Incidents:

On the evening of October 25, the company released its 2019 three-quarter report: the company achieved revenue of 1,110 billion yuan in the first three quarters, an increase of 53.96% over the previous year, achieved net profit attributable to shareholders of listed companies of 256,72.1 million yuan, a decrease of 5.10% over the previous year, and achieved net profit attributable to shareholders of listed companies of 248.83 million yuan after deduction, a decrease of 4.59% over the previous year. Our comments on this are as follows:

Key points of investment:

The performance was in line with expectations, and the 53.96% increase in revenue was mainly due to the contribution of the engineering business

The company achieved revenue of 1,110 billion yuan in the first three quarters of 2019, an increase of 53.96% over the previous year, and achieved net profit attributable to shareholders of listed companies of 256.721 million yuan, a decrease of 5.10% over the previous year, in line with market expectations. The sharp increase in revenue was due to the increase in heating area and the increase in heating revenue. Second, the company added additional engineering business in 2019 (2019H1 contributed 228 million yuan in revenue). The decline in net profit was mainly due to the impact of the repurchase of Wang Xinzhuang Sewage Works in December 2018. The company's comprehensive gross margin in the first three quarters was 39.31%, a year-on-year decrease of 6.81 pct, mainly due to the impact of new engineering business with low gross margin. In terms of period expenses: The management/R&D expenses ratio was 4.81%/2.09%, respectively, down 1.43/1.09pct from the previous year, and the sales and financial expenses ratio was 0.21%/5.28% respectively, up 0.15/3.41pct respectively over the previous year. The increase in financial expenses was significant, mainly due to the increase in loans as the project progressed. Net cash flow from operating activities was $617 million, an increase of 161.27% over last year's $236 million, and cash flow continued to improve.

The industrial chain is continuously improved+sufficient orders+sufficient capital, and the company is strong after future development

The company has continuously expanded its industrial chain based on urban sewage treatment and centralized heating. It has now extended to reclaimed water reuse, biogas utilization, construction waste, village and town sewage, watershed treatment, sludge treatment, environmental protection equipment manufacturing, new energy manufacturing, landscaping, etc. The company's business scope covers “large public use, big environmental protection, big ecology” and other sectors. The company has continuously improved the industrial chain to build a comprehensive environmental service provider, and has shown first-class ability to take orders. Since 2017, the company has successively won bids for projects such as Xinmi, Chonggou, Xinyang Lihe, Minquan, Fangcheng, Neihuang, Shangcai, Gongyi Environmental Management, Dengfeng Rural Sewage, Domestic Waste Sorting in the Central Plains District, and Construction Waste Removal in Duyun, Guizhou. The total investment of the projects has exceeded 12 billion yuan, and there are plenty of on-hand orders. As of 2019Q3, the company had capital of 1,973 billion yuan in hand. At the same time, the balance ratio was only 40.30%. There is still plenty of room for financing. Orders are full and capital is plentiful, and the company is strong for future development.

Selected as two hundred state-owned enterprises to reform and join forces with Henan's assets, asset injection is expected to accelerate

In August 2018, the company was included in the State-owned Assets Administration Commission of the State Council as a state-owned enterprise reform enterprise. In October, the company and the controlling shareholder Utility Group signed a strategic cooperation framework agreement with Henan Assets. The three parties plan to cooperate in supporting the implementation of the “Double Hundred Enterprise” reform, promoting resolution of competition in the industry, integration of business resources, and comprehensive financial services. Henan Asset is a local asset management company controlled by Henan Investment Group. It is shouldered by the three major missions of mitigating regional financial risks, serving the reform of state-owned enterprises, and supporting industrial transformation and upgrading. At the same time, Henan Assets has already purchased company shares from the secondary market. The shareholding ratio increased from 4.30% in the 2018 annual report to 4.95% in 2019Q3. The company teamed up with Henan Assets. It is expected that the reform process and transformation and upgrading of state-owned enterprises will accelerate. In April 2019, it was announced that the majority shareholder, Utility Group, will transfer 100% of its shares in the purification company to the listed company for a fee. It was previously promised that the asset injection will be completed by the end of 2019. The purification company has the Zhengzhou New Area Sewage Treatment Plant (1 million tons/day), the Shuangqiao Sewage Plant (600,000 tons/day), and the sludge business. If assets are injected, it will bring great flexibility to the company's performance. Furthermore, the majority shareholders have assets such as waste-to-energy and tap water businesses, and the possibility that they will be injected into listed companies in the future is not ruled out. As the only state-owned environmental protection platform in Henan Province, the reform of state-owned enterprises is worth looking forward to.

Profit forecasts and investment ratings: Maintain the company's “increase in holdings” rating. Due to the impact of the repurchase of the Wang Xinzhuang sewage treatment plant, we slightly lowered the company's profit forecast for 2019. At the same time, the engineering business began to gradually contribute to performance. We raised the profit forecast for 2020-2021 without considering the impact of asset injection on the company's performance. We expect the company's 2019-2021 EPS to be 0.35, 0.40, and 0.44 yuan respectively, corresponding to the current stock price PE 18, 16, and 15 times, maintaining the company's “increase holdings” rating.

Risk warning: the risk of sewage treatment fees falling short of expectations, the risk of PPP project expansion falling short of expectations, the risk of a sharp increase in accounts receivable, the risk that PPP project construction falls short of expectations, the risk that the company's future acquisitions and asset injection are uncertain, the risk that the project will not advance as expected, and the risk of a macroeconomic downturn.