Event: the company released its annual results for 2020, with an annual operating income of HK $3.52 billion, an increase of 29.8% over the same period last year, and a net profit of HK $430 million, an increase of 58.3% over the same period last year.

Comment

Sanitation projects are increasing rapidly and have become the main driver of growth.

Revenue from the company's sanitation services sector increased by 43.3% year-on-year to HK $2.82 billion, accounting for 80.1% of revenue, up 7.9% from 2019, and gross profit accounted for 76.5%, up 15.1% from 2019. The high growth of sanitation business is mainly due to the fast-paced project expansion and the preferential policies of the 2020 epidemic. In terms of project expansion, 23 new sanitation services were added in 2020, with a total contract value of HK $11.3 billion and an annual income of HK $1.05 billion, of which HK $543 million was contributed in 2020. By the end of 2020, the company had 113 projects in hand. In terms of preferential policies, the reduction of VAT in 2020 brought about an increase of HK $125 million in sanitation revenue, excluding preferential policies, sanitation service revenue increased by 37% compared with the same period last year. Therefore, under the basic condition of the good prosperity of the industry, the rapid expansion of the company's service items is the main reason for the high growth of sanitation service business.

Hazardous waste continued to improve and returned to positive growth in the second half of the year.

Under the influence of the epidemic, the company's hazardous waste sector fell significantly, with full-year revenue falling 10.6 per cent year-on-year to HK $483 million. But at the same time, the marginal improvement of hazardous waste business has continued, with revenue decline sharply narrowing 19.6 percentage points compared with the first half of the year, with revenue growth turning positive in the second half of the year, achieving 10 per cent year-on-year growth. Excluding the impact of sold projects, revenue from hazardous waste for the whole year fell by only 4.1%. From the perspective of quantity and price: in terms of volume, the annual handling capacity increased by 13.1% compared with the same period last year, an increase of 15.1% over the first half of the year, of which the number of harmless projects increased by 48.4% compared with the same period last year. At the price level, the average selling price fell 15.2% year-on-year, 2.6 percentage points lower than in the first half of the year. Therefore, in 2020, the company's hazardous waste business continues to improve marginally. In addition, as the important reason for the decline in volume and price of the company's hazardous waste business lies in the epidemic situation, with the continued weakening of the impact of the epidemic and the continuous landing of projects under construction and preparation, we believe that the company's hazardous waste sector will return to steady growth.

Preferential policies drive up gross profit, but excluding it, the growth rate is still considerable.

In terms of profitability, the company achieved a gross profit margin of 30.9% for the whole year, up 2.0 percentage points from the same period last year, and a net profit rate of 12.1%, up 2.2 percentage points from the same period last year. The main driving force is the boost of the epidemic preferential policy to the profitability of sanitation services. 2020 companies' gross profit margin on sanitation services is 29.5%, up 5 percentage points from the same period last year. Preferential policies have brought about a 170 million increase in gross profit to the service sector through value-added tax concessions and social security deductions. If the preferential amount is deducted, the overall gross profit margin of the sanitation service sector is 24.6%, which is basically the same as in 2019. According to the results forecast announced earlier by the company, on the whole, VAT relief contributes HK $125 million to the company's contribution income, and social security relief and other contribution costs are optimized by HK $69 million. Under the assumption of a 25 per cent income tax rate and a 20 per cent profit-loss ratio of minority shareholders, the net profit increment contributed by the preferential policy is about HK $120 million. After deducting the sanitation services sector, the performance growth rate is still 68.4% compared with the same period last year, and the overall performance growth rate is about 13.9%.

Profit forecast and valuation: from the industry level, the sanitation service industry is still in a market-oriented dividend period. Despite the epidemic in 2020, the annual increase in annual growth is close to 30%. The output and stock of hazardous waste industries are large, and the demand is well support. at the same time, the clearance of backward production capacity may be accelerated. From the company level, due to the background of state-owned assets of the "North Control system", the strong capital strength and rich operation experience of the superimposed head enterprises, the environmental sanitation order ability may continue to be highlighted in the future; in terms of hazardous waste business, the company's size and gross profit margin are in the first echelon, and take the lead in seizing Shandong, Qinghai and other major provincial markets. Therefore, on the whole, we think that the company's sanitation service will maintain a high growth rate, and the hazardous waste sector will be dragged down and will return to steady growth. The company is expected to achieve a net profit of HK $5.53 and HK $722 million in 2021-2022, corresponding to 9 times and 7 times of PE respectively, maintaining a "buy" rating.

Risk hints: sanitation marketization is not as expected; competition in the industry is intensified; recovery of hazardous waste business is not as expected