Excerpts from analysts' report

JP Morgan analysts: Elaine Wu & Boris Kan

SIIC Environment 
(SIIC SP, Not Covered, mkt cap US$1.2B) is the water subsidiary of Shanghai Industrial. SIIC grew its water treatment capacity five fold the past five years and is now a top five player in the space. But it’s not stopping here. The plan is to increase current capacity by another 50% in the next two years, management said. Also on the cards is an IPO in HK and asset injection from the parent co.

Below are our key takeaways from SIIC’s analyst briefing on 3Q14 results.

Treatment capacity to grow to 8MM tons/day in 2016. SIIC currently has 5.2MM tons/day of water and wastewater treatment capacity. Management maintained its annual capacity growth target at 1.0-1.5MM pa and aims to achieve total capacity of 8MM tons/day by 2016.

400_Zhou-Jun-w-investorsSIIC Environment executive chairman Zhou Jun.
NextInsight file photo
Acquisition size getting smaller, but still the main source of growth. Management said there were fewer acquisitions of sizeable water companies (with treatment capacity of > 1MM tons/day) available than a few years ago. However, SIIC will still use acquisitions as its main source of new projects, accounting for two-thirds of its new capacity growth. The rest will come from award of new projects from local governments. They added that it would be more common to acquire companies or projects with only 0.1-0.3MM tons/day of treatment capacity in future.

No plans to go to rural regions. SIIC will continue to expand by acquiring water treatment capacity in urban areas as management believes this is where they have an edge.

HK IPO possible in 2015. SIIC has delayed its plans for a dual-listing in HK because the company has to complete certain major acquisitions before moving forward with a listing. So, this is still in the works and it’s possible that it could come in 2015, management said.

Parent asset injection also possible. Shanghai Industrial has a JV that owns >5MM tons/day of water treatment capacity. It’s possible these projects could be injected into SIIC Environment in the future, potentially alongside the HK IPO, management said.

Net gearing was 31% as of 30 Sep 2014 vs 19% as of 31 Dec 2013. Management said a tolerable level of net gearing was 100%, but they would like to keep it within 60%.

5.6% finance cost to be lowered. SIIC’s finance cost in 9M14 was 5.6% vs 5.3% in 2013. At the project level, loans are obtained at the PBOC standard rate of 6-7%. Management said they planned to lower funding cost by refinancing some of its mainland debt with overseas loans and loans from the parent company.

Disposal of EPC company because of low margins. SIIC disposed of Wuhan Kaidi, its EPC (engineering, procurement and construction) company which built wastewater treatment plants for industrial customers. Management said the company decided to sell the company because they wanted SIIC to focus on BOT (build, operate, transfer) projects. Another reason is because Kaidi was able to achieve gross margins of only 12-13% and management saw the possibility of margin erosion in future due to increased competition.

Acquisition of Yinchuan TOT project at RMB3,520/ton. SIIC announced it would acquire a TOT (transfer, operate, transfer) project in Yinchuan for RMB176MM. This project has 50,000 tons/day of wastewater treatment capacity, with commitment from the local government to double the capacity within the next two years. The reason the capex/ton acquisition price of this project is at the high end of RMB3,520/ton vs industry average of ~RMB2,500 is because this project receives a higher treatment tariff of >RMB1.5/ton, with a committed expansion project, management said.

Potential 800,000 tons/day of new projects from Longjiang. In Jul 2014, SIIC acquired a 25% stake Longjiang Environmental Protection, a wastewater treatment operator in Northeast China with 2.4MM tons/day of treatment capacity. Longjiang has a project pipeline of ~800,000 tons/day. SIIC may directly invest in these news projects in future because Longjiang is already highly geared, SIIC management said.

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