586 tons 3,886 tons 4,186 tons Attributable capacity 1,386 tons 2,986 tons 4,486 tons 5,986 tons 7,486 tons 8,986 tons Total capacity 1,386 tons 2,986 tons 4,486 tons 5,986 tons 7,486 tons 8,986 tons Beneficiary of policy support and mature PPP models CEHL is one of the beneficiaries of the favorable policies in the solid waste sector, where the Chinese government is shifting its focus to environmental protection in its 13 th Five Year Plan. As required by the government, the PPP model will be adopted in all waste treatment projects, where the private firms are responsible for construction of new projects and entitled to a long concession period upon completion. Private firms could leverage and replicate their mature business models and be guaranteed of a stable cash flow within the concession period, which would bring in considerable profit to the investors. Capital Environment (3989 HK) 13

14 3.2 Strong brand for acquiring new projects Build up brand for future bidding CEHL has introduced various solid waste treatment technology to control its operating costs and retain a high treatment quality in compliance with the environmental standard. With advanced waste treatment technology from EU and incineration technology from Japan, CEHL is capable of providing treatment services for all kinds of solid waste, including the hazardous waste that requires the most advanced technology to enter the market. CEHL is also the first company to introduce anaerobic digestion technology in China. The company is committed to building up its brand in the waste treatment industry to increase its competiveness in future bidding. Figure 16. CEHL s comprehensive solid waste treatment technology Extensive network and good track record to facilitate new acquisitions With strong support from its parent company Beijing Capital, CEHL has established an extensive national network covering about 37 cities to acquire new projects with the main focus on Henan, Jiangxi and Beijing-Tianjin-Hebei areas. Beijing Capital, one of the largest SOEs under Beijing State-owned Assets Supervision and Administration (SASAC), has been the controlling shareholder of Capital Environment since Beijing Capital has already built up its reputation and maintains an outstanding track record of wastewater treatment projects nationwide. We anticipate that CEHL could easily facilitate the acquisition of high quality projects taking advantages of its extensive network and experience. Capital Environment (3989 HK) 14

15 3.3 Well-funded business expansion plan Rapid capacity expansion with Capex budget of RMB1.2bn CEHL has formulated a robust business expansion plan, which we estimate that it would require an annual Capex of about RMB1.2bn, based on an incremental operating capacity costs of about RMB300k/ton as well as a daily operating capacity growth of 4k tons per annum. As at Jul 2017, the company has signed 15 waste-to-energy projects, 11 waste collection and transfer projects, 4 anaerobic treatment projects, 4 landfills and 3 hazardous waste treatment projects with attributable daily capacity of over 20k tons, of which about 2,661 tons are currently in operation. CEHL has been accelerating its progress in construction of new projects, in which the common construction period for each of its existing projects would be less than one year and a half. The Capex requirement of its expansion can be well financed at a low funding cost of around 5%. Looking ahead, we expect the CEHL s daily attributable waste treatment capacity in operation could further increase to 21.9k tons by FY21E, representing a CAGR of about 52.4% during the period. Figure 17. CEHL s incremental daily operating waste treatment capacity and Capex required 8, ,000 6,000 5,000 4, , , ,000 4, ,000 2,000 2, , E 2018E 2019E 2020E 2021E 0.00 Incremental attributable operating capacity (tons) (LHS) Capex Required (RMB'bn) (RHS) Capital Environment (3989 HK) 15

16 3.4 Sound synergy from BCG NZ CEHL acquired 51% interests of BCG NZ from its parent company Beijing Capital Group in 2016 at equity consideration of USD234mn, issuing about 4.54bn new shares at HKD0.40/share. In 2014, Beijing Capital Group acquired the entire interests of Transpacific New Zealand (TPINZ) at consideration for a about NZD950mn, equivalent to about RMB5bn, which was later renamed to BCG NZ. BCG NZ is the largest waste management service provider in New Zealand retaining over 30% market share, serving over 200k customers in the largest cities of New Zealand, covering collection, transfer, treatment and recycling of residential, commercial and industrial waste. This investment does not only deliver stable profit and cash flow, but also brings in mature and profitable business models as well as practical experience regarding project operation and integration. BCG NZ is currently operated at an optimal level and generated an operating profit of about RMB265mn in FY16. Should CEHL consider purchasing the remaining 49% stake from its parent, there would be an additional profit of over RMB175mn, representing 52% of its attributable profit in FY18E. Figure 18. Comprehensive waste management service of BCG NZ Services Residential waste collection Commercial waste collection Solid waste treatment Liquid waste treatment Highlights Collect and transfer residential waste to interchange station Collect and transfer commercial waste to interchange station Cover solid waste treatment, landfill and recycle services Cover liquid, medical and hazardous waste treatment services Capital Environment (3989 HK) 16

17 4. Industry Outlook 4.1 Solid waste industry starting to drive revenue In the 13 th Five Year Plan, it is expected that the total investments in solid waste sector would substantially expand to about RMB4.5trn during the period, representing 26% of total investments in the environmental protection industry. The latest budget is about 463% larger than in the previous Five Year Plan, reaching about RMB4.5trn during the period. Figure 19. Total investments in solid waste sector from 10 th to 13 th Five Year Plan RMB trn th 11th 12th 13th 0.8 Source: Forward Institute Solid waste comes from a variety of sources including industrial, urban and agricultural. The entire solid waste treatment industry is currently at an initial development stage being driven mainly by favorable policies. Thanks to the fast industrialization and urbanization in China, treatment demand from urban and industrial wastes continued to drive the sector growth during the past decades. Direct landfill, requiring smaller amounts of investments and operating costs, still plays a dominant role in solid waste treatment. Going forward, waste-to-energy treatment, which minimizes the residue size and regenerates energy, is expected to see accelerated growth and become the prevailing method in the coming five years. Capital Environment (3989 HK) 17

18 Figure 20. Flow chart of solid waste treatment Source: Quam Securities Figure 21. Current solid waste treatment structure in China 1% 35% 64% Landfill Waste-to-energy Others Source: Quam Securities Capital Environment (3989 HK) 18

19 4.2 Waste-to-energy sector in China While the volume of municipal solid waste (MSW) treatment had maintained stable growth in the past five years, the weight of waste-to-energy treatment has been increasing steadily during the period. The improved technology has made waste-toenergy treatment a better solution for MSW, which has smaller foot print, lower levels of residues and more efficient power regeneration. In the 13 th Five Year Plan, China aims to further increase the weight of waste-to-energy treatment from the current about 35% to over 50% by 2020, which implies great potential for future growth of the WTE sector in the coming years. Figure 22. Urban waste transferred volume and weight of waste-to-energy treatment mn tons % % 35.0% 40% 32.2% 35% 27.5% 30% 21.9% 23.0% 25% 20% 15% 10% 5% 0% Urban waste transferred volume (mn tons) (LHS) Weight of WTE treatment (RHS) Source: Quam Securities Compared with the traditional landfill business, waste-to-energy operators have two major revenue streams, namely, subsidy income from local governments and power tariff from the State Grid. With PPP models fully implemented in the business, which better protects the profitability of operators within the concession periods, it is expected that larger scale of funds would be attracted from the private sector to invest in the industry. Capital Environment (3989 HK) 19

20 4.3 Expanding demand on hazardous waste treatment Hazardous waste constitutes about 5% of overall industrial solid waste, and requires a much higher environmental standard because of its corrosive, toxic, inflammable or infectious characteristics. Although the growth in treatment capacity has been catching up in the past five years, it is still far below the actual demands for hazardous waste treatment, especially in the several eastern provinces with intensive industrial zones such as Shandong, Jiangsu and Hunan. It is expected that the hazardous waste treatment demand will maintain a stable double-digit growth in the coming three years. Figure 23. Hazardous waste actual generation and operating volume in China, mn tons % % % % 39% Actual generation vol (mn tons)(lhs) Actual operating volume (mn tons) (LHS) 80% 70% 60% 50% 40% 30% 20% 10% 0% Treatment rate (RHS) Source: Quam Securities Figure 24. Hazardous waste treatment methods in China in % 51% 29% Recycled Harmless Treatment In Storage Source: Quam Securities Capital Environment (3989 HK) 20

21 Given the harmful characteristics of hazardous waste, it is a segment with a high entry barrier, consisting of three aspects including qualification, technology and sites. A long approval period and extremely high environmental standards are required in license application for collection, transfer, storage and treatment of hazardous wastes. Since there are various kinds of hazardous waste, it also requires advanced harmless treatment technology and a relatively long time to find suitable sites for a new hazardous treatment plant. PPP models are widely adopted in hazardous waste treatment projects where its high profitability has been attracting more players from private sector to enter the market. As such, the current decentralized sector has begun to consolidate, mainly through M&As to bypass the high entry barriers. Figure 25. Entry barrier of hazardous waste sector Categories Qualification Technology Entry barriers Time-consuming and high costs required for license application Advanced technology required for harmless treatment Sites Source: Quam Securities Difficulties in finding suitable locations for hazardous waste treatment Capital Environment (3989 HK) 21

22 Revenue (RMB million) 5. Financial Analysis 5.1 Revenue breakdown CEHL s two major business segments: BCG NZ and domestic projects contributed about 78% and 22% of its total revenue in FY16, respectively. CEHL has been accelerating the construction of its committed domestic projects, where the construction revenue would increase to about RMB900mn in the coming years. The domestic segment is the core revenue driver and is expected to deliver substantial growth with a CAGR of 74.2% in FY17-19E, accounting for about 56.2% of FY19E s total revenue. The BCG NZ, which has optimized its operation, will also maintain its stable growth at about 5% YoY during the period, reaching about RMB2.50bn in FY19E s revenue. Anticipating a strong domestic growth as well as the stable revenue contribution from BCG NZ, CEHL is expected to generate a CAGR of 29.3% in revenue in FY17-19E, reaching about RMB5.71bn in FY19E. Figure 26. Revenue forecast of segments 8,000 50% 7,000 6,000 5, % 33.7% 4,817 5,707 6,398 7,106 45% 40% 35% 30% 4,000 3,604 25% 3,000 2, % 20% 2, % 11.1% 15% 10% 1,000 5% E 2018E 2019E 2020E 2021E 0% Revenue YoY Growth. Capital Environment (3989 HK) 22

23 5.2 Profitability We expect the company to continue to improve its overall margins starting FY17E with the introduction of the lucrative waste treatment business as well as the normalized SG&A and the absence of costs related to the acquisition of BCG NZ. It is estimated that revenue contribution from anaerobic and hazardous waste treatment that will deliver a high gross profit margin of 25% and 60% respectively will commence in FY17-18E, driving the overall gross profit margin to about 31.2% by FY19E. With the effective costs control in project operation thanks to advanced technologies as well as insignificant finance cost backed by PPP models and its parent company, we anticipate that CEHL will further improve its operating margin and net profit margin to about 20.5% and 11.8% respectively in FY19E. Figure 27. Profit margins of CEHL 35% 30% 28.2% 29.4% 27.7% 29.9% 31.2% 31.7% 32.1% 25% 20% 15% 15.3% 11.3% 13.3% 16.5% 19.4% 10.5% 20.5% 11.8% 21.9% 13.2% 23.2% 14.5% 10% 5% 4.9% 7.5% 0% 2015* E 2018E 2019E 2020E 2021E Gross Profit Margin Operating Profit Margin Net Profit Margin. Data in FY15 is restated. Capital Environment (3989 HK) 23

24 5.3 Financial position CEHL has a healthy financial position with an adequate level of liquidity and reasonable borrowings. As of 31 st Dec 2016, it had net debt of about RMB2.94bn, calculated from a cash balance of RMB771mn and interest-bearing debt of RMB3.72bn, equivalent to net gearing ratio of about 69%. With strong support from its parent Beijing Capital Group and PPP models adopted in the projects, CEHL had well controlled its funding costs to about 4.9% in FY16. Going forward, we anticipate that the company will further increase its financial leverage to support its business expansion plan in FY17-18E, where its net gearing ratio will reach about 105% in FY18E. After that, the company s Capex from new projects development could be well-financed by its internal resources. It is estimated that CEHL will generate a strong operating cash flow of about RMB1.26bn in FY19E with considerable profit from project operations. At an effective interest rate of about 5%, the finance costs in the coming years should remain insignificant. Figure 28. Liquidity and solvency ratios 5.10% 5.00% 4.90% 4.91% 5% 5% 5% 5% 5% 200% 180% 160% 4.80% 4.70% 4.60% 4.50% 4.40% 4.30% 4.53% 69% 43% 37% 40% 100% 105% 102% 91% 77% 45% 46% 46% 43% 40% 140% 120% 100% 80% 60% 40% 20% 4.20% 2015* E 2018E 2019E 2020E 2021E Costs of borrowing (LHS) Total D/A Ratio (RHS) Net D/E Ratio (RHS) 0%. Data in FY15 is restated. Capital Environment (3989 HK) 24

25 Days 5.4 Operating efficiency With BOT and PPP models widely adopted in its business, CEHL could guarantee a stable cash flow from government subsidies and collect electricity tariff from the State Grid. The mature BCG NZ operated at an optimal level also contributed stable cash flow to the company. As a result, CEHL has maintained its operating efficiency with operating cycle and cash conversion cycle of about 92.5 days and 47.3 days respectively. Since the government subsidies are included in the financial budget of local governments, receivables should be well controlled within the concession period of the projects. Looking ahead, we anticipate that the operating cycle and cash conversion cycle of CEHL would remain stable at about 91 days and 46 days in FY17-21E. Figure 29. Operating Efficiency * E 2018E 2019E 2020E 2021E Days Inventory Operating Cycle Days Accounts Receivable Cash Conversion Cycle Source: Company Data, Quam Securities. Data in FY15 is restated. Capital Environment (3989 HK) 25

26 6. Company Background 6.1 Key milestones CEHL is the leading solid waste management operator in China. Beijing Capital, one of the largest SOEs under Beijing SASAC, has been the controlling shareholder of CEHL since CEHL raised about HKD2.1bn in the 1-for-1 rights issue of HKD0.45/share in June Its market capitalization reached HKD4.29bn as at 31 st Jul Figure 30. Key milestones Beijing Capital became controlling shareholder of CEHL Disposed clothing business Stepped into solid waste treatment business Acquired high quality projects in Huizhou, Yangzhou and Huai'an Changed name to Capital Environment Total daily treatment capacity reached over 6,000 tons Beijing Capital increased its shareholding to 51% with a 1-for-1 rights issue Acquired 51% interests of NZ urban waste treatment business Source: Company data Capital Environment (3989 HK) 26

27 6.2 Strong support from Beijing Capital Group CEHL is one of the four cornerstones of the Beijing Capital Group with a focus on the solid waste management industry. Beijing Capital Group, one of the large SOEs of SASAC, covers four major industries in China, namely environment, infrastructure, real estate and financial services. With strong support and extensive national network of Beijing Capital Group, CEHL is capable of acquiring high quality assets in China and overseas. Figure 31. Background of Beijing Capital Group Source: Company data Capital Environment (3989 HK) 27

28 6.3 Shareholding structure Figure 32. Shareholding structure as at 31 st Jul 2017 Source: Company data Capital Environment (3989 HK) 28

29 6.4 Financial statements Income Statement (RMB mn) 2015* E 2018E 2019E Revenue 2,639 2,708 3,604 4,874 5,707 Cost of goods sold (1,894) (1,913) (2,607) (3,415) (3,925) Gross profit ,459 1,783 Other income and gains, net Operating expenses (399) (486) (469) (585) (685) EBIT ,173 Finance costs (65) (173) (236) (261) (276) Profit before tax Income tax expense (42) (55) (90) (172) (224) Profit after tax Minority interest Attributable profit to shareholders Per Share Items (RMB fen) 2015* E 2018E 2019E EPS Diluted EPS DPS N/A N/A N/A N/A N/A BVPS Balance Sheet (RMB mn) 2015* E 2018E 2019E Non-current assets PPE 1,303 1,687 2,714 3,219 3,696 Intangibles 1,692 1,882 2,127 2,270 2,419 Goodwill 1,718 1,927 1,927 1,927 1,927 Non-current prepayments 1,766 2,064 2,064 2,064 2,064 Total non-current assets 6,479 7,560 8,833 9,480 10,107 Current assets Inventories Trade and bills receivables ,135 1,329 Other receivables Due from associates Cash and cash equivalents 1, Other current assets Total current assets 2,434 1,705 1,553 1,802 1,991 Total assets 8,913 9,265 10,385 11,282 12,098 Current liabilities Trade and bills payables Other payables and accruals Bank borrowings , Shareholders loan Other current liabilities Total current liabilities 1,268 1,344 2,164 1,592 1,685 Non-current liabilities Bank borrowings 2,935 3,257 3,522 4,694 4,964 Deferred tax liabilities Other non-current liabilities Total non-current liabilities 3,281 3,629 3,894 5,066 5,336 Total liabilities 4,549 4,973 6,058 6,657 7,020 Shareholders equity Share capital 797 1,188 1,188 1,188 1,188 Reserves 2,403 1,914 1,949 3,238 3,691 Total shareholders equity 3,201 3,102 3,137 4,427 4,879 Minority interest 1,164 1,190 1,190 1,190 1,190 Total equity 4,365 4,292 4,327 4,625 5,078 Cashflow Statement (RMB mn) 2015* E 2018E 2019E Operating activities EBITDA ,438 1,746 Other gains/losses (141) (123) (120) (120) (120) Operating cashflow before W/C ,318 1,626 Change in working capital (392) (177) (124) (209) (140) Tax paid (78) (76) (90) (171) (224) Cash flow from operations ,263 Investing activities Capex (227) (419) (1,601) (1,140) (1,200) Others (103) (96) (100) (100) (100) Cash flow from investing activities (330) (515) (1,701) (1,240) (1,300) Financing activities Change in bank borrowings (464) 334 1, Interest paid (57) (244) (236) (261) (276) Others 1,617 (546) Cash flow from financing activities 1,096 (456) Net increase/decrease in cash 801 (720) (346) (60) (13) and cash equivalents Cash and cash equivalents at 646 1, beginning of the Year Effect of foreign exchange rate (5) Cash and cash equivalents at end of the Year 1, Ratio Analysis 2015* E 2018E 2019E Growth (YoY%) Revenue 2.6% 33.1% 35.2% 17.1% EBIT -10.7% 64.9% 58.7% 24.0% Attributable profit -72.2% 158.8% 194.3% 43.0% Diluted EPS -76.2% 158.8% 194.3% 43.0% Margins Gross profit margin 28.2% 29.4% 27.7% 29.9% 31.2% EBIT margin 15.3% 13.3% 16.5% 19.4% 20.5% Net profit margin 11.3% 4.9% 7.5% 10.5% 11.8% Other ratios Return on assets 3.3% 1.4% 2.6% 4.6% 5.6% Return on equity 6.8% 3.1% 6.2% 11.1% 13.2% ROIC 3.9% 1.7% 3.0% 5.2% 6.4% Dividend payout ratio N/A N/A N/A N/A N/A Valuation measures PER (x) PBR (x) Dividend yield N/A N/A N/A N/A N/A Key Ratios 2015* E 2018E 2019E Debt to equity Net debt to equity Current ratio (x) Quick ratio (x) Interest coverage (x) Days inventory (days) Days receivable (days) Days payable (days) Operating cycle (days) Cash conversion cycle (days) Capital Environment (3989 HK) 29

30 Appendix: CEHL s solid waste treatment projects Figure 33. CEHL s current waste-to-energy projects Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage Nanchang, Jiangxi 100% 1,200 tons RMB 78/ton In operation Shenzhen, Guangdong 46% 900 tons RMB 128/ton Initial stage Huizhou, Guangdong 97.85% 600 tons RMB 146/ton In operation Ruijin, Jiangxi 51% 1,200 tons RMB 69/ton Initial stage Gao an, Jiangxi 60% 900 tons RMB 65/ton In construction Xinxiang, Henan 70% 1,050 tons RMB 80/ton Initial stage Xihua, Henan 100% 900 tons RMB 68/ton Initial stage Qianjiang, Hubei 100% 600 tons / Initial stage Linyi, Shanxi 100% 900 tons / Initial stage Duyun, Guizhou 95% 900 tons RMB 132/ton In construction Shicheng, Jiangxi 60% 600 tons / Initial stage Suixian, Henan 100% 1,200 tons RMB 65/ton Acquired in 2017 Lushan, Henan 100% 1,200 tons RMB 60/ton Acquired in 2017 Qixian, Henan 100% 600 tons RMB 63/ton Acquired in 2017 Suichuan, Jiangxi 100% 900 tons RMB 62/ton Acquired in 2017 Total 13,650 tons RMB /ton Figure 34. CEHL s current anaerobic treatment projects Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage Dongcun, Beijing 20% 930 tons RMB 85/ton Initial stage Yangzhou, Jiangsu 100% 200 tons RMB 202/ton Initial stage Ningbo, Zhejiang 100% 1,200 tons RMB 198/ton Initial stage Jinzhong, Shanxi 63.88% 160 tons RMB 230/ton Initial stage Total 2,490 tons RMB /ton Capital Environment (3989 HK) 30

31 Figure 35. CEHL s current hazardous waste treatment projects Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage Yangzhou, Jiangsu 100% 930 tons RMB 3,200/ton Initial stage Zibo, Shandong 100% 1,200 tons / Initial stage Meishan, Sichuan 100% 160 tons / Initial stage Total 2,290 tons RMB 3,200/ton Figure 36. CEHL s current waste collection and transfer projects Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage Nanyang, Henan 100% 724 tons RMB 279/ton In construction Linyi, Shanxi 100% 260 tons RMB 160/ton Initial stage Duyun, Guizhou 100% 150 tons RMB 150/ton In construction Shicheng, Jiangxi 100% 252 tons / Initial stage Xihua, Henan 100% / RMB 125/ton Initial stage Qianjiang, Hubei 100% / RMB 93/ton Initial stage Suixian, Henan 100% 400 tons RMB 100/ton Acquired in 2017 Lushan, Henan 100% / RMB 116/ton Acquired in 2017 Suiping, Henan 100% 300 tons RMB 113/ton Acquired in 2017 Qixian, Henan 100% 600 tons RMB 123/ton Acquired in 2017 Suichuan, Jiangxi 100% 300 tons RMB 120/ton Acquired in 2017 Total 2,986 tons RMB /ton Capital Environment (3989 HK) 31

32 Figure 37. CEHL s current landfill projects Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage Duyun, Guizhou 92% 300 tons RMB 125/ton In operation Weng an, Guizhou 80% 150 tons RMB 120/ton In operation Huludao, Liaoning 100% 424 tons RMB 77/ton In operation Zibo, Shandong 100% 100 tons / Initial stage Total 974 tons RMB /ton Figure 38. CEHL s current worn electronic appliances dismantling projects Project Location Equity Interest Total Annual Capacity Treatment Fees Development stage Maanshan, Anhui 95% 1.2mn units RMB 135/unit In operation Huai an, Shandong 55% 2mn units RMB 135/unit In operation Total 3.2mn units RMB 135/unit Capital Environment (3989 HK) 32

33 Rating Definitions BUY We expect the stock to have a total return of > 15% over the next 12 months HOLD We expect the stock to have a total return of < 15% and >-15% over the next 12 months SELL We expect the stock to have a total return of < -15% over the next 12 months Disclosures Disclaimer and Risk Statement This document is published by Quam Securities Company Limited ( Quam Securities ), a licensed corporation (central entity number AAC577) regulated by the Securities and Futures Commission in Hong Kong. This document is for distribution in Hong Kong only to persons who are Professional Investors as defined in Part 1 of Schedule 1 of Securities and Futures Ordinance (Cap 571) of Hong Kong and any rules made thereunder. This document is not intended for distribution to or use by, any person or entity who is a citizen or resident of any jurisdiction where such distribution or use would be contrary to applicable law or regulation within such jurisdiction. This document does not constitute an offer or a solicitation of an offer to buy or sell any securities. This document is circulated to addresses solely and may not be reproduced or redistributed to any other person or published, in whole or in part, for any purpose. The research is based on information obtained from sources believed to be reliable, but Quam Securities does not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without prior notice. Any recommendation does not have regard to specific investment objectives, financial situation and particular needs of any specific addressee. Quam Securities accepts no liability whatsoever for any direct or consequential loss arising from any use of this document. Quam Securities and its affiliates as well as persons associated with any of them from time to time may or may not have interests in the securities mentioned in this document. The prices of securities may move up or down, and past performance is not an indication of future performance. Investors shall consider seeking separate legal or financial advice before making investment decisions. Analyst Certification: The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Li Yiming (CE No. BIE646), the authors of this document and their associates declare that as of the date of the publication of this report, they do not hold any financial interest in the company. Capital Environment (3989 HK) 33