Suspend strategies after spin-off and listing, and focus on strengthening operation management

Before the quiet period, we conducted research and learned that the company adjusted its development strategy in response to the announcement in September to suspend plans to split the tap water and direct drinking water business, and changed from rapidly adding new projects to strengthening existing operations and management to reduce capital expenses. This strategic adjustment will mainly result in a decline in the non-cash flow construction revenue contribution of the two businesses of tap water and drinking water from pipelines. We expect the company's construction revenue to fall from 45.5% of FY24 to 42.0%, 41.2%, and 39.8% of FY25-27, respectively.

The tap water price adjustment process continues

Meanwhile, the tap water price adjustment process continues. FY24 received price increases for four projects. Two of them were tap water projects in Hanchuan, Hubei and Huaihua, Hunan, with a total production capacity of 0.065 million tons/day. The company said earlier that more than 20 tap water projects have initiated price adjustment applications and are awaiting government review, accounting for about one-third of the company's total production capacity of tap water projects. We have noticed that since June, some regions have issued announcements or held hearings on price adjustments, such as Yanshan County in Jiangxi and Shishou City in Hubei. Since the price adjustment process generally takes about a year, it is expected that the results of the increase in water prices will be reflected one after another starting from FY26.

Increase the room for the dividend ratio to increase

We expect the company's cash outflow from investing activities to decrease during the FY25-27 period. Furthermore, domestic and foreign interest rates are declining, making it easier for companies to obtain favorable additional financing costs. For example, in August, the company issued 0.5 billion yuan of 3-year panda bonds, with a coupon interest rate of 3%. The above factors will give the company more room to increase its dividend ratio in the future.

Maintain a “buy” rating

Combining the above factors, we reduced FY25-26 shareholders' net profit forecasts by 16.6% and 23.3%, respectively, and added FY27 forecasts. Taking into account the decline in market risk compared to the time of the last update, we rolled to a target price-earnings ratio of 7.5 times FY26. We reduced our target price from HK$6.30 to HK$6.10, corresponding to a 29.1% increase. Subject to the implementation of tap water price adjustments and dividend ratios, we do not rule out the possibility of raising the valuation in the future. Maintain a “buy” rating.

Risk warning: (1) polluted water sources; (2) the increase in water prices is lower than expected; (3) exchange rate risk.