Key points of investment

The results for the first half of the year were generally in line with expectations. The company achieved operating income of RMB 1,657 million in the first half of the year, an increase of 91.0% over the previous year; achieved net profit of RMB 92 million, an increase of 14.5% over the previous year; converted to basic earnings of RMB 0.08 per share, the performance was basically in line with expectations. The results for the first half of the year accounted for 21% of our full-year performance forecast, which was relatively low mainly because revenue from the construction and equipment sales business was mainly settled and confirmed in Q4.

Construction contributed to high income growth, and rapid expansion contributed to high debt ratios. The company's water project was under intensive construction in the first half of the year, boosting sewage treatment revenue up 136% year-on-year to RMB 596 million, and water supply business revenue increased 100% to 620 million yuan. The hazardous waste business that was deployed earlier began to gain strength, boosting solid waste business revenue by 119% to RMB 228 million. The company's comprehensive gross margin fell 7.1 percentage points to 24.9%, the operating efficiency of some newly acquired projects is improving, and the consolidation of some newly launched BOO projects are the main factors. It is expected that there will be a steady recovery in the future. In terms of period expenses, the sales and management expenses ratio both declined slightly in the first half of the year, but the increase in debt due to rapid business expansion caused financial expenses to rise from RMB 79 million in the same period last year to RMB 235 million, eating up a lot of profits. The balance ratio increased 13.2 percentage points to 74.9% over the same period last year, and the debt ratio was too high.

During the period of rapid business expansion, there were plenty of orders on hand to help growth. As of 2017 H1, the company's sewage and water supply treatment capacity reached 3.87 million tons/day, an increase of 1.24 million tons (+47%) over the end of 2016, and the hazardous waste and domestic waste treatment capacity was 1.45 million tons/year, an increase of 100,000 tons (+7%) from the end of 2016. It has grown into a force that cannot be ignored in the domestic water and hazardous waste market. With the company's state-owned enterprise background, technical strength and efficient operation mechanism, the company has actively promoted outreach expansion to seek growth in recent years. The coverage area has been expanded to more than 20 provinces across the country and Southeast Asia overseas markets. Many early acquisition projects are currently in the stage of efficiency improvement and management efficiency improvement. As production capacity climbs and efficiency increases, mergers and acquisitions are expected to become the company's key performance release point. The release of hazardous waste business performance in the first half of this year is clearly reflected.

Integrated environmental service providers have gradually formed, and PPP has helped accelerate growth. Since its listing in May 2015, while maintaining the “big water” model covering raw water, tap water, and sewage treatment, the company actively promoted the extension of its business scope from the water sector to the field of hazardous waste and domestic waste treatment through outreach mergers and acquisitions, and transformed into a comprehensive urban environmental service provider integrating water, solid waste and hazardous waste. In addition to adopting active M&A acquisition projects, the company is also actively using the PPP model to seek endogenous growth. It has signed a number of PPP cooperation agreements with government departments or partners in Fujian Province, Renhuai City in Guizhou, and Zhanjiang in Guangdong. Some PPP construction has already started, which is expected to become a new growth point for the company.

Risk warning. Projects under construction have fallen short of expectations, and external mergers and acquisitions are progressing slowly; there is a risk of repayment of accounts receivable; and factors such as tight land finance may have led to a decline in the government's willingness or ability to pay.

Profit forecasting and valuation. Considering that the company's interim performance is in line with expectations, the profit forecast of RMB 0.37/0.46/0.58 yuan from 2017 to 2019 remains unchanged. Currently, the corresponding P/E of the stock price is 7/6/5 times. Taking into account factors such as multiple business segments driving the company's performance expected to continue to rise, having advantages in membrane treatment technology, rich experience in the PPP field, the current results of the hazardous waste & solid waste business layout, and the M&A strategy is expected to continue to advance, referring to the valuation level of comparable companies, 10 times P/E for 2017, corresponding to the target price of HK$4.30, maintaining the “buy” rating