Main points of investment

Kangda Environmental Protection released its 2016 results: income was 1.927 billion yuan, up 4.90% from the same period last year, and its net profit was 335 million yuan, up 2.98% from the same period last year.

The performance has basically stabilized and a smooth transition has been achieved in the transitional period. Despite a 17.82 per cent drop in interim results in 2016, Kangda's net profit for the whole of 2016 basically stabilized. As the BT business has been virtually terminated since 2015, according to the company's estimates, the revenue from continuing operations increased by 22% in 2016, and gross profit increased by 18.3%.

The gross profit margin has declined due to non-operating factors and will remain stable in the future. Kangda Environmental Protection's gross profit margin for construction services fell 9.63pps in 2016 compared with the same period last year, mainly affected by last year's large BT revenue; operating services gross profit margin was 36.35%, down 5.30pps from the same period last year, mainly affected by the new VAT rebate policy. Overall, according to our estimates, excluding non-operating factors, the company's EBITDA profit margin in 2016 is about 37%, a year-on-year decline of only 1.50pps, basically stable, and is expected to continue to maintain this level in the future.

With the reform of the system of the business department, performance flexibility is expected to be fully released. Kangda Environmental Protection newly set up three major divisions of urban water, water environment and rural sewage in 2016, benefiting from the promotion of PPP policies, the rapid development of comprehensive treatment of the water environment and the rural sewage market. Currently, such orders amount to about 4.8 billion yuan, and we expect construction revenue to increase significantly to about 2 billion yuan in 2017.

The scale of water operation and the actual handling capacity have been accelerated, and the construction service income structure has ushered in a substantial adjustment. In 2016, the company's total designed water treatment scale increased by 19.8%, which is better than that of last year. In 2016, the actual treatment capacity also increased from 643 million tons to 713 million tons, an increase of 10.89 percent. The total income of construction services from the new business plate of comprehensive treatment of water environment and rural sewage treatment amounts to 260 million yuan, accounting for 26.5% of the income from construction services, indicating that the company's construction income structure has ushered in a substantial adjustment.

Investment suggestion: we slightly raise Kangda's profit forecast for environmental protection, and expect the company's 2017 / 2018 return net profit to be 4.56 / 582 million yuan respectively. It still gives the target price 2.48 Hong Kong dollars according to 10 times Pamp E in 2017, which is 24.8% higher than the current price. Maintain the "overweight" rating.

Risk hint: the local financial ability to pay is declining, the rate of return of PPP is lower than expected, and the RMB depreciates.