Poor performance in fiscal year 20; continued growth in sanitation sector and strong recovery in hazardous sector in fiscal year 21; reiterate the rating of "long position"

The revenue / net profit of Beijing Control City Resources (3718 HK) in fiscal year 20 increased by 29.8% / 58.3% year on year to 3.5 billion / 426.8 million (HK $, the same below), which was lower than the 3.6 billion / 449 million expected by the market. Excluding (1) one-time epidemic-related subsidies (about 120 million of the impact on net profit) and (2) income from asset disposal, the core net profit was 303 million (up 4.8 per cent year-on-year). The increase in net profit was mainly driven by the strong sanitation sector (core net profit: year-on-year + 63%), but was offset by the weak performance of the hazardous waste sector (core net profit: year-on-year-46%). Mainly due to the decline in its average selling price (the average selling price of harmless disposal projects / recycling projects fell by about 24% and 4.8% respectively). In 2021, with the strong recovery of the hazardous waste sector and the steady growth of the sanitation sector, we expect the company's core net profit for fiscal year 21 to grow by about 56% and 24% compared with the same period last year.

Reiterate the "long position" rating.

Main points of meeting minutes

Sanitation sector will achieve strong growth in fiscal year 21

In FY20, there were 113 sanitation projects on hand, with an annualized income of about 3.33 billion, an increase of 38% over the same period last year (the annualized income of 22 new projects was 1.048 billion). Gross profit margin rose to 29.5%, mainly driven by epidemic-related subsidies (up 500 pips from a year earlier, compared with 24.5% in fiscal year 19). Management indicated that the gross profit margin of existing projects is roughly in the range of 22% to 28%, usually low in the first two years of the project period. Looking ahead to FY21, the management goal is to increase the project value by 1 billion, mainly to (1) larger and longer-term contracts (more than 40 million for individual projects, compared with an overall average of HK $29 million in FY20). The total target contract amount is more than 4.3 billion or an increase of about 33% over the same period last year; and (2) focus on the Yangtze River Delta, Dawan area and Beijing-Tianjin-Hebei region. Capital expenditure in the sanitation sector accounts for about 50 per cent of capital expenditure in fiscal year 21 (total: about 1.2 billion).

The volume of hazardous waste disposal will recover strongly in fiscal year 21, but the average selling price is not expected to rise sharply. Management expects the hazardous waste sector to achieve a strong recovery in fiscal year 21, and the capacity of harmless disposal projects will more than double with a substantial increase in production capacity. The average selling price for the first two months of 2021 is similar to the average for the whole of FY20, and management believes that due to increased competition, the average selling price is unlikely to return to the level of FY19, so low single-digit growth is more reasonable. Management expects the division's net profit to be no lower than the level of fiscal year 19.

Reiterate the "long position" rating and lower the target price to HK $1.80

We downgraded our net profit forecast for fiscal year 21 to 22 by 9-13% to reflect our latest assumptions about sanitation sector revenue and gross profit margin. We see that the competition pattern is more intense than expected when other industry participants enter the industry one after another. For example, under the strong capital endorsement, property management companies enter the industry one after another and provide enterprising performance guidance. In terms of execution speed, the company's state-owned enterprise background may be a competitive disadvantage. We lowered the target valuation multiple and lowered the target price to HK $1.80 within 12 months (the sanitation / hazardous waste sector's target price-to-earnings ratio for fiscal 22 is 15 / 10).

However, at a time when the valuation is still attractive and the certainty of earnings growth is high, we maintain a "long position" rating on the company.