Initiation: cleaning up in China China Water...

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4 November 2014

Initiation: cleaning up in China • The central government’s determination to address water scarcity

and pollution should herald a new wave of growth for the sector • While valuations appear rich, a further rerating is likely for the

top players on their solid capacity and earnings-growth outlooks • Our top pick is CTE, for its industrial WWT and sludge exposure;

we also like BEW, the dominant consolidator in municipal water

China Water Sector

Positive (initiation)

Neutral

Negative

How do we justify our view?How do we justify our view?

Utilities / China


■ Investment case We initiate coverage of the China Water Sector with a Positive rating, backed by 2013-16 net profit CAGR forecasts of 31-47%. Our coverage universe comprises a leading industrial waste water treatment (WWT) operator and 2 municipal water players. We expect more opportunities for market consolidation as well as greenfield projects in the coming years. Supportive government policies should not only equip the industry with better infrastructure that reaches underpenetrated regions, but also enhance profitability and visibility on water supply, water reclamation, WWT, sludge treatment, and seawater desalination projects. We expect the WWT industry to sustain accelerating investment growth, driven by untapped demand associated with: 1) the scarcity of water, high water pollution and greater public awareness in China, 2) increasing wastewater discharge, 3) low penetration in lower-tier cities and rural areas for municipal

WWT, 4) increased demand for professional centralised industrial WWT, and 5) stricter discharge standards and enforcement. ■ Catalysts We highlight the following as potential share-price catalysts:

• New government policies to tackle water pollution. Specifically, we expect the Water Pollution Prevention and Control Plan to be introduced in 2H14-2015.

• A policy-driven increase in investment in the water sector, which we forecast to total CNY2tn over 2016-20.

• Tighter policy enforcement and government monitoring.

• Tougher discharge standards, which could accelerate market consolidation and spur demand for plant upgrades, with WWT tariff hikes a possibility thereafter.

• Government guidance and support for sludge treatment.

■ Valuation The sector is trading at 2015E PERs of 14-23x, which we see as justified by its high earnings visibility and resilience to macro conditions and policy tailwinds. Given our expectation of more favourable policies, and backed by the companies’ aggressive capacity expansion plans, we expect a further rerating for the top players. Our top pick is CT Environmental (CTE) (1363 HK, HKD8.27, Buy [1]),

for which we raise our target price to HKD9.60 (from HKD8.88). We like its leading position in the industrial WWT and sludge treatment market. We initiate coverage on Beijing Enterprises Water Group (BEW) (371 HK, HKD5.55) with an Outperform (2) rating and target price of HKD6.30, given its strong position in tier-1 and -2 cities and solid WWT expansion plans. Also, we initiate on Kangda International Environmental (6136 HK, HKD3.58) with an Outperform (2) rating and target price of HKD4.10. With its strategic positioning in mid-tier cities, Kangda should benefit from urbanisation and aggressive capacity expansion, given it has a relatively small project portfolio. ■ Risks The main risk to our Positive sector view is the sector’s reliance on policy initiatives.

4 November 2014

Initiation: cleaning up in China

• The central government’s determination to address water scarcity and pollution should herald a new wave of growth for the sector

• While valuations appear rich, a further rerating is likely for the top players on their solid capacity and earnings-growth outlooks

• Our top pick is CTE, for its industrial WWT and sludge exposure; we also like BEW, the dominant consolidator in municipal water

China Water Sector

Key stock calls

Source: Daiwa forecasts

Utilities / China


Neutral

Negative

Dennis Ip, CFA(852) 2848 [email protected]

Cindy Li(852) 2773 [email protected]

New Prev.CT Environmental Group (1363 HK)Rating Buy BuyTarget 9.60 8.88Upside 16.1%

Beijing Enterprises Water Group (371 HK)Rating OutperformTarget 6.30Upside 13.5%

Kangda International Environmental (6136 HK)Rating OutperformTarget 4.10Upside 14.5%


China Water Sector 4 November 2014

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How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook China: wastewater discharge amount

The penetration rate for municipal WWT in China’s major cities stood at nearly 90% in 2013, and is targeted to reach 100% by 2015, according to China’s 12th Five-Year Plan (FYP). In our view, market consolidation will remain the major theme within the sector in the coming years, but the focus will gradually shift to mid-tier cities from top-tier ones. As such, we believe industrial WWT operators will be presented with more project opportunities as the use of their services (which offer higher standards, are easier to monitor, and have better economies of scale than WWT being done in-house) becomes more prevalent.

Source: National Bureau of Statistics, Ministry of Environmental Protection,

State Council, Frost & Sullivan

Valuation China Water Sector: 1-year forward PER

Although valuations in the sector, at an average 1-year forward PER of 20x, are rich, we see few grounds for a derating. Indeed, we look for further share-price upside, and forecast 2013-16 net profit CAGRs of 31-47% for the 3 companies under our coverage. We also look for favourable government policies to drive the development of the WWT market. Our top pick, CTE, has the most upside potential to our target price, as we believe it merits a premium valuation for its status as a leading industrial WWT operator and early mover in the sludge treatment market. We also assign CTE the highest 2013-16E earnings CAGR, of 47%, among the 3 water stocks under our coverage.

Source: Bloomberg, Daiwa forecasts

Earnings revisions China Water Sector: consensus 2015E EPS revisions

The Bloomberg consensus 2015 EPS forecasts have generally been revised up over the past 12 months, though they have been pretty stable in recent months. We believe the improving earnings outlook has flowed from the range of policies that have been implemented in China since 2013 to tackle pollution. Given our Positive outlook for the sector, we believe there is further upside to the consensus forecasts.

Source: Bloomberg


Neutral

Negative

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CTE BEW CEISGL Kangda Avg

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Sector stocks: key indicators

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Beijing Enterprises Water Group 371 HK 5.55 Outperform 6.30 0.193 0.238

CT Environmental Group 1363 HK 8.27 Buy Buy 9.60 8.88 8.1% 0.280 0.276 1.4% 0.366 0.359 1.7%

Kangda International Environmental 6136 HK 3.58 Outperform 4.10 0.142 0.197

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


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Executive summary ..................................................................................................................... 6

Foundations in place for a long-term structural growth story ................................................ 6

Stock recommendations .......................................................................................................... 6

Valuations expected to expand ................................................................................................ 6

Are earnings growth and high-PER valuations sustainable? ................................................... 7

WWT: solutions needed ............................................................................................................. 13

Rising demand for WWT ........................................................................................................ 13

Municipal WWT: opportunities for leading players ............................................................... 14

Industrial WWT: specialising in the niche market ................................................................ 20

Raising discharge standards: a catalyst for market leaders ................................................... 25

Sludge treatment: good potential .......................................................................................... 29

Exploring the value chain .......................................................................................................... 32

Privatisation and tariff hikes ................................................................................................. 33

A drop in the ocean ................................................................................................................. 37

Valuation: peer comparison ...................................................................................................... 39

CTE has the most potential upside to our target price .......................................................... 39

Appendix I: introduction to China’s water industry .................................................................. 41

China is thirsty for water to meet its needs ............................................................................ 41

Severe water pollution needs tackling ....................................................................................45

Secular growth underpinned by policy reform ...................................................................... 46

Appendix II: impact of floods and droughts .............................................................................. 51

Appendix III: BOT/TOT business model ................................................................................... 53

Appendix IV: pollutant surcharges ............................................................................................ 57

Company Section

CT Environmental Group ...................................................................................................... 58

Beijing Enterprises Water Group .......................................................................................... 62

Kangda International Environmental ................................................................................... 80


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Executive summary

Foundations in place for a long-term structural growth story

CNY2tn investment plan China’s water industry has seen a flurry of privatisation and consolidation over the past few years, and we expect it to deliver significant growth in the coming years, especially in the WWT market, supported by policy tailwinds, mainly in terms of increasing penetration and standards of WWT. We look for China’s Water Pollution Prevention and Control Plan, which could be issued in 4Q14-2015, to call for investment in the sector of up to CNY2tn for 2016-20. In our view, the serious shortage of fresh water in China, ongoing urbanisation, escalating pollution concerns, and insufficient WWT treatment capacity all serve as the foundations for a long-term structural growth story. We expect accelerating capacity and earnings growth for the operators in the China’s water sector, against the backdrop of more project opportunities and market consolidation, in the coming years, driven by: 1) more stringent discharge standards and favourable government policies, 2) increased demand for professional third-party WWT operators, 3) enhanced water pipelines to improve utilisation of current projects and allow access to rural areas, and 4) potential regulation of the sludge treatment industry which should open up a large market along the water value chain and support higher tariffs for WWT. Sector preference: sludge treatment > industrial WWT > municipal WWT (mid-tier cities) > municipal WWT (tier-1 and tier-2 cities) > water supply > rural WWT Within the sector, we prefer the sludge treatment segment, as we believe it will benefit from more greenfield opportunities than water supply or WWT projects, and that current players will enjoy first-mover advantage once the relevant regulations become clear. Elsewhere, sludge treatment and industrial WWT have relatively higher entry barriers than water supply and municipal WWT due to their dependence on hi-tech solutions, whereas water supply and municipal WWT

projects are typically subject to more intense competition from SOEs. Finally, rural WWT tends to feature relatively high credit risks associated with local governments, yet these risks are not well rewarded by returns given the absence of strong financial support at the state level.

Stock recommendations

Our top sector pick is CTE. We reiterate our Buy (1) rating on CTE and raise our 6-month target price to HKD9.60 (from HKD8.88). We believe CTE is the best placed in our coverage universe to capitalise on the ongoing investment in China’s environmental and water industries, given its leading position in the industrial WWT and sludge treatment markets, especially in Guangdong Province. We forecast CTE to realise a higher-than-peers’ gross profit margin of some 75% (vs. around 40% for peers) for each year over 2014-16 and generate a net profit CAGR of 47% for 2013-16. We initiate on Kangda with an Outperform (2) rating, backed by a 6-month target price of HKD4.10. We highlight the company’s strategic positioning in mid-tier cities and its aggressive capacity expansion plans, which reflect its status as a newly listed company (since July 2014) with a relatively small project portfolio. We initiate on BEW with an Outperform (2) rating and a 6-month target price of HKD6.30. BEW is a leading consolidator in the municipal water supply and WWT segments. It is a low-cost player thanks to its SOE status and sound execution by its private management team, and we like its strong position in tier-1 and tier-2 cities, as well as its WWT capacity expansion plans.

Valuations expected to expand

Since 2012, BEW and China Everbright International (unrated) have been rerated from a PEG of 0.4x for both stocks (based on 2-year forward EPS CAGRs) to 0.8x and 0.9x, respectively, as investors have been accumulating environmental (water and solid-waste treatment) stocks. The appeal of these stocks has been underlined by their rising 2-year forward EPS CAGRs (from 11-28% in 2012 to 22-34% currently), driven by government policies aimed at cleaning up water and waste, alongside a period of industry consolidation similar to that experienced by China’s gas sector in the early 2000s.


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However, the big-cap water stocks have been the most favoured by investors, likely because these companies have strong track records of project execution and M&A activity. Hence, we believe emerging water utilities, such as CTE and Kangda, which focus on niche markets like industrial WWT and sludge treatment, or mid-tier city municipal WWT, in which they face less competition from large-cap SOE water companies, have the potential to be rerated further. In our view, these stocks could see their PEGs rerated from 0.6x currently to 1x if they prove capable of expanding their WWT capacities as fast as BEW and China Everbright International (CEI) (not rated) have done so over the past few years. China WWT operators: 2-year average PEG since 2012

Min PEG 0.39Max PEG 1.03Source: Companies, Daiwa forecasts

Note: PEG multiples for CTE, BEW and Kangda are Daiwa estimates; those for CEI and Sound Global (SGL) (Not rated) are according to the Bloomberg consensus forecasts

China WWT operators: 2-year forward EPS CAGR

2013-16E EPS CAGR 2015E PER 2013-16E PEGCTE 35% 22.6x 0.6x BEW 28% 23.3x 0.8x CEI 23% 20.1x 0.9x SGL 32% 13.5x 0.5x Kangda 31% 14.3x 0.5x Source: Companies, Daiwa forecasts

Note: PEG multiples for CTE, BEW and Kangda are Daiwa estimates; those for CEI and SGL are based on the Bloomberg consensus forecasts; multiples are based on share prices as of 31 October 2014

Are earnings growth and high-PER valuations sustainable?

Investors looking at the WWT operators will probably inevitably ask themselves whether these companies are at risk of emulating the lacklustre earnings performance of China’s IPP sector in 2008-10, or going through a derating similar to the one now being faced by China’s gas distribution sector. In our opinion, neither of the above scenarios is likely, as the sector is in the early stages of consolidation, with a less volatile cost structure than that for the IPPs or gas distributors, and adjustable tariffs depending on the terms and conditions of the relevant build-operate-transfer (BOT) agreements:

• Early consolidation stage. The WWT sector is still in the early stages of consolidation. The top-10 municipal WWT operators account for only 15.8% of the overall market in China, while penetration of centralised industrial WWT and sludge treatment is currently only c.20-30%. These figures are similar to those of China’s gas distribution sector 7 years ago. Hence, we believe that if the WWT operators follow the same rate of development as the gas distributors, the WWT sector should prosper in the coming years.

China WWT vs. gas operators

Source: Company, Daiwa research

Note: the circles denote market share of the gas operators vs. municipal WWT operators; the triangles show the penetration of gas operators vs. industrial WWT

• BOT contracts underpin project IRRs.

Municipal WWT operators and centralised industrial WWT operators typically earn project IRRs of 8-10% and 15-20%, respectively. Their operating costs are usually passed through, depending on the terms of the BOT/ build-own-operate (BOO) contracts, while local governments generally guarantee a 70-80% minimum wastewater intake. If there is a plant upgrade following a higher discharge standard being implemented, the WWT operators can also be entitled to a tariff hike in order to achieve the

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China gas - residential penetration rateChina centralized industrial WWT / sludge treatment penetration rateChina gas - market share of top 5 distributorsChina municipal WWT - market share for top 10 operators


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contracted IRR. The average water tariff in China currently accounts for just 0.6% of disposable income and we expect the ratio to decline further. Hence, we do not expect the WWT operators to have difficulty passing through increased WWT costs in the form of tariff hikes.

China: average water tariff compared with disposable income

Source: Price Monitoring Center of National Development and Reform Commission, National Bureau of Statistics, Frost & Sullivan

• Cost structure is relatively defensive. Compared with the coal-fired IPPs and gas distributors, the cost structure of China’s WWT operators is less exposed to movements in the global commodities markets. For WWT projects, around 40% of operating costs are attributable to electricity and 60% to chemicals, making the WWT operators less exposed to changes in raw-material prices. This is in contrast to IPPs and gas distributors, which are generally exposed to volatility in coal prices and competing fuels of natural gas. According to CTE, the ASP of sulphuric acid has declined by more than 15% per year since 2012, while the ASPs of chemicals, such as poly aluminium chloride and potassium phosphate monobasic, have held steady over the past 3 years.

• Also, with regards to the cost structure, the average city-gate cost of major listed gas distributors has increased by 9% per year on average since 2008, due to the rising proportion of imported natural gas (2-7x more expensive than domestic gas) from c.10% in 2009 to c.30% in 2013. In turn, the China’s National Development and Reform Commission (NDRC) has launched gas price reform measures to increase natural gas tariffs (see China Gas - Plenty of juice despite the squeeze, published on 17 October 2014).

CTE: YoY growth in ASPs of chemicals*

Unit 2011 2012 2013 1H14 Sulphuric acid CNY per ton 604 472 402 343 Ferrous sulphate CNY per ton 258 240 240 240 PAM (acrylamide) CNY per ton 16,800 16,800 16,800 16,800 Poly aluminium chloride CNY per ton 1,820 1,868 1,890 1,950 Potassium phosphate monobasic CNY per ton 6,233 6,500 6,400 6,400

Source: Source: Company, Daiwa research

*Note: figure for 1H14 is HoH

China gas: average city-gate cost of 6 major listed gas distributors and imported gas portion in China

Source: companies, Daiwa forecasts

Finally, in China’s power segment, despite the existence of a tariff-coal price linkage mechanism policy, there were mismatches in 2008 and 2010, when the unit fuel cost of Huaneng Power International (HPI) (not rated) surged by 47% YoY and 26% YoY, respectively. As a result, the dark spread fell to CNY77/MWh and CNY97/MWh, respectively, well below the 15-year average of CNY172/MWh (2013: CNY219/MWh). HPI also posted unsatisfactory ROEs of -9% for 2008 and 2% for 2010.

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Average cost of 6 major listed gas distributorsyoy growth of average cost of 6 major listed gas distributorsGas supply - overseas import portion

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/China_Gas_Sector_141017.pdf#page=1


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Huaneng Power: on-grid tariff, unit fuel cost and dark spread

Source: Company, Daiwa

Huaneng Power: YoY growth in on-grid tariff, unit fuel cost and dark spread


Huaneng Power: dark spread and ROE


Therefore, we conclude that the returns of China’s utilities are primarily affected by their cost structures, as cost pass-through mechanisms are not always effective. However, the major costs (electricity and chemical) of the WWT operators have been stable in recent years, thereby allowing these companies to maintain stable unit gross profits. Given this relative stability, and our view that WWT and sludge treatment are in the initial stages of consolidation, we believe that in the coming years the market will ascribe the listed WWT operators forward PERs of c.20-25x and PEGs of c.0.8-1.0x.

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China: water industry participants

Water

resources Desalination Water supply City

municipal WWT

(1st/2nd tier)

City municipal WWT

(mid-tier)

Rural municipal

WWT

Industrial WWT

Sludge treatment

Sub-sector appeal n.a. ★ ★★★ ★★★☆ ★★★★ ★★ ★★★★☆ ★★★★★ Key participant (H-share listed)

China Water Affairs (CWA) (855 HK)

BEW (371 HK)

Kangda (6136 HK)

SGL (967 HK)

CTE (1363 HK)

CTE (1363 HK)

Note: stars denote the sub-sector’s appeal within the China water sector: one star denotes the least appealing, five stars = the most appealing in terms of investment appeal; for instance, we are most bullish on the sludge-treatment subsector, hence it carries 5 stars



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China: water industry participants Water

resources Desalination Water supply City municipal

WWT (1st/2nd tier)

City municipal WWT(mid-tier)

Rural municipal WWT

Industrial WWT Sludge treatment

Sub-sector appeal n.a. ★ ★★★ ★★★☆ ★★★★ ★★ ★★★★☆ ★★★★★

Key participant (H-share listed) CWA (855 HK) BEW (371 HK) Kangda (6136 HK) SGL (967 HK) CTE (1363 HK) CTE (1363 HK) Entry barrier for operators Extremely high,

as almost no private

operators can enter this

government- controlled segment

Extremely high, as sophisticated technology and

significant capex are required

Low, given a standardised

process can be applied;

management’s industry know-how

can be a distinguishing

feature

Medium, as while a generally

standardised process can be

applied, the ability to secure and

execute projects is particularly important

Medium, as while a generally standardised

process can be applied, the ability to secure and execute

projects is particularly important

Medium, mostly due to relatively

high project-selection

requirements in order to balance risks and returns

High, as the field requires

professionalism, technical know-how, industry experience, and connections with

clients

High, as the field requires

professionalism, technical know-how, industry experience,

and connections with clients

Penetration n.a. Extremely low Over 95% in cities, but penetration in

rural areas is relatively low due to a lack of pipelines

80%+ 70%+ 5%- Nearly 100%, but mostly carried out in factories. There is a

shortage of centralised WWT

facilities operated by professional players,

for which the penetration is around

5%

20 - 25%

Market potential for operators Almost none Likely has good market potential once technology

advances support

economic returns

Relatively low market potential regardless of low penetration, given lower return and

higher risks compared with city

municipal WWT

Large market potential, given

increasing demand for professional third-

party WWT

Massive market potential, given an

urgent need to improve the

penetration of sludge treatment, which is tracking

well below the level targeted in China’s

12th FYP Tariff n.a. Clarity on

regulations is lacking currently,

but tariffs are likely to be significantly

higher than the current tap water

supply tariff, given higher

costs

Under reforms to implement

progressive water tariffs. Possibility of further tariff hike in future as a result of

market reform or increase in water resources costs

Negotiated with the government. A BOT contract

generally includes conditions whereby tariff hikes can be

applied for

Negotiated with the government. A BOT contract generally

includes conditions whereby tariff hikes can be applied for

Negotiated with the government. A BOT contract

generally includes conditions whereby tariff hikes can be

applied for

Negotiable directly with customers

Clarity on regulations is

lacking currently. Negotiable directly

with customers

Return for operators n.a. n.a. ROE of 8-12%, regulated by government

Equity IRR of 10-12%, based on the

BOT contract

Equity IRR of 10- 12%, based on the

BOT contract

Equity IRR of around 10%, based

on the BOT contract

Equity IRR of 15-20%, on our estimates

Equity IRR of 15-20%, on our estimates

Project model n.a. n.a. BOO/TOO BOT/TOT/BOO BOT/TOT/BOO BOT/TOT/BOO BOT/TOT/BOO BOO/TOO Policies n.a. Increase national

capacity from 0.6mtpd to

2.2mtpd in 2010-15

Targeting penetration of

95%/85%/75% for city/town/county by

2015

Targeting penetration of 85%

by 2015

Target penetration of 85% by 2015

Target penetration of 30% by 2015

Promotion of professional third-

party treatment

Targeting 80% in major cities, 70% in other cities and 30% in counties by 2015

Operation risk Pollution Immature technology;

operating cost overrun

Water resources pollution; water

pipeline damage

Long accounts receivable period

due to cooperation with government; credibility of local government; tariff cut led by central

government

Long accounts receivable period due

to cooperation with government; credibility of local government;

tariff cut led by central government

Long accounts receivable period

due to cooperation with government; credibility of local government; tariff cut led by central

government

Credibility and affordability of

industrial clients; long-term plant

utilisation influenced by the operations of

industrial clients

Credibility and affordability of clients; unclear

value chain at the moment


Note: stars denote the sub-sector’s appeal within the China water sector: one star denotes the least appealing, five stars = the most appealing in terms of investment appeal; for instance, we are most bullish on the sludge-treatment subsector, hence it carries 5 stars


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China Water Sector: valuation summary

Ticker Company Rating Price

Target price

(HKD) Upside

Mkt cap

(USDm)Turnover

(USDm)

PER (x)

PBR (x)

ROE (%)

Net debt-to-equity (%)

EPS CAGR 2013-

2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E 2016E

H-share listed China water utilities 1363 HK CT ENVIRONMENTAL GROUP LTD BUY 8.27 9.60 16.1% 1,538 4.8 29.6 22.6 16.6 6.6 5.3 4.2 27.3 26.7 29.0 63 52 38 36%6136 HK KANGDA INTERNATIONAL ENVIRON Outperform 3.58 4.10 14.5% 954 6.4 19.9 14.3 11.9 2.0 1.8 1.5 13.9 13.2 13.9 81 103 128 31%371 HK BEIJING ENTERPRISES WATER GR Outperform 5.55 6.30 13.5% 6,230 8.6 28.7 23.3 19.0 3.4 3.1 2.8 11.8 13.8 15.5 122 144 155 28%967 HK SOUND GLOBAL LTD NR 8.98 1,699 4.2 18.2 14.1 10.6 2.6 2.2 1.8 15.8 16.9 17.7 1 14 16 28%257 HK CHINA EVERBRIGHT INTL LTD NR 10.7 6,186 11.3 27.2 20.7 17.7 3.2 2.8 2.5 12.3 14.6 15.3 23 40 51 24%855 HK CHINA WATER AFFAIRS GROUP NR 3.95 719 2.3 17.6 19.3 n.a. 1.5 1.5 n.a. 7.4 8.1 n.a. 59 70 n.a. n.a.1065 HK TIANJIN CAPITAL ENVIRON-H NR 5.52 1,793 2.3 20.5 19.4 16.9 1.5 1.4 1.3 7.9 8.1 8.8 73 69 59 10%270 HK GUANGDONG INVESTMENT LTD NR 10.2 8,208 9.5 16.4 15.5 14.6 2.2 2.0 1.8 13.2 12.6 12.4 Net cash Net cash Net cash 10%

Simple average 22.3 18.7 15.4 3.2 2.5 2.3 13.7 14.2 16.0 60 70 75 24%Weighted average 23.3 18.5 16.1 2.9 2.6 2.3 13.0 14.3 14.9 46 56 59 21%

A-share listed China water utilities 601158 CH CHONGQING WATER GROUP-A NR 6.05 4,750 16.2 14.8 14.3 13.0 2.1 2.0 1.9 14.2 14.1 14.7 n.a. n.a. n.a. 4%600874 CH TIANJIN CAPITAL ENVIRON-A NR 8.72 1,793 18.8 46.6 42.1 35.6 3.0 2.8 2.7 n.a. n.a. n.a. n.a. n.a. n.a. 7%600008 CH BEIJING CAPITAL CO LTD-A NR 7.61 2,739 24.5 27.2 22.5 17.6 2.6 2.5 2.3 7.9 8.9 7.1 63 81 70 15%300070 CH BEIJING ORIGINWATER TECHNO-A NR 28.35 4,964 42.8 24.6 17.6 13.8 4.9 3.9 3.2 21.0 22.9 23.1 Net cash Net cash Net cash 37%600649 CH SHANGHAI CHENGTOU HOLDING-A NR 7.23 3,533 26.7 13.9 11.9 10.5 n.a. n.a. n.a. 10.0 10.7 11.0 n.a. n.a. n.a. 7%


Regional water utilities HYF SP HYFLUX LTD NR 1.01 641 0.6 n.a. 34.8 18.0 0.9 0.9 0.9 11.1 1.7 5.3 Net cash 87 145 -2%VE US VEOLIA ENVIRONNEMENT-ADR NR 16.27 9,390 2.5 28.4 20.5 n.a. n.a. n.a. n.a. 3.0 3.1 n.a. n.a. n.a. n.a. n.a.SIIC SP SIIC ENVIRONMENT HOLDINGS LT NR 0.169 1,277 2.9 25.8 21.6 17.0 2.0 1.8 1.6 7.8 9.1 9.1 33 64 81 17%HANKORE SP HANKORE ENVIRONMENT TECH GRP NR 0.865 346 1.2 19.5 16.4 14.6 1.1 1.0 n.a. 6.3 7.7 7.4 14 48 66 4%UENV SP UNITED ENVIROTECH LTD NR 1.465 1,054 2.3 34.9 26.2 19.0 3.5 3.1 n.a. 9.3 10.2 11.7 16 23 45 33%MWC PM MANILA WATER COMPANY NR 28.9 1,297 1.1 10.4 9.7 9.1 1.8 1.6 1.4 17.8 16.8 15.3 60 66 57 8%


Note: Based on closing prices as at 31 October 2014


Note: For China Water Affairs, whose financial year-end is 31 March, 2014E refers to its financial year ending 31 March 2015, et al.


- 13 -

WWT: solutions needed

“There has been a long-term build-up to this problem, and the resolution will require a long-term process. But we must act.” – Premier Li Keqiang

Rising demand for WWT

With billions of tonnes of waste being discharged into the world’s waterways every day, the United Nations estimates that at least 1.2bn people globally lack access to clean drinking water and that at least 1.8m children under 5 years of age die each year from water-related diseases (one every 20 seconds). In 2012, China discharged 68.5bn tonnes of wastewater from industrial and municipal sources, which contains 15m tonnes of chemical oxygen demand (COD). Municipal wastewater accounted for 68% of the total and industry wastewater the remainder. Thanks to stricter discharge controls and the shutdown of some high-polluting factories, the annual discharge of industrial wastewater has stabilised in recent years and is expected to decrease by 2-3% per year over the next few years, according to Frost & Sullivan. However, the amount of municipal wastewater discharged has been increasing as a result of improving living standards and urbanisation, in line with China’s GDP growth, and is expected to continue to at a 5% CAGR for 2014-15, according to Frost & Sullivan.

China: wastewater discharge amount

Source: National Bureau of Statistics, Ministry of Environmental Protection,

State Council, Frost & Sullivan (2013-15E)

At the provincial level, Guangdong, which has China’s largest provincial population (106m, or 8% of the country’s population as of end-2011) and a high per-capita wastewater discharge amount as a result of its economic development, contributed 14% of China’s municipal wastewater and was the fourth-largest industrial wastewater producer in 2011. China: wastewater discharge amount by province (2011)

Source: National Bureau of Statistics

China: industrial wastewater discharge by province (2011)


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COD-Industrial (RHS) COD-Municipal (RHS)

(m tonnes) (m tonnes)

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Industrial Minicipal Municipal per capital discharge (RHS)

(mn tonnes) (ton per capita)

Others46.8%

Jiangsu10.7%

Shandong8.1%

Zhejiang7.9%

Guangdong7.7%

Fujian7.7%

Henan6.0%

Hebei5.1%


- 14 -

China: municipal wastewater discharge by province (2011)


Given that China is still going through a period of rapid development, it is reasonable to assume that it will generate increasing amounts of wastewater in the next few years. Hence, WWT, an effective measure to balance economic development with environmental considerations, is seen as a necessity. Against the backdrop of fast-growing demand and policy tailwinds, the WWT industry is set to enjoy significant growth over the next few years, in our view. General WWT treatment procedure


Municipal WWT: opportunities for leading players

China’s municipal WWT industry is going through a period of rapid development, as evidenced by the ongoing improvements in infrastructure, opening-up of the sector to market capital, promotion of greater efficiency, and further enhancement of discharge standards. The amount of municipal wastewater discharged has been growing broadly in line with China’s economic growth, and according to Frost & Sullivan will see about a 5% CAGR for 2014-15, to reach some 54bn tonnes in 2015. Rapid urbanisation, especially in mid-sized cities, will be a key driver of the incremental rise in urban sewage discharge, in our view. We highlight Kangda, which we see as well positioned strategically in mid-tier cities, as offering the most exposure to this market segment among our universe of coverage. With the amount of municipal wastewater discharged increasing each year, the municipal WWT market has been expanding. China’s municipal WWT capacity rose by a 6% CAGR from 2008 to 2013 to 149mtpd, and further to 153mtpd in 1Q14. However, the demand for WWT demand is not being fulfilled: the amount of municipal wastewater discharged saw a 9% CAGR from 2010 to 2012. China: municipal wastewater discharge amount


Others51.5%

Guangdong14.2%

Jiangsu8.1%

Shandong6.0%

Henan5.6%

Zhejiang5.6%

Sichuan4.7%

Hubei4.4%

Wastewater

Coarse grid and water pump station

Fine grid and sand sedimentation tank

Biological reaction tank

Secondary sedimentation

tank

Adding oxygen

Coagulation sedimentation

tankFiltration tankDisinfection tank

Discharge or reuse after meeting standards

Sludge concentration/storage tank

Sludge dehydration

Dry sludgeLandfill or reuse

Sludge

Sludge

0%

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Municipal waste water discharged (LHS) YoY (RHS)

(m tonnes)


- 15 -

China: municipal WWT capacity


China: municipal WWT capacity breakdown (2012)


To overcome the shortage of WWT facilities that meet the latest standards, the government has been promoting investment in the construction and upgrading of WWT infrastructure in recent years, with a particular focus on facilities in large cities. Private companies have been invited to enter the sector through BOT/BOO contracts (as well as transfer-operate-transfer [TOT] and build-transfer [BT] contracts) with the relevant local governments. There are now around 280 companies or institutions conducting municipal WWT business in China. China: annual investment in municipal WWT infrastructure

Source: Ministry of Housing and Urban-Rural Development

China: municipal utility infrastructure investment allocation


Although municipal WWT penetration in China’s major cities stood at 89.21% as of 2013, according to data from the Ministry of Environment Protection only 9% of villages and towns currently treat their wastewater. With the rollout of municipal WWT in major cities now entering a mature phase, we think rural areas have the potential to be the next growth driver, provided that local authorities can properly enforce environmental controls, ensure project return, and make timely payments. However, we are more excited by the near-term potential of the municipal WWT market in mid-tier cities, as these cities are also seeing increased demand driven by urbanisation and economic development. Moreover, we believe that, compared with rural WWT, conducting municipal WWT business in mid-tier cities will offer a better risk/reward profile. China: municipal WWT in villages


Privately owned companies have been entering the municipal WWT industry since 2000, as a result of the following factors: 1) their flexibility in business development and bidding for projects, 2) their operational efficiency and adaptability, which are made possible by their extensive technical know-how, 3) a reduced burden on the public budget for infrastructure development due to private companies’ involvement in

0%

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(mtpd)

Municipal WWT capacity (LHS) YoY (RHS)

Guangdong12.5%

Jiangsu11.4%

Shandong7.0%

Guangxi5.3%

Shanghai5.1%Zhejiang

5.0%Liaoning

4.9%

Others48.8%

(60%)

(40%)

(20%)

0%

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WWT infrastructure investment (LHS) YoY (RHS)

(CNYbn)

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# of villages treat wastewater (LHS) % of villages treat wastewater (RHS)

(# of villages) (%)


- 16 -

the service-concession-right model (accounting for 80% of the municipal WWT market , according to Frost & Sullivan), and 4) their stable cash flow, backed by water tariffs and government funding. In 2013, private companies accounted for 23.5% of China’s daily municipal WWT capacity. Among the private players, Kangda is the top operator, with a market share of around 5%. China: municipal WWT treatment capacity breakdown by type of company (2013)

Source: Ministry of Housing and Urban-Rural Development, Frost & Sullivan

China: top 5 privately-owned municipal WWT service providers (2013)

Capacity in operation

(ktpd)Capacity in and pending operation

(ktpd)Kangda 1,390.0 1,897.0Guozhen Environmental 1,201.0 1,622.3

Sound Global 1,179.9 1,219.0Pengyao Group 992.0 1,079.8GSEGC 965.8 1,042.0

Source: Company, Frost & Sullivan

12th FYP targets China exceeded most of the municipal WWT targets it set in the 11th Five-Year-Plan (FYP) for 2006-10, and saw a significant improvement in the WWT penetration rate, most notably at the county level. However, sewage pipeline construction fell behind schedule, and this has been a major drawback for WWT operators, as they cannot fully use their facilities in the absence of pipelines to pass them sufficient amounts of wastewater. The result: inefficiencies in the municipal WWT market.

China: major accomplishments during 11th FYP 2010 target 2010 actualWWT rate (%) Cities >=70 77.5

Counties >=30 60.1WWT capacity (ktpd) 105,000 124,760 - New treatment capacity (ktpd) 45,000 64,780Wastewater annual treatment volume (bcm) 29.6 31.8New sewage pipeline ('000 km) 160 70New COD reduction (mn ton) 3 5Utilisation rate of municipal WWT plants (%) >=70 78.9Investment (CNYbn) 332 376.6

Source: State Council

As part of the 12th FYP, China targeted 100% penetration of municipal WWT in 36 major cities and overall WWT capacity of 208mtpd. Judging by the difference between national municipal WWT capacity as at end-2012 and the targeted level for 2015, capacity expansion will need to accelerate in 2014 and 2015. In our view, this need for speed is likely to translate to more greenfield developments or consolidation opportunities for existing major operators in the market. China: municipal WWT related target during 12th FYP 2010 2015 Net add WWT rate (%) Cities 77.5 85 7.5

- 36 major cities n.a. 100 - Prefecture-level cities n.a. 85 - County-level cities n.a. 70 Counties 60.1 70 9.9 Towns <20 30 >10

Sludge non-hazardous treatment rate (%)

Cities <25 70 - 36 major cities <25 80 Counties <25 30 Towns <25 30

Water reclamation rate (%) <10 15 >5 Pipe network ('000 km) Cities 130 203 73 Counties 36 89 53 Towns 0 33 33 WWT capacity (ktpd) 124,760 208,050 45,690

(new projects) 37,600

(under construction at 2010)

Upgrade current WWT plant (ktpd)

26,110

Sludge treatment capacity (ktpy)

2,790 5,180

Reclaim water capacity (ktpd)

12,100 38,850 26,750

Note: Some 37,600ktpd WWT capacity were under construction in 2010, which is neither included in the 2010 capacity nor included in the net add during 12th FYP


According to the Ministry of Environmental Protection, all major cities except Shigatse in Tibet and Sansha in Hainan had municipal WWT plants up and running as at the end of 2013, and the penetration rate in major cities stood at 89.21%. Based on province-by-province municipal WWT capacity data as at end-2012, we conclude that Jiangsu, Guangxi and Guangdong have the most development potential for 2013-15.

SOEs69.0%

Privately-owned companies

23.5%

Foreign companies

7.6%


- 17 -

Although it already has the most WWT capacity in China, Guangdong province’s 12th FYP also features the most aggressive provincial municipal WWT capacity target. It is targeting to increase its municipal WWT capacity to 22,000ktpd by 2015 with the addition of 225 new WWT plants (from 305 WWT plants), and achieve a WWT plant utilisation rate of 80% and WWT penetration rate of 85% (90% for the Pearl River Delta Economic Zone). China: municipal WWT capacity targets (ktpd) 2010 2012 Net add during 12th FYP % of total FYP targetBeijing 3,647 4,005 1,196 3%Tianjin 2,158 2,572 600 1%Hebei 7,106 5,228 1,448 3%Shanxi 2,731 1,901 756 2%Inner Mongolia 2,131 1,674 1,049 2%Liaoning 5,367 6,709 1,815 4%Jilin 2,297 2,478 910 2%Heilongjiang 2,541 3,232 2,030 4%Shanghai 6,797 7,013 1,100 2%Jiangsu 10,101 15,645 2,930 6%Zhejiang 7,397 6,911 2,441 5%Anhui 4,470 5,114 2,270 5%Fujian 3,389 3,921 1,753 4%Jiangxi 2,829 2,260 2,080 5%Shandong 9,794 9,540 1,845 4%Henan 6,659 5,278 1,903 4%Hubei 4,524 5,570 2,470 5%Hunan 5,385 5,753 2,349 5%Guangdong 14,807 17,053 3,075 7%Guangxi 3,314 7,202 1,886 4 %Hainan 760 739 774 2%Chongqing 2,383 2,384 1,063 2%Sichuan 3,962 4,031 1,934 4%Guizhou 1,705 1,248 1,246 3%Yunnan 2,367 2,297 1,126 2%Tibet 0 0 180 0%Shaanxi 2,353 2,272 1,305 3%Gansu 1,042 1,591 782 2%Qinghai 264 321 225 0%Ningxia 587 795 289 1%Xinjiang 1,893 2,142 860 2%Total 124,760 136,879 45,690 100%

Source: State Council, National Bureau of Statistics

To deliver on the targets in the 12th FYP, China has budgeted for CNY427bn of investment in municipal WWT-related fields. Of this sum, CNY104bn is to be invested directly in the construction of WWT facilities, which translates to an average expected construction cost of CNY2,276/tpd, and a further CNY13.7bn in upgrading existing WWT facilities totalling 26,110ktpd, which translates to an average expected cost of CNY525/tpd. China: 12th FYP municipal WWT investment breakdown


Pipeline57.2%New WWT

capacity24.4%

Existing WWT upgrade

3.2%

Sludge treatment

8.1%

Water reuse7.1%


- 18 -

China: 12th FYP investment plan for municipal WWT and water reclamation (CNYm) Pipeline New WWT capacity Existing WWT upgrade Sludge treatment Water reuse TotalBeijing 2,400 3,000 0 1,600 2,100 9,100Tianjin 4,700 1,300 0 900 4,500 11,400Hebei 6,300 3,000 1,000 2,300 2,300 14,900Shanxi 5,200 1,900 700 600 700 9,100Inner Mongolia 4,700 4,300 300 500 1,700 11,500Liaoning 7,000 4,400 1,000 1,200 500 14,100Jilin 5,400 2,000 500 600 200 8,700Heilongjiang 5,400 6,100 100 1,200 400 13,200Shanghai 7,400 4,100 0 1,600 0 13,100Jiangsu 18,700 6,200 200 4,800 500 30,400Zhejiang 12,400 5,200 500 2,400 400 20,900Anhui 10,000 4,000 900 700 500 16,100Fujian 7,300 3,400 200 600 700 12,200Jiangxi 8,200 4,400 400 400 200 13,600Shandong 9,200 4,000 200 1,300 1,600 16,300Henan 7,500 4,000 1,000 1,800 1,300 15,600Hubei 12,100 4,400 900 900 500 18,800Hunan 13,100 5,300 1,900 1,600 2,600 24,500Guangdong 26,600 5,800 600 3,800 2,200 39,000Guangxi 6,100 3,500 0 600 500 10,700Hainan 3,400 2,100 200 200 300 6,200Chongqing 4,600 2,800 1,200 400 400 9,400Sichuan 8,400 4,700 300 1,200 500 15,100Guizhou 7,600 3,200 400 500 700 12,400Yunnan 10,500 2,900 100 400 1,600 15,500Tibet 600 600 0 0 0 1,200Shaanxi 11,200 2,200 400 1,100 1,700 16,600Gansu 7,400 2,000 400 700 400 10,900Qinghai 1,100 500 100 100 100 1,900Ningxia 2,900 700 0 200 400 4,200Xinjiang 3,700 1,500 100 500 800 6,600Military 3,200 500 100 0 100 3,900Total 244,300 104,000 13,700 34,700 30,400 427,10012th FYP addition target during the period 159,000km 45,690ktpd 26,110ktpd 5,180ktpy (dry sludge) 26,750ktpdAverage expected construction cost CNY1,536,478/km CNY2,276/tpd CNY525/tpd CNY6,699/tpy CNY1,136/tpd



- 19 -

One constraint on the development of the WWT business has been a lack of sewage pipelines. The government recognises this constraint and made the construction of sewage pipelines a key target in both the 11th and 12th FYPs. For the 12th FYP, the government targets to almost double the length of municipal wastewater pipelines alongside the development of WWT plants, over half of which are to be constructed in rural areas. Guangdong Province again has the most aggressive target, in line with its WWT capacity expansion plans. China: city wastewater discharge pipeline length (2010)

Source: National Bureau of Statistics, State Council

China: municipal wastewater pipeline length target (km) 2010 Net add during 12th FYP % of total FYP targetBeijing 4,479 790 0%Tianjin 7,519 2,906 2%Hebei 7,722 4,528 3%Shanxi 2,498 3,479 2%Inner Mongolia 7,357 1,880 1%Liaoning 3,221 5,983 4%Jilin 2,678 5,406 3%Heilongjiang 2,544 4,485 3%Shanghai 5,058 1,185 1%Jiangsu 22,577 11,665 7%Zhejiang 15,959 7,267 5%Anhui 6,635 7,300 5%Fujian 5,757 4,945 3%Jiangxi 3,948 6,085 4%Shandong 12,965 8,003 5%Henan 7,480 5,341 3%Hubei 4,462 8,423 5%Hunan 4,129 8,492 5%Guangdong 5,366 12,483 8%Guangxi 2,062 3,195 2%Hainan 1,110 1,388 1%Chongqing 4,384 2,921 2%Sichuan 7,873 5,412 3%Guizhou 2,639 4,892 3%Yunnan 3,089 7,580 5%Tibet 59 355 6%Shaanxi 3,946 10,320 3%Gansu 2,050 4,641 0%Qinghai 570 728 1%Ningxia 730 2,077 2%Xinjiang 4,138 2,739 0%Military 1,170 2,232 1%Total 166,174 159,125 100%


Despite these ambitious-looking targets and what we see as the market’s sound potential, we are cautious on the development of the municipal WWT market outside China’s tier-1 to tier-3 cities, given the following factors: 1) our concern over the rural governments’ ability to pay, 2) rural WWT projects tend to be small in size, given the scattered nature of settlements in villages and towns, so there is a risk of operating deleverage and lower profitability compared with urban projects, and 3) municipal WWT projects are typically contracted with the government, meaning there is little individual pricing power (because of government control over WWT tariffs, project IRRs are limited to 8-12% and gross margins for WWT operators can be grouped, from high to low like so: industrial > municipal > rural.

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(km) (km/ktpd)


- 20 -

China: government debt outstanding (1H13)

Source: National Audit Office

Accelerating development in 2014 and 2015 By the end of 2013, China had met around half of the target in the 12th FYP for municipal WWT. In order to meet the 12th FYP target, some CNY213bn will have to be invested in the municipal WWT market during 2014 and 2015 relative to the originally planned total investment, which would be an acceleration compared with 2010-13. China: percentage of 12th FYP targets met (2013)

Source: Ministry of Housing and Urban Rural Development

China: investment in municipal WWT market during 12th FYP

Source: Ministry of Housing and Urban Rural Development, State Council

China: municipal WWT investment during 12th FYP

Source: Ministry of Housing and Urban Rural Development, State Council

Industrial WWT: specialising in the niche market

The amount of industrial wastewater discharged has gradually stabilised in recent years to 20-25bn tonnes per year, thanks to strict industrial waste control carried out by the central government, along with the closure or upgrading of heavily polluting facilities. Given China is now facing a deceleration in its GDP growth, we believe the amount of industrial wastewater discharged will hold firm around the current level. China: industrial wastewater discharged

Source: National Bureau of Statistics, Daiwa estimates and forecasts

China: industrial wastewater discharged by province (2011)


Provincial level1,778,084

City level4,843,461

County & Town level

4,264,372

(CNYm)

50.5%58.9%

41.3% 43.4%

29.9%

0%

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100%

New pipeline New WWTcapacity

Upgrade ofexisting WWT

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Sludgetreatment facility

Water reclaimfacility

0

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Water reuse

(CNYm)

Invested during 2010-13 Planned investment during 2014-15

214.44

212.67

427.10

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Planned investment during12th FYP

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- 21 -

China: industrial COD discharged

Source: Ministry of Environmental Protection

We note that the per unit wastewater discharge amount of output value for the textile industry declined by more than 40% during the 11th FYP period (2005-10) and is targeted to fall further during the 12th FYP period (2011-15) through a reduction in primary water usage and the amount of waste discharged, according to the State Council. We contend that such a decline presents only limited downside risk for WWT operators, given the following factors: 1) industrial customers have been upgrading their manufacturing/production techniques to provide more high-end products, but while they are discharging less wastewater, it has a higher density of pollutants, for which WWT operators can charge a higher tariff, and 2) stricter monitoring and tougher discharge standards are driving demand for professional third-party WWT. In our view, the rising demand for professional third-party WWT is being driven by the following factors: 1) factories may not have the technology to treat their wastewater properly, 2) in-house treatment may be more costly than outsourcing due to a lack of expertise or scale economies, 3) if they outsource the service, factories do not need to take on the risks should the treated wastewater fail to meet discharge standards, and 4) local authorities are encouraging the use of centralised third-party WWT as it allows for better monitoring. In sum, we believe the WWT market for professional operators is indeed growing. The industrial WWT market is forecast to see an 18% CAGR during 2012-15 and be worth some CNY50bn by 2015, according to Ernst & Young, which sees increases in WWT tariffs as a major driver.

China: market size for industrial WWT

Source: China Environmental Protection Bulletin, Ernst & Young

China: average industrial WWT tariff in major cities

Source: H2O China Water Net, Daiwa forecasts

Significant investment has been channelled into industrial waste treatment and control infrastructure in recent years, with around 30% of the annual sum going toward WWT. Shandong Province, which has a large concentration of heavy industries, such as petroleum process and coking, rubber and plastic products, metal smelting and rolling processing, automobile manufacturing, and chemical materials and product production, has led the way in investing in industrial WWT. China: annual investment in industrial waste treatment/control


-20%

-15%

-10%

-5%

0%

5%

10%

15%

0

1

2

3

4

5

6

7

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

COD (LHS) YoY (RHS)

(mn tonnes)

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2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

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Market size (LHS) YoY (RHS)

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2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

(CNY/tonne)

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2004

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2012

WWT Waste gas treatmentSolid waste treatment Noise controlOthers % of investment in WWT

(CNYm)


- 22 -

China: industrial waste treatment/control investment by provinces (2012)


Currently there are over 85,000 industrial WWT plants in China, most of which are in the south and east of the country. Guangdong Province leads with an 11% share of the total number of plants, while the most-penetrated 4 provinces together account for 35% of the total.

China: locations of industrial WWT facilities in China (2011)


0%

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0

2,000

4,000

6,000

8,000

Beijin

gTi

anjin

Heb

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Inne

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golia

Liao

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Hei

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jiang

Shan

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iang

Anhu

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Jian

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Shan

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Hen

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Nin

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Xinj

iang

WWT Waste gas treatmentSolid waste treatment Noise controlOthers WWT - % of national total (RHS)

(CNYm)

Number of industrial WWT facility, 2011 (unit)

1 – 500

500 – 1,500

1,500 – 3,000

3,000 – 5,000

> 5,000

Beijing

GuangdongGuangxi

Hunan

Hubei

Xinjiang

Qinghai

Ningxia

Shaanxi

Jiangxi

Jiangsu

Shanghai

Hebei

Inner Mongolia

Shanxi

Tianjin

Shandong

Tibet

Sichuan Chongqing

Yunan

Guizhou

Henan

Heilongjiang

Jilin

Liaoning

Anhui

Zhejiang

Fujian

Gansu

Hainan


- 23 -

Industrial wastewater – unlike municipal wastewater with its stable mix of pollutants and ability to be treated using a standardised process – has very different compounds across different industries, and as such, requires customised treatment procedures. Such customization is not only reflected by the different compounds or concentrates of the chemicals, but the design of the whole facility needs to be altered to fit the process needed for the specific industry(ies). Moreover, the COD level for municipal wastewater is generally 200-500mg/L according to the China Pollution Source Census, whereas the COD level for industrial wastewater can be well above 1,000mg/L, thus professional high-standard treatments are a necessity. Due to the highly differentiated nature of the technologies required to treat wastewater from various industries, which leads to strong pricing power for the operators, industrial WWT operators sit close to the top of the water value chain, and are our most preferred investment target in the China Water industry. We expect the expansion of industries with special water requirements for water quality or reliability to drive market growth going forward. Industrial WWT vs. municipal WWT Industrial Municipal Discharging sources - Manufacturers

- Petrochemical refineries - Other industrial companies

- Households - Offices - Urban public facilities such as public washrooms

Characteristics - High level of suspended matter and COD - Concentration and components differ from industry to industry

- High level of phosphorus and nitrogen contents - Relatively less harmful to the environment

Treatment process - Requires professional and customized treatment process with complicated techniques and operations - Typically combines both chemical, physical and biological treatment

- Standardized treatment process for all wastewater

Treatment tariff - Little to no government control over pricing, operators can negotiate directly with clients - Thus usually enjoys higher margins

- Typically pre-determined when entering into a contract with the government - Generally has an IRR of 8-12%

Government support - Preferential policies and other support measures in establishing industrial parks - More free market compared with municipal WWT

- Government typically offers support through guaranteed minimum volume - Low-cost land usage rights

Source: Companies, Daiwa

COD level comparison

Source: China Pollution Source Census, Ministry of Environmental Protection, General Administration of Quality Supervision, Inspection and Quarantine, Companies, Daiwa

WWT procedure for the dyeing and textile industry

Source: Companies

WWT procedure for pulp and paper industry

Source: Companies

Positioned in a niche market, industrial WWT operators are able to enjoy much higher returns than municipal WWT operators, and their gross profit margins are significantly higher. This is mainly attributable to their BOO operating model, under

10,000

3,000

1,000 200-500 100 50 20-30 0

2,000

4,000

6,000

8,000

10,000

Leac

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Text

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1-A

CTE

trea

ted

text

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aste

wat

er

(mg/L)

Rotary grid machine (remove suspended solids)

pHadjustment

Flocculation sedimentation tank

Water collection tank

Sedimentation adjustment

Adding chemicals

Lift pump Acidic hydrolysis tank

Aerobic tankSecondary

sedimentation tank

Sludge concentration

tank

Remaining sludge

Disinfection

Discharge of treated wastewater

Reclamation of treated wastewater

Settled sludge

Chemical treatment process

Biological treatment process

Wastewater

Water pump stationCoarse grid

machine

Fine grid rotary sand sedimentation tank

UV disinfection

Wastewater discharge or reclaim

Acidic hydrolysis tank

Biological treatment (Aerobic treatment)

Super effective gas flotation

sedimentation tank

Flocculation sedimentation tank

Sludge concentration tank

Sludge dehydration unit

Post-treated sludge

(Returned sludge)Adding chemicals

Adding chemicals

Wastewater


- 24 -

which industrial WWT fees are negotiated directly between operators and customers, leading to higher bargaining power, and thus pricing ability for the operators, making it easier for them to pass on any additional costs and sustain better gross margins. China has been setting up a large number of industrial parks in recent years in an attempt to centralise WWT and therefore have better administration and supply special-need utilities. This centralisation process has been the driver for industrial WWT operators such as CTE to expand their businesses. According to the Ministry of Industry and Information Technology, China had 222 National Economics and Technological Development Zones (ETDZ) and 1,568 Provincial ETDZs in 2010. A survey conducted by the China Environment Federation in 2010, which included 18 industrial parks (2 national, 7 provincial and 9 municipal industrial parks), concluded that 100% of the industrial parks discharged untreated or improperly treated wastewater, 78% had air pollution issues and 17% had solid waste pollution issues. We believe this situation will open up a large market for professional WWT operators when the industrial companies look to outsource their WWT to comply with the government’s discharging regulations. Without such outsourcing they would not be able to efficiently conduct their businesses due to the more strict government control and enforcement in the near future. Does industrial WWT have higher risk? Based on our on-the-ground research, certain WWT professionals seem to believe that the industrial WWT market inhabits higher risk due to the need for operators to cooperate directly with end-customers rather than with governments. Some investors also seem to be concerned about this risk associated with the industrial WWT operators. Admittedly, the life span for a corporate is, on average, less than that for a government body, thus creating risk for the long-term utilisation of an industrial WWT plant. However, we would argue that with their superior ability to choose customers in more healthy financial positions, or choose the industries for which to specialise their treatment techniques, leading industrial WWT operators can ensure quality for their customers, and thus can have good visibility on their long-term plant utilisation and WWT fee collection. To illustrate, CTE has a large customer base in the dyeing & textile industry, which is a regulated industry in which only licensed operators are allowed to conduct

business. Any bankrupted small player would likely sell its licence/factory to another player; as such, the industry is stable in the sense that its financial cycles do not have a large impact on overall wastewater discharge amounts. According to the Qualifications to enter into the dyeing & textile industry issued by the Ministry of Industry and Information Technology, any new factories have to be built in industrial parks where centralised heating and waste treatment is provided; and they can only be built in regions where there is a relatively abundant water supply, in addition to other technical and environmental requirements. CTE has the technology to treat wastewater from the dyeing & textile industry, pulp & paper industry, rice industry, beverage production industry and the power cable industry. In fact, it is capable of treating more than 30% of the industrial wastewater in China. CTE’s rich experience and deep WWT knowledge provides it with a competitive edge to sustain its leading position in the market. China: industrial wastewater discharge amount (2012)


Pulp & paper16.9%

Chemical13.5%

Dyeing & textile11.7%Agri food

processing7.7%

Others50.2%

http://xfps.miit.gov.cn/n11293472/n11505629/n11506447/n11515598/13165558.html


- 25 -

Raising discharge standards: a catalyst for market leaders

Stricter policies and better returns are pushing companies to consolidate Upgrading WWT facilities The government has been pushing for existing WWT facilities to be upgraded, allocating CNY13.7bn in investment for the upgrade of 26.75mtpd existing municipal WWT capacity over the 12th FYP period. We see a good chance that the government will focus more on plant upgrades upon the issuance of the Water Pollution Prevention and Control Plan (in late 2014/early 2015), which will likely call for all WWT treatment plants to be upgraded to Grade I-A standards at least by 2020. We also see the possibility of further uplifts to WWT plant discharge standards, which could also create plant upgrade demand. According to the latest statistics released by the Ministry of Housing and Urban-Rural Development in their Report on municipal wastewater discharge and treatment status 2006-2010, only 20.7%/15.4% of sewage treatment facilities qualify as Grade I-A in terms of number of plants/capacity, respectively. China: number of sewage treatment plants by discharge standard (2010)


China: capacity of sewage treatment plants by discharge standards (2010)


We see huge market potential for municipal WWT upgrade projects, and estimate at least CNY41.7bn in investment demand, driven by around 80mtpd of upgrade needs, in addition to the budget in the 12th FYP. China: untapped municipal WWT upgrade project potential

By 2010 (ktpd)

Municipal WWT capacity 124,760- among which, Grade IA capacity 19,213- Lower than Grade IA capacity 105,547To be upgrade during 12th FYP 26,110Further capacity upgrade potential 79,437

Source: State Council, National Development and Reform Commission, Ministry of Housing and Urban-Rural Development, Daiwa estimates

China: further municipal WWT upgrade investment

Upgrade

12th FYP Capacity (ktpd) 26,110Investment (CNYm) 13,700Average unit capex (CNY/tpd) 525

Further market potential Capacity (ktpd) 79,437Additional Investment (CNYm) 41,681

Source: Source: State Council, National Development and Reform Commission, Ministry of Housing and Urban-Rural Development, Daiwa estimates

According to our research, after being upgraded to Grade I-A discharge standards from Grade I-B, a municipal WWT plant can generally raise its tariffs by 30-50%. Therefore, we believe an untapped municipal WWT upgrade market suggests a potential profitability improvement for the WWT operators. Upward revisions to discharge standards creates opportunities China started to implement the latest discharge standards for municipal WWT plants in July 2003, and for industrial WWT plants in August 2008. Due to their complexity, the industrial WWT discharge standards were issued separately accordingly to 11 industries. The discharge standards for industrial WWT are similar to the Grade III standards for municipal WWT.

Grade I-A20.7%

Grade I-B57.7%

Grade II17.3%

Grade III0.9%

Others3.4%

Grade I-A15.4%

Grade I-B48.0%

Grade II28.4%

Grade III0.4%

Others7.8%

http://www.mohurd.gov.cn/xytj/tjzljsxytjgb/w02012051519761830152701250.docx


- 26 -

In our opinion, the current standards, which aim to regulate the WWT industry and eliminate water pollution, are far from reaching the targets. It concerns us that after comparing municipal WWT discharge standards with the country’s classification for surface water, even well-treated wastewater that meets Grade I-A discharge standards is a threat to the environment under the country’s classification. This is because Grade I-A standards are lower than the lowest classification (Grade V) standards for natural bodies of water, whereas Grade V natural bodies of water are by definition useless and possibly hazardous (see table at bottom of the page). China: discharge of treated municipal wastewater

Discharge of treated municipal wastewater

Grade I-A The minimum standard for reclaimed water. Allowed to be discharged into rivers/lakes or used as urban landscape water.

Grade I-B Allowed to be discharged into Grade III surface water (excluding water sources and restricted areas), Grade II Seawater, and enclosed/semi-enclosed lakes and reservoirs

Grade II Allowed to be discharged into Grade IV and Grade V surface water, Grade II and Grade III Seawater

Grade III Allowed to operate outside protected water source areas and outside major water bodies if the local economic conditions cannot support more advanced techniques; but are required to be upgraded to Grade II in phases


Should China want to eliminate the highly polluted water that is lower than Grade V (widely expected to be one of the policy focuses in the forthcoming Water Pollution Prevention and Control Plan), an upward revision to the WWT discharge standards might be

necessary. Our discussions with several WWT companies indicated that the potential new Grade I-A discharge standards may be lifted to the level of Grade IV or even Grade III surface water. Indeed, some local municipal WWT discharge standards are already higher than the national standard and meet the level of Grade III/IV surface water. For instance, the Beijing local municipal WWT discharge standard, which was implemented on 1 July 2012, requires all new WWT plants to comply with the local Grade A standard if the treated wastewater is discharged into Grade II/III surface water, or comply with the local Grade B standard for discharges into Grade IV/V surface water. It further states that existing WWT plants should comply with the local Grade B standard starting from 31 December 2015. According to the Beijing Municipal Environmental Protection Bureau, Beijing’s local municipal WWT discharge standard Grade A/Grade B generally meets the level of Grade III/Grade IV surface water, respectively. The upgrade of discharge standards would also prepare China to enter the next phase of the water industry, namely, water recycling and conservation, to mitigate the water scarcity issue in China, given reclaimed water should at least meet the Grade I-A discharge standards.

China: surface water standards vs. national WWT pollutant discharge standards vs. Beijing local WWT pollutant discharge standards

Surface water classification standard

National municipal WWT discharge standard Beijing local municipal

WWT discharge standard

(mg/L) Grade I Grade II Grade III Grade IV Grade V Grade I-A Grade I-B Grade II Grade III Grade A Grade BChemical Oxygen Demand (COD) 15 15 20 30 40 50 60 100 120 20 30Biochemical Oxygen Demand (BOD5) 3 3 4 6 10 10 20 30 60 4 6Suspended Substance (SS) n.a. n.a. n.a. n.a. n.a. 10 20 30 50 5 5Fat and Grease n.a. n.a. n.a. n.a. n.a. 1 3 5 20 0.1 0.5Oil and Petroleum 0.05 0.05 0.05 0.5 1 1 3 5 15 0.05 0.5Linear Alkylbenzene Sulfonates (LAS) 0.2 0.2 0.2 0.3 0.3 0.5 1 2 5 0.2 0.3Total nitrogen 0.2 0.5 1 1.5 2 15 20 n.a. n.a. 10 15Ammonia - normal (at or below 12°C) 0.015 0.5 1 1.5 2 5 (8) 8 (15) 25 (30) n.a. 1 1.5Total phosphorus - lake (reservoir) 0.02 (0.01) 0.1 (0.025) 0.2 (0.05) 0.3 (0.1) 0.4 (0.2)Total phosphorus - commenced operation before (after) 31st Dec 2005

1 (0.5) 1.5 (1) 3 (3) 5 (5) 0.2 (0.2) 0.3 (0.3)

Chroma n.a. n.a. n.a. n.a. n.a. 30 30 40 50 10 15pH 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9 6 - 9Fecal Coliform (unit/L) 2x10^2 2x10^3 10^4 2x10^4 4x10^4 10^3 10^4 10^4 n.a. Fecal Coliform (MPL/L) 500 1000

Source: Ministry of Environmental Protection, General Administration of Quality Supervision, Inspection and Quarantine, Beijing Municipal Environmental Protection Bureau


- 27 -

Leading professional operators in the sector have been able to achieve high discharge standards. According to our industry checks, CTE and BEW’s treated wastewater contains 20-30mg/L of COD, above the WWT pollutant discharge Grade 1-A standard, and meeting the surface water Grade V standard. On a recent visit to CTE’s Yonghe Haitao WWT plant, for example, we noted that its treated wastewater contained COD of 23.958mg/L and ammonia of 0.284mg/L. CTE: real-time monitor of examination of treated wastewater


As the WWT market is highly segmented, with the top-10 players only having a 15.8% market share in 2012, we believe the potential raising of discharge standards, coupled with stronger enforcement, would be a share-price catalyst for the market leaders, as it would create more M&A opportunities for them, such that: 1) smaller operators lacking operating scale, financial capital or the competence to cope with the higher discharge standards may be compelled to sell, and 2) companies with cutting-edge technologies, long-term track records of operation and cooperation with the government, and sizeable portfolios would also be ideal targets. We believe acquisitions or embarking upon TOT projects would be the key growth strategies for large companies aiming to expand their project portfolios and geographic footprints, and given that economies of scale can give way to improved operating efficiency and yields. Indeed, some of the China water companies we cover, such as CTE, BEW and the newly listed Kangda, have been gearing up or seeking more financing sources to take advantage of M&A opportunities.

China: top-10 water companies by market share (2012)

Company name Ticker Capacity in and pending

operation (ktpd)* Market share

Veolia China VIE FP 14.41 2.77%Beijing Capital 600008 CH 13.99 2.69%Beijing Enterprises Water 371 HK 13.36 2.57%China Water Investment unlisted 7.5 1.64%Sino French Water unlisted 7.47 1.43%SIIC Environment SIIC SP 5.88 1.13%General Water of China unlisted 5.16 0.99%Xing Rong Group 000598 CH 4.95 0.95%Tianjin Capital Environmental Protection 1065 HK 4.84 0.80%

Sound Group 000826 CH / 967 HK 4.26 0.82%

Top 10 81.82 15.79%

*Note: Represents total capacity by mid-2013

Source: China Water Net

Specifically, on the industrial WWT side, we see a strong likelihood that more stringent regulations and monitoring standards will force factories to outsource their WWT services to third-party professional operators instead of in-house, given: 1) there is still room for improvement in terms of all discharged industrial wastewater meeting the relevant standards, 2) treated and monitored in-house, only a few indicators are tested for pollutants, therefore the current reported value might not be precise; and the accurate percentage of wastewater that has met the discharge standard might be lower, and 3) more and more factories are being moved to industrial parks equipped with centralised treatment.

Top 5 players11.1%

6th - 10th player4.7%

Others84.2%


- 28 -

China: % of discharged industrial wastewater that meets standards

2003 2004 2005 2006 2007 2008 2009 2010

Tianjin 99.8% 99.4% 99.6% 99.8% 99.7% 99.9% 100.0% 100.0%Beijing 99.3% 98.6% 99.4% 99.3% 97.4% 98.3% 98.4% 98.8%Fujian 97.2% 97.2% 97.7% 97.9% 98.3% 98.4% 98.8% 98.7%Hebei 94.7% 96.4% 96.3% 93.4% 92.3% 95.5% 98.3% 98.6%Shandong 97.1% 97.0% 98.2% 98.0% 98.1% 98.9% 98.6% 98.4%Jiangsu 97.7% 97.2% 97.5% 97.7% 97.4% 97.7% 98.1% 98.1%Shanghai 94.9% 96.3% 97.1% 97.5% 97.7% 98.8% 98.8% 98.0%Anhui 95.9% 96.9% 97.4% 97.1% 94.8% 96.2% 96.2% 98.0%Hainan 93.9% 93.8% 93.6% 94.6% 94.6% 94.7% 96.6% 97.8%Shaanxi 86.9% 91.6% 92.7% 89.2% 96.1% 97.2% 96.7% 97.5%Henan 91.5% 93.7% 91.9% 93.0% 94.0% 94.9% 96.1% 97.4%Guangxi 86.5% 86.6% 83.7% 92.9% 92.8% 85.7% 95.0% 96.9%Hubei 83.8% 85.8% 87.6% 91.0% 93.6% 93.7% 95.9% 96.8%Sichuan 81.8% 86.4% 88.3% 84.5% 91.4% 94.9% 95.4% 96.5%Zhejiang 97.2% 95.9% 96.6% 86.4% 86.1% 90.8% 95.3% 96.2%Chongqing 89.9% 93.4% 93.7% 93.8% 92.1% 93.5% 94.3% 94.7%Shanxi 87.1% 89.6% 88.9% 68.9% 88.2% 85.6% 82.3% 94.7%Jiangxi 83.1% 88.7% 92.1% 93.2% 93.9% 93.0% 93.8% 94.2%Hunan 79.9% 83.6% 89.7% 91.6% 89.8% 92.1% 91.4% 93.7%Guangdong 82.9% 83.9% 83.9% 84.9% 86.0% 89.7% 92.3% 93.1%Heilongjiang 94.2% 93.7% 92.5% 87.8% 85.4% 86.8% 91.8% 92.7%Liaoning 91.6% 93.9% 95.1% 92.9% 92.4% 88.5% 85.9% 92.6%Yunnan 69.7% 74.7% 81.0% 89.2% 90.5% 92.7% 92.6% 91.8%Inner Mongolia 64.0% 61.2% 66.6% 77.0% 73.7% 82.6% 85.1% 90.2%Jilin 76.7% 79.5% 81.2% 81.4% 87.6% 87.2% 81.5% 89.0%Gansu 76.1% 73.2% 73.2% 79.1% 81.0% 58.9% 81.1% 83.3%Ningxia 58.6% 80.7% 67.8% 64.8% 69.7% 87.5% 87.4% 78.7%Guizhou 56.0% 58.2% 67.7% 71.8% 71.9% 71.7% 71.0% 77.3%Qinghai 59.9% 62.7% 44.6% 48.6% 50.2% 53.1% 55.8% 59.9%Xinjiang 59.7% 61.4% 59.3% 61.1% 65.0% 65.9% 66.7% 57.3%Tibet 0.0% 0.0% 0.0% 28.2% 29.2% 29.7% 22.3% 29.5%Total 89.2% 90.7% 91.2% 90.7% 91.7% 92.4% 94.2% 95.3%


In fact, with more government monitoring, better execution of related regulations, and the promotion of centralised treatment of wastewater, market consolidation could have already begun in 2012, when the total number of industrial WWT facilities dropped by nearly 6,000 nationwide. China: number of industrial WWT facilities


We see a good chance that CTE, as a market leader and with its one-stop solution for industrial WWT, water reclaim and sludge treatment, will be a key beneficiary.

CTE: one-stop integrated industrial WWT, sludge treatment and reclaim water supply model


85,673

-10%

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0%

5%

10%

15%

60,000

70,000

80,000

90,000

100,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Number of industrial WWT facilities (LHS) YoY (RHS)


- 29 -

Sludge treatment: good potential

Sludge treatment is an essential step for water operators aiming to offer an integrated WWT service. According to the Technical guidance for sludge treatment for municipal WWT plants issued by the National Development and Reform Commission and the Ministry of Housing and Urban-Rural Development, every unit of wastewater produces 0.5-1% of wet sludge (with an 80% moisture rate) after the WWT process. Originated from wastewater, sludge contains a high concentration of chemical/organic waste and heavy metal, and tends to be toxic and harmful to the environment. Therefore, sludge can lead to secondary pollution and directly threat public health if not properly treated. Heavy medal and bacterial contents of sludge (as dry sludge) Bacterial (unit/kg) Primary sludge Activated sludge Digested sludgeTotal Bacterial Count (TBC) 47,170 73,800 3,830Fecal Coliform 15,800 1,210 120Parasite Ova 0.233 (78.3% alive) 0.170 (67.8% alive) 0.139 (60% alive)Heavy Medal (mg/kg) Max Average MinCd 999 2.01 0.04Cu 9,592 219.00 51.00Pb 1,022 72.30 3.60Zn 30,098 1,058.00 217.00Cr 6,365 93.10 20.00Ni 6,206 48.70 16.40Hg 18 2.13 0.04As 269 20.20 0.78

Source: National Development and Reform Commission, Ministry of Housing and Urban-Rural Development

Various pollutant limits have been placed on treated sludge by the China government depending on its end-product, such as green brick, nutrition soil or simply landfill. In all cases, the waste and harmful components must be reduced to a reasonable level. Sludge treatment, similar to industrial WWT, requires specialist skills and a degree of professionalism, as different kinds of sludge/solid waste and various end products require different kinds of treatments. In this sense, we believe industrial WWT operators are probably better at handling this business. Indeed, as sludge is a by-product of WWT and given that industrial companies generally also produce solid waste in addition to wastewater, synergies exist

between sludge treatment and WWT. To this end, the WWT operators are now more actively exploring this potentially lucrative sludge/solid waste treatment market, and we expect more business expansion and M&A in this area going forward. Treated sludge pollutant content limits Nutrition soil

pH 5.5 - 8.5 Moisture rate ≤ 45% Pollutants (mg/Kg dry sludge) pH < 6.5 pH ≥ 6.5Cd 5 20Hg 5 15Pb 300 1000Cr 600 1000K 75 75Ni 100 200Zn 2000 4000Cu 800 1500B 150 150Mineral oil 3000 3000Benzoapyrene 3 3PCDD/PCDF (ng/Kg) 100 100AOX 500 500PCB 0.2 0.2Green Brick pH 5-10Moisture rate ≤ 40%Pollutants (mg/Kg dry sludge) Cd 20Hg 5Pb 300Cr 1000K 75Ni 200Zn 4000Cu 1500Mineral oil 3000Volatile phenolic 40Hydride 10Landfill pH 5-10Moisture rate ≤ 45%Pollutants (mg/Kg dry sludge) Cd 20Hg 25Pb 1000Cr 1000K 75Ni 200Zn 4000Cu 1500Mineral oil 3000Volatile phenolic 40Hydride 10

Source: Ministry of Housing and Urban-Rural Development, General Administration of Quality Supervision, Inspection and Quarantine, Standardization Administration

http://www.mohurd.gov.cn/zcfg/jsbwj_0/jsbwjjskj/201103/P020110518575321092122.pdf


- 30 -

Sludge minimisation and stabilisation process

Source: Companies

Sludge treatment process for waste landfills

Source: Companies

Sludge treatment process for green brick

Source: Companies

According to the Technical guidance, the treatment cost for every tonne of wet sludge with a moisture rate of 80% is CNY150-250/tonne, including non-hazardous and stabilisation treatment. The most economical way to deal with treated sludge is to apply it as a substitute for fertilizer or soil, among which using it in green city projects could generate as much as a CNY400/tonne unit net profit (excluding treatment cost, depreciation, etc.). Cost-benefit analysis for nutrition soil as an end-product of sludge treatment (CNY/ton of 45%-50% moisture wet sludge) Fertiliser

Nutrition soil

Land restoration Lawn

Urban greening Forestry

Cost (packaging, transportation, etc)

220 100 160 80 100 160

Saving (replace regular fertiliser or soil)

600 300 200 300 500 500

Net benefit 380 200 40 220 400 340

Source: Source: National Development and Reform Commission, Ministry of Housing and Urban-Rural Development

In the 12th FYP, the government targets a municipal sludge non-hazardous treatment rate of 80% for major cities, 70% for other cities and 30% for country areas and towns, from less than 25% as of 2010. As such, the

Air compressor

Gas tank

Dryer Valves

Sludge pressure filer

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Mud pool

Sludge

Landfill

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ReutilizationGreen bricks

Soil medium

Pump station

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Blowback

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Pump station

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Filtration

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Transportation

WWT plantLeachate

Urban greening

Disinfection and insect-killing

Raw material for green bricks

Landfill gas

Landfill

AgeingGridding and

AgitationSortingMeasurement

Release

Recycle


- 31 -

government targets to spend CNY35bn during the 12th FYP period to nearly triple the current municipal sludge treatment capacity in China. However, as reported recently by the China Securities Journal, in a speech given at the 8th Environment Technology Industry Forum (from 20-21 June 2014 http://zt.h2ochina.com/meeting/2014/2014_8th_tec/news.html), the Chief Secretary of the Ministry of Housing and Urban-Rural Development said the 12th FYP target for sludge treatment would be unlikely to be reached, and that the sludge treatment rate in major cities may still have been below 20% in China by 1H14, according to preliminary estimates. In our view, the main reason the development of the sludge treatment market has fallen well behind target is due to the unclear industry guidelines, and mainly as there is no official benchmark tariff for sludge treatment. According to our research, currently in China, sludge treatment tariffs are only applicable to Changzhou and Tai Lake district in Jiangsu Province, and Guangzhou in Guangdong Province, with no less than CNY0.2 per tonne of wastewater at Tai Lake and CNY0.04 per tonne of wastewater at Guangdong. Lack of economic incentives is a major drawback for the development of the sludge treatment industry, especially given its high treatment cost of CNY300-800 per tonne of dry sludge. In March 2014, the China Environment Chamber of Commerce proposed regulating the sludge treatment industry and encouraged the government to set clear tariffs, at no less than CNY0.3 per tonne of wastewater. Nevertheless, no clear government policy regarding the subject has been issued, leaving the sludge treatment market in an underdeveloped phase. This deregulation in some way has created opportunities for companies positioned at the higher end of the water value chain, as they can leverage on their extensive WWT experience and clientele, as well as their solid financial positions, to develop this high potential market. Their ability to enter into such a market at an early phase would give them first-mover advantage. Moreover, it is possible that their opinion would be considered when the government sets the regulations, if they had become significant operators in the market at that time. To address fully the environmental problem in China and to effectively control water pollution, the government needs to gradually transfer part of its focus on wastewater into sludge, in our opinion. We see the likelihood of the government clearing up related

regulations and accelerating its investment in the sludge treatment market during the 13th FYP period. China: 12th FYP municipal sludge treatment target (’000tpa) 2010 Net add during 12th FYPBeijing 260 226Tianjin 70 120Hebei 165 347Shanxi 60 108Inner Mongolia 27 113Liaoning 130 163Jilin 50 84Heilongjiang 70 144Shanghai 60 140Jiangsu 375 502Zhejiang 207 389Anhui 94 142Fujian 70 144Jiangxi 39 94Shandong 275 232Henan 160 261Hubei 60 157Hunan 50 249Guangdong 208 566Guangxi 40 83Hainan 20 45Chongqing 30 55Sichuan 80 169Guizhou 20 78Yunnan 20 64Tibet 0 9Shaanxi 100 198Gansu 20 113Qinghai 0 23Ningxia 20 37Xinjiang 10 115Military 0 10Total 2,790 5,180



- 32 -

Exploring the value chain

China’s green movement and urbanisation are driving long-term secular growth in the water sector Water is a closed-loop industry that starts with the extraction of raw water from natural resources and ends with treated wastewater being released back into the environment. Economic benefits for the government and the operators flow along the chain. China’s water industry, from upstream to downstream, has seen over the past few years, and will likely continue to see, significant growth in terms of market value, thanks to unfilled and expanding market demand and supportive government policies. With rising concerns over pollution and the speeding-up of urbanisation, large investment is required for the construction of water infrastructure, such as pipelines and WWT plants.

With the current national (and global) dynamics of water supply and demand, we believe the water sector offers numerous growth opportunities for those companies with exposure to the industry’s value chain. Apart from water resources, which are generally owned by the government, privately owned companies have been actively participating in other areas, especially following the privatisation and consolidation process, which has been ongoing in China since 2002, when the government officially opened up the water market, and has been accelerating in recent years given more government initiatives have been focused on this sector. We believe the sector is poised for rapid growth in the foreseeable future fuelled by rising tariffs, strong government policy support, increasing demand and industry consolidation. In this section, we look at other fields within the water industry to better illustrate and revisit our investment thesis, which favours the sludge treatment and WWT operators. In our view, these companies have the most exposure to the long-term growth opportunities offered by the water industry thanks to their highly differentiated nature of technologies and strong pricing power, which put them at the top of the water value chain. Among these players, CTE is our sector top pick.

China: water and wastewater operation structure in China

Source: State Council, Companies, Daiwa

Water Supply CompaniesGovernment

(Bureau of finance)

Residential Users Industrial Users Operational Service UsersAdministrative Users Special Users

Distribution System to Customers

WWT PlantRaw Water

Treatment Plant

Environment

Sludge Treatment Plant

Unified water tariff

Water resource tariff & Environmental tariff

Distribution paymentWater treatment payment

Sludge

Raw water Portable water Reclaimed water

Wastewater

Treated wastewater

Environment

Leave Blank

Leave Blank

Leave BlankLe

ave

Blan

k


- 33 -

Privatisation and tariff hikes

Privatisation leads to better returns The water industry in China has long been dominated by the government. China started its water privatisation journey in the early 1990s. The milestone year was 2002 when the government officially opened up water services to the market to commercialise water utilities. In the past, tap water supply plants in China suffered distress-level operating returns due to their nature of being run as public welfare enterprises. However, in an attempt to return the industry to profit, in the early 2000s, the government started allowing the privatisation of many of these companies, handing over operations to both foreign and domestic investors and guaranteeing an 8-12% ROE. As a result, the number of loss-making tap water supply enterprises in China dropped from a peak of 50% of all water companies in China in 2004 to 32% by 2013. Privatisation has also led to market consolidation, mainly via the acquisition of low-efficient local government-owned companies/projects by private operators. At a glance, the total number of participants in the water supply industry dropped significantly over the 2004-13 period as well. China: number of participants in the water supply industry


Unlike in WWT, water supply infrastructure is more developed. By 2010, the percentage of households in China with access to clean tap water had reached 90%, and the water supply pipeline spanned more than 590,000km. As such, there are few greenfield opportunities and companies have to expand via the acquisition of existing projects that are being operated at low efficiency so as to trigger an incentive for the government/owner to sell it.

China: tap water penetration rate in major cities


Notwithstanding the above, the percentage of the population in rural areas with access to clean tap water was comparably low at 78.8% in counties and 62% in towns as at the end of the 11th FYP (2010). Yet, following our lesser preference for rural WWT operators, we do not favour rural water supply operators given our concerns about their timely collection of water supply tariffs and the lack of water supply pipelines in China’s rural areas. China: water supply pipeline length


The improvement in profitability following privatisation is also a result of improved operating efficiency, represented by a lowered leakage rate. Leakage occurs in aged pipelines that lack regular maintenance, or the water supply operator has failed to respond timely to an incident, or water has been stolen due to inaccurate monitoring or unauthorized use of water. According to our discussions with tap water supply operators, some have seen their leakage rate improve from 15% to 10% over the past few years. The government expects leakage rates in China to continue on a downward trend thanks to: 1) the one-household-one-meter policy which enforces monitoring, 2) privatisation of the operators, leading to quicker response times and more efficient management, and 3) the financial support provided by

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- 34 -

the government for the construction and maintenance of water supply pipelines. At the end of the 11th FYP period (2010), the leakage rate in China was 14.6% in cities, 15.3% in prefecture-level cities and 10.8% in towns. China: leakage rate at end of 11th FYP period (2010)

City Prefecture-level city Town

Beijing 17.1% 17.1% 0.0%Tianjin 15.1% 15.1% 17.3%Hebei 14.0% 16.4% 9.3%Shanxi 10.4% 11.1% 8.6%Inner Mongolia 13.0% 14.0% 9.0%Liaoning 31.3% 32.0% 20.4%Jilin 28.6% 29.1% 23.6%Heilongjiang 24.2% 25.4% 12.2%Shanghai 10.2% 10.2% 0.0%Jiangsu 12.6% 12.8% 10.1%Zhejiang 13.0% 12.5% 14.9%Anhui 17.6% 19.4% 11.9%Fujian 11.3% 11.4% 10.8%Jiangxi 15.2% 19.3% 7.4%Shandong 10.3% 11.5% 5.3%Henan 15.5% 17.3% 10.4%Hubei 15.2% 15.8% 11.1%Hunan 16.7% 17.7% 14.0%Guangdong 14.0% 14.1% 12.4%Guangxi 13.7% 14.6% 11.1%Hainan 12.0% 13.7% 5.9%Chongqing 14.7% 14.9% 13.3%Sichuan 12.9% 13.3% 12.0%Guizhou 12.3% 13.8% 9.1%Yunnan 12.7% 13.4% 11.0%Tibet 8.5% 10.1% 3.6%Shaanxi 11.8% 12.7% 8.8%Gansu 10.9% 11.8% 6.2%Qinghai 16.1% 19.0% 9.1%Ningxia 8.3% 8.2% 9.0%Xinjiang 10.9% 11.6% 8.0%China average 14.6% 15.3% 10.8%


Further market potential for water supply investment During the 12th FYP, an aggregate amount of CNY410bn investment is planned, including CNY46.5bn for water supply plant upgrades, CNY94bm for the construction of new water supply plants, CNY83.5bn for pipeline upgrades, CNY184.3bn for the construction of new pipelines, and CNY1.7bn for monitoring and emergency control. Through these investments, China’s tap water quality and tap water penetration rate should be increased.

China: 12th FYP for water supply industry 2005 2010 2015 target

Water supply capacity (mtpd) 354 387 442 - Cities 276 307 - Counties 47 62 - Towns 64 73Penetrated population (m) 534 630 - Cities 381 - Counties 118 - Towns 131Water supply penetration rate - Cities 89.5% 95% - Counties 78.8% 85% - Towns 62.0% 75%Pipeline network (’000 km) 813.4 1035.5 1220.8 - Cities 539.8 607.7 - Counties 159.9 217.6 - Towns 335.8 395.5Annual water supply amount (bcm) 71.4 - Cities 50.8 - Counties 9.3 - Towns 11.3Upgrade of water supply plants (mtpd) 67Upgrade of pipeline ('000 km) 92.3Upgrade of secondary supply facility (mtpd) 8

Source: National Development and Reform Commission

China: 12th FYP investment for water supply industry

Source: National Development and Reform Commission

One of the focuses of the soon-to-be-released Water Pollution Prevention and Control Plan is expected to be on enhancing the municipal water supply. We see demand for new plants in order to further increase water supply penetration, and demand for the upgrade of certain supply plants that fail to consistently comply with the national tap water quality standards. We estimate investment demand of CNY145bn, with upgrade projects to contribute CNY56.9bn. China: untapped water supply market potential

New water supply plant Upgrade of water supply plantAddition during 12th FYP (mtpd) 55 6712th FYP capex (CNY bn) 94 46.5Per unit capex (CNY/ktpd) 1,709 694Further market potential (mtpd) 33 126.5Further market potential (CNYbn) 56.9 87.8

Source: National Development and Reform Commission, Daiwa estimates

CNY46.5bn

CNY83.5bn

CNY94bn

CNY184.3bn

CNY1.5bn CNY0.2bn

Upgrade of water supply plants

Upgrade of pipelines

Construction of new water supply plants

Construction of new pipelines

Water quality control and testing

Contigency facility


- 35 -

Tariff hikes can fire up the market The water supply tariff and environmental tariff are the 2 components of the unified residential water tariff. According to Frost & Sullivan, the environmental tariff is expected to rise from CNY0.82/tonne in 2013 to CNY0.86/tonne in 2015, with further upward potential thanks to the government’s continuous efforts to raise wastewater discharge standards. China: average unified residential water tariff

Source: H2O China, Frost & Sullivan

China’s water usage prices differ by province and depend on the relative water supply/demand status of the region and people’s living standards. Beijing has the most expensive residential water usage price of CNY5.0/tonne, and Lhasa the cheapest, at CNY1.40/tonne. China: residential water tariffs (October 2014)

Source: Price Monitoring Center of National Development and Reform Commission, China Water Net

Regardless of water scarcity, per capita spending on water only accounted for 0.6% of people’s disposable income in China in 2013 (assuming annual per capita water usage of 60 tonnes), whereas in other parts of the world (such as in Denmark and some cities in the US and France), it was as high as 2%.

Average water tariffs for selected major countries (2013)

(USD/ton) Unified water

tariffWater supply

tariff Environmental

tariff % of per capita disposable

incomeDenmark 8.45 3.88 4.56 2.0%Australia 6.17 3.22 2.95 1.2%Germany 5.80 3.08 2.72 1.1%United Kingdom 4.40 2.15 2.24 1.0%France 4.34 2.37 1.97 0.9%Canada 3.54 2.07 1.47 0.7%Czech Republic 3.64 1.87 1.77 1.3%United States 3.35 1.48 1.87 0.5%Poland 3.10 1.41 1.69 1.1%Japan 2.15 1.22 0.93 0.5%Portugal 2.44 1.69 0.75 0.8%Spain 2.21 1.52 0.69 0.6%Turkey 1.73 1.29 0.44 0.4%Italy 1.75 0.88 0.87 0.4%Russia 1.02 0.63 0.40 0.4%South Korea 0.83 0.60 0.24 0.3%Mexico 0.83 0.70 0.13 0.4%China 0.45 0.32 0.13 0.6%India 0.14 0.13 0.01 0.7%

Source: Global Water Intelligence, Frost & Sullivan, National Bureau of Statistics, The Organization for Economic Co-operation and Development (OECD), Euromonitor International

Per capita disposable incomes in China have risen at a 12% CAGR over the past 10 years (from 2003-13). With this rapid increase in wealth, average per capita spending on water bills declined from 1.6% of a person’s annual disposable income to 0.6% over the same period. We see a high likelihood that tap water tariffs will continue to rise, considering that to keep the ratio at the 0.6% level, which is at the low end compared with other countries, residential water tariffs would need to rise by around 10% annually, not to mention the potential further increase in water tariffs to reflect the scarcity of water in China. Overall, China’s tap water tariffs have been on the rise, with national average tariffs rising by 18%, 28%, 51% and 98%, respectively, for residential, commercial, industrial and special industry users as of June 2014 compared with January 2007. With the government putting more focus on resolving the scarcity of water issue in China, and with its ambition to commoditise water, tap water tariffs are likely to remain on a continuous upward trend for the next few years, in our view.

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- 36 -

China: average water tariff compared with disposable income

Source: Price Monitoring Center of National Development and Reform Commission, National Bureau of Statistics, Frost & Sullivan

China: disposable income per capita


China: water tariff for residential, commercial, industrial and special industry users since 2007

Source: Price Monitoring Center of National Development and Reform Commission

In January 2013, the NDRC, MoF and MoWR together issued the Notice on issues related to water tariff setting mechanism, which specified targets for each city in China to promote progressive water tariffs before the end of 2015. Accordingly, Changsha, Guangzhou, Shanghai and Beijing are gradually implementing progressive water tariffs, and we believe other major cities in China will follow soon in late 2014/2015. Beijing: water pricing scheme for residential users (CNY/ton) Previous Starting 1 May 2014 Increment0 - 145 tpa 4.00 5.00 25%146 - 260 tpa 4.00 7.00 75%Above 260 tpa 4.00 9.00 125%

Source: Beijing.gov.cn

Beijing: water pricing scheme for non-residential users (CNY/ton) Previous Starting 1 May 2014 Starting 1 Jan 2015Non-residential (average) 6.15 7.15 8.15Special industry 61.68 - 81.68 160 Reclaimed water 1.00 Max 3.50

Source: Beijing.gov.cn

Tariff hikes are widely regarded as a positive catalyst for the water supply market, yet we believe they have limited benefits for the water supply operators given: 1) these companies are operating in a highly regulated market where the government enforces an 8-12% ROE; as such, we believe it is doubtful as to whether the economic benefits of tariff hikes can be passed on to them, and 2) if tariff hikes lead to better profitability for the tap water supply operators, SOEs or local governments may have less of an incentive to sell their water supply projects, which could negatively influence the development as well as earnings growth potential of non-SOE operators, as their business expansion almost purely depends on acquisitions. To sum up, with the great transformation under way in China’s water sector, driven mainly by privatisation, project upgrades and tap water tariff hikes, the future for the water supply industry looks bright. However, compared with other segments in the sector, such as WWT and sludge treatment, we see less growth potential for non-government operators.

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http://www.sdpc.gov.cn/fzgggz/jggl/zcfg/201301/t20130114_522940.html


- 37 -

A drop in the ocean

As one of a few methods that can increase water supply, seawater desalination is becoming an increasingly popular solution for water scarcity. As of 2013, there were more than 17,000 desalination plants located in 150 countries worldwide, with total commissioned capacity of 80mcmpd and covering a population of more than 300m. Desalination is poised to be the future mainstream water source if technology advancements can overcome the current high production cost, mostly associated with high energy demand to press the salt out of the water. Theoretically, around 0.86KWh/m3 of energy is needed to desalinate normal salt water (3.45% salt at 25°C). However, due to a lack of energy-efficient solutions, desalination plants operating currently consume 5-26x as much as this theoretical minimum energy requirement, depending on the type of process used. Energy requirements of 4 industrial desalination processes

(KWh/m3) Multi-stage Flash MSF

Multi-Effect Distillation MED

Mechanical Vapor Compression MVC

Reverse Osmosis RO

Electrical energy 4–6 1.5–2.5 7–12 3–5.5Thermal energy 50–110 60–110 None NoneElectrical equivalent of thermal energy

9.5–19.5 5–8.5 None None

Total equivalent electrical energy 13.5–25.5 6.5–11 7–12 3–5.5

Source: United Nations Educational, Scientific and Cultural Organization, Encycolopedia of Life Support Systems

Reverse osmosis is the approach most often applied, and is widely accepted as the most effective and economical approach for desalinating water. This process currently has a 60% market share, according to the International Desalination Association. The process involves pressing inflow seawater through a semipermeable membrane so that pure water passes to the other side while the salt remains. The production cost is CNY5.0/m3 and capex is CNY6,000-8,000/m3.

An illustration of reverse osmosis

Source: NanoH2O of LG Chem

Global: desalination installed capacity breakdown

Source: Global Water Intelligence, International Desalination Association

Note: RO=reverse osmosis; MSF=multi-stage flash; MED= multi-effect distillation; EDI= electrodeionization; ED= electrodialysis

The International Desalination Association’s energy task force has specifically challenged the desalination industry to achieve a reduction of 20% in energy requirements by 2015, from 2013’s level, following the steady decline in energy requirements in past decades. However, even if the industry’s heavy reliance on energy (which constitutes around 60% of the operating and maintenance costs of desalinated water) is resolved through technology advancements, the greenhouse gases and highly concentrated brine (salt solution) generated during the desalination process are still of concern.

RO60.0%

MSF26.8%

MED8.2%

EDI3.6%

Hybrid0.8%

ED0.3% Other

0.3%


- 38 -

Highly concentrated brine is of particular concern, because if left untreated, it can destroy coastal environments and harm marine wildlife; and if buried untreated, this toxic chemical can salinize soil and pollute underground water. In fact, we are sceptical as to whether any near-term large-scale adoption of seawater desalination will occur in China – not to mention provide any alluring investment opportunity. Selected methods of desalination Desalination tech Mechanism Comment Thermal A spray of seawater is (repeatedly)

evaporated to form a salt-free steam and then condensed into pure water

Highly energy intensive

Electrodialysis (ED) Salt ions are transported from seawater through ion-exchange membranes, from 1 side of the membrane to another, under the influence of an applied electric potential difference

Strong method for low salt feeds

Electrodeionization (EDI) Advanced ED, by combining ED with semipermeable membrane technology

Strong method for low salt feeds

Reverse Osmosis (RO) An applied pressure is used to overcome osmotic pressure, thus pure water passes through a semipermeable membrane whereas the salt remains

Low energy demand but with low efficiency. Strong when with advanced membranes.

Source: Daiwa

By 2010, China had more than 70 seawater desalination plants with designed capacity of 0.6mcmpd, among which 60% used the reverse osmosis approach and 33% used the MSF/MED approach. During the 12th FYP period, China targets to increase its desalination capacity to 2.2mcmpd with an estimated investment of CNY21bn. Note that, BEW has a seawater desalination plant located in Tangshan Caofeidian, Hebei Province, with designed capacity of 50ktpd, which is planned to supply desalinated water to Beijing, likely in 2019. By 1H14, the plant was running under a pilot programme and had not yet been transferred to BEW. We believe the market potential of seawater desalination in China largely depends on the implementation of progressive tap water supply tariffs or reasonable government subsidies offered to the desalination plants. According to estimates from the management of BEW’s seawater desalination business unit, desalinated seawater costs would be CNY8.0/tonne when it reaches Beijing – including CNY4.5/tonne for desalination and CNY3.5/tonne for transmission – which is 60% higher than the lowest tap water tariff in Beijing currently. Being a potentially lucrative market and definite global trend, seawater desalination looks very likely to become a commercially feasible approach for fresh

water supply in the long term. We expect more companies or scientific institutions to enter this field and help with its advancement. Nevertheless, we do not see any near-term investment opportunity in the equity market.


- 39 -

Valuation: peer comparison

Sorting out the winners and losers

CTE has the most potential upside to our target price

The consolidation of China’s water sector over the past few years has accelerated the commercialisation of the market, increased WWT/water supply penetration, and turned out a handful of winners, with the adoption of aggressive acquisition strategies by the consolidators to sustain earnings growth proving a successful approach. The average 1-year forward PER for the operators in the water sector has risen from 12x in early 2013 to 20x currently, stimulated primarily by a series of favourable government policies. With the sector trading currently at an average 1-year forward PER of 20x, it is regarded by the market as having relatively rich valuations. While share prices could seem vulnerable after their recent rally, we do not see any solid justification for a sector devaluation given the favourable outlook thanks to both market demand and policy support. CTE has the most upside potential, in our view, as it is a leader in the industrial WWT market and an early mover in the sludge treatment market. China Water Sector peer comparison: 1-year forward PER, 1-year forward PBR and market cap comparison


China Water Sector peer comparison: 1-year forward PER comparison


China Water Sector peer comparison: 1-year forward PBR comparison


China Water Sector peer comparison: share price performance vs. market tracking index


Debt-to-equity ratio for Kangda is 2014E, all others based on 2013

CTE, USD1,538m

CEI, USD6,186m

BEW, USD6,230m

SGL, USD1,699m

Kangda, USD954m

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0

1

2

3

4

5

6

Jan-

13

Feb-

13M

ar-1

3

Apr-1

3M

ay-1

3

Jun-

13Ju

l-13

Aug-

13

Sep-

13O

ct-1

3

Nov

-13

Dec

-13

Jan-

14

Feb-

14M

ar-1

4

Apr-1

4M

ay-1

4

Jun-

14Ju

l-14

Aug-

14

Sep-

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(x)


(20%)

(10%)

0%

10%

20%

30%

40%

50%

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14

1363 HK Equity 371 HK Equity6136 HK Equity MSCI China Energy IndexHSI Index HSCEI Index


- 40 -

China Water Sector peer comparison: 2013-16E EPS CAGR and 2015E PER comparison

China Water Sector peer comparison: 2015E PER and 2015E ROE comparison


Note: debt-to-equity ratio for Kangda is 2014E, all others based on 2013 Source: Bloomberg, Daiwa forecasts

1363 HK

371 HK6136 HK

967 HK

257 HK

1065 HK270 HK

0%

5%

10%

15%

20%

25%

30%

35%

40%

10 12 14 16 18 20 22 24

(EPS CAGR)

(PERx)

1363 HK

371 HK6136 HK

967 HK

257 HK

1065 HK

270 HK

0%

5%

10%

15%

20%

25%

30%

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0

(ROE)

(PBRx)


- 41 -

Appendix I: introduction to China’s water industry

“China is a 3,000-year-old civilisation in the body of an industrial teenager; mega-rich, dirt-poor, overpopulated, under-resourced, ethnically diverse mass of humanity that is going through several stages of development simultaneously” – Jonathan Watts, When a Billion Chinese Jump

China is thirsty for water to meet its needs

China is one of the most water-deficient countries in the world. Its average annual water resources are about 2,800bcm depending on climate variations during a specific year, accounting for about 6.5% of the world’s water resources and ranking as the 5th largest country in the world in terms of water resources. However, as China has the world’s second-largest population globally, its water resources per capita are only about 2,000 m3 (based on the National Bureau of Statistics’ data for 2013) – representing only one-third of average water resources per capita in the world. According to the World Bank, in 2012 China ranked as 103 among 178 countries (for which water resource records are available) worldwide in terms of water resources per capita. China: annual trend in water resources

Source: National Bureau of Statistics, Ministry of Water Resources

China: annual trend in per capita water resources


World: annual average per capita water resource (2012)

Source: The World Bank, United Nations

While the level of a country’s water resources is not directly related to a country’s economic development or output, our industry research reveals that well-developed and high-income regions tend to have more plentiful water resources per capita. In addition, China’s limited water resources could in past years have hindered the country’s economic growth and development and the government needs to address this issue if it wishes to narrow the gap between China’s rich and poor people. According to the World Bank, there is a global concern that at some point, water may become scarcer than oil, and a supply-demand imbalance could potentially manifest itself in increased domestic social unrest and trans-boundary disputes.

-25%

0%

25%

50%

75%

100%

(1,000)

0

1,000

2,000

3,000

4,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Surface water Underground waterOverlap Total water resourceTotal water resource YoY

(bcm)

1,500

1,800

2,100

2,400

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

(cu.m per capita)

0

30,000

60,000

90,000C

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(cu.m per capita)

World average water resource per capita is at 6,122 cu.mChina average water resource per capita is at 2,181 cu.m

(World average)


- 42 -

World: per capita water resources by income and region (2012)

Source: The World Bank

China, which has a population of over 1.3bn, consumed 617bcm of water, of which nearly 388bcm or 63% was for agricultural usage, in 2013. China: annual water consumption by consumer type

Source: Ministry of Water Resources

China: water consumption breakdown by consumer type (2013)


World: water consumption by consumer type (2012)

Source: The World Bank

The Food and Agriculture Organization of the United Nations estimates that 1,000x more water is required for use in agriculture to feed a population than to satisfy the population’s drinking needs. With living standards in emerging countries like China on the increase, the organisation expects food demand to rise over the coming years, especially for higher-protein-based sources, potentially exacerbating the water demand-supply imbalance already evident in China and some other countries, given: 1) those farmers who lack advanced agricultural techniques tend to extract water at a very high rate, and 2) farming livestock is more water-intensive than farming crops – a broad estimate by the UNESCO-IHD Institute for Water Education is that in the world it requires 15,500l of water to produce 1kg of beef, whereas it requires only 1,500l of water to produce 1kg of wheat. World: average water content of key agricultural products (2013 average)

Source: UNESCO-IHD Institute for Water Education

0

5,000

10,000

15,000

20,000

25,000

Wor

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Low

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Euro

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A

(cu.m per capita)

-China-

0

100

200

300

400

500

600

700

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(bn cu.m)

Residential Agricultural Industrial Ecological protection

Residential12.1%

Agricultural62.7%

Industrial23.4%

Ecological protection

1.8%

0%

20%

40%

60%

80%

100%

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Agriculture Industry Domestic

900 1,500 2,000 3,000

3,900 4,900

15,500

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Corn Wheat Soy Rice Poultry Pork Beef

(cu.m / ton)


- 43 -

China vs. US: per capita meat consumption (1990-2012)

Source: US Department of Agriculture

We believe that China’s industry will become a bigger consumer of water as the country develops over the coming years. Based on the 2013 data, demand from industry represents 23% of China’s total water consumption, which is 5pp higher than the global average, yet industry’s consumption of water rises to about 60% in developed countries. Water is the raw material for many industrial products and is one of the key elements used in cleaning, heating, cooling and power generation – over the coming years we expect demand from all of these usages to rise as China’s economy develops, especially through large-scale industrialisation (which is occurring largely at the cost of the environment – we discuss the issue of pollution further on in this Appendix). While in China water for residential use constitutes the smallest segment (12.1% of total water consumption for 2013), we believe in the long term the residential market will continue to be a small yet increasingly significant consumer of water as the country’s urbanisation is leading to growing demand for water for residential use. According to the latest available data (for 2012) from the Ministry of Water Resources, per capita water consumption at prefecture-level cities is less than 30% of that of major cities in China. The country’s urbanisation rate in China reached 53.7% of the total population in 2013, and the government has a target for this to reach 60% by 2020.

China: residential water consumption in cities (2012)


China’s water shortage has been compounded by natural disasters. Some parts of the country suffer from droughts and floods each year, causing disruptions to agriculture, industry and daily life. For instance, in 2012, though there were no exceptional floods, 21 provinces, mostly in central and north China, experienced a drought that resulted in a direct economic loss of CNY53.3bn and left some 16.4m people with only limited access to clean drinking water; 31 provinces experienced floods that resulted in a direct economic loss of CNY267.5bn and affected 124m people. Also in 2012, areas that were affected by typhoons caused a direct economic loss equating to 24% of the direct economic loss caused by floods. China: drought-affected areas (mostly middle and north regions) in 2012


0

10

20

30

40

50

1990 2012 1990 2012

China US

(kg/capita)

Chicken Beef Pork

0

50

100

150

200

250

300

Tian

jinH

ebei

Shan

xing

olia

Liao

ning Jilin

Hei

long

jiang

Shan

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Jian

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Zhej

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Anhu

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(L/capita/day) Cities average: 172 litresPrefecture level cities average: 48 litres

Beijing

GuangdongGuangxi

Hunan

Hubei

Xinjiang

Qinghai

Ningxia

Jiangxi

Jiangsu

Shanghai

Hebei

Inner Mongolia

Shanxi

Tianjin

Shandong

Tibet

Sichuan Chongqing

Yunan

Guizhou

Henan

Heilongjiang

Jilin

Liaoning

Anhui

Zhejiang

Fujian

Gansu

Hainan

Taiwan

Hong KongMacau

Shaanxi

People do not have enough access to drinking water, 2012 (‘000)

0

1 – 200

200 – 500

500 – 1,000

> 1,000


- 44 -

China: typhoon-affected areas in 2012


China has been trying to improve its management of water in an attempt to: 1) control floods, 2) bring relief from droughts and 3) alleviate the uneven distribution of water. In 2012, the government allocated CNY9.4bn to address this matter. For example, China’s south-to-north water diversion project, which will be the largest water structure in the world, aims to transport water from the wetter parts to the dryer parts of the country to achieve the 3 goals noted above. Within this project, the construction of the eastern line started in December 2002 with 3 phases, and commenced operation in December 2013. The construction of the central line started in December 2003 and is on track to commence operation in November 2014. The western line is still at the planning stage due to this region’s geographic complexity.

China: south-to-north water diversion project

Source: Office of the South-to-North Water Diversion Project Commission of the State Council

The long-term water supply challenges for China are substantial, in our view. In the absence of a notable improvement in the efficiency of agricultural, industrial and residential water use, we project demand to continuously overshoot supply in the coming years and expect the country to continue to struggle to meet its water needs. This is especially the case as water pollution is becoming ever more severe, threatening not only the public’s health but also its access to fresh water, as we go on to discuss. World: water demand by 2030E

Source: Water Resources Group

Disaster due to Typhoon (2012)

1 time

2 times

3 times

4 times

Beijing

GuangdongGuangxi

Hunan

Hubei

Xinjiang

Qinghai Ningxia

Jiangxi

Jiangsu

Shanghai

Hebei

Inner Mongolia

Shanxi

Tianjin

Shandong

Tibet

Sichuan Chongqing

Yunan

Guizhou

Henan

Heilongjiang

Jilin

Liaoning

Anhui

Zhejiang

Fujian

Gansu

Hainan

Taiwan

Hong KongMacau

Shaanxi

Water Resources (cu.m per capita)

1 – 500

500 – 1,500

1,500 – 3,000

3,000 – 5,000

> 5,000

Beijing

GuangdongGuangxi

Hunan

Hubei

Hainan

Xinjiang

Qinghai Ningxia

Shaanxi

Jiangxi

JiangsuShanghai

Hebei

Inner Mongolia

Shanxi

Tianjin

Shandong

Tibet

Sichuan

Yunan

Guizhou

Henan

Heilongjiang

Jilin

Liaoning

Anhui

Zhejiang

Taiwan

Fujian

Hong Kong

Macau

Gansu Yellow River

Yangtze RiverYa-lung River

Han River

Western Route

Eastern Route

Central Route

0 100 200 300 400 500 600

China

India

Sub-Saharan Adrica

Rest of Asia

N America

S America

Europe

MENA

Oceania

(bn cu.m)

Agriculture Industrial Municipal and Domestic


- 45 -

Severe water pollution needs tackling

China’s water pollution has raised fewer alarm bells than its air pollution, which continues to make the headlines. Yet we believe addressing the country’s water pollution is at least as urgent, and adds pressure to its already limited water resources. Discharges of industrial, agricultural and municipal waste water, with the lack of sufficient high-standard WWT facilities, have contaminated China’s water resources such that only 67% of its rivers and 44% of its lakes are classified as containing water that is clear enough for residential daily use; 16% of its rivers and 24% of lakes are classified as containing water that is useless and even toxic, according to the 2012 data from the Ministry of Water Resources. China: classification of water quality Grade I All usages Source water, national nature reserves Grade II All usages Centralised drinking water sources

Grade III Drinking water Centralised drinking water sources, agricultural and industrial use

Grade IV Usages except for drinking water

General industrial use, recreational water area without human contact

Grade V Usages except for drinking water General agricultural use, artificial landscape use

Lower than Grade V Useless Useless and possibly hazardous


China: quality of water resources (2012) Grade I II III IV V Lower than V River (% of total river length) 5.5% 39.7% 21.8% 11.8% 5.5% 15.7% Lake (% of total lake area) 44.2% 31.5% 24.3% Reservoir (% of no. of reservoirs) 7.2% 50.2% 31.3% 6.7% 2.0% 2.6% Underground water 3.4% 20.6% 76.0% -


The Ministry of Environmental Protection estimates that there are 10,000 petrochemical plants along the Yangtze River and 4,000 along the Yellow River. An insufficient sewage and WWT infrastructure is giving rise to an inefficient use of water and polluted water being discharged directly into the environment. On top of that, the Ministry of Supervision has reported that there are about 1,500 water pollution accidents in the country each year. Indeed, we believe China’s water quality might be worse than the official data reveals, as: 1) the frequency of testing at WWT plants is too low, and only half of them have the capacity to test for all 106 indicators, 2) there are only a few independent water-quality monitoring bureaus and most water testing is conducted in-house by factories or WWT plants, and 3) there is currently limited transparency on test results, as there is little public supervision or pressure.

Untreated industrial wastewater discharged directly into the river, Huizhou city, Guangdong Province (May 2014)

Source: people.cn

China: water quality of major rivers (2013)


Unlike air pollution, which can be observed directly during daily life, water pollution threatens the health of the public in a more subtle way – and this is one of the reasons the Chinese public has not been paying enough attention to it, in our view. In fact, water pollution can be fatal; according to a study conducted by the Chinese Centre for Disease Control and Prevention, water pollution is directly correlated with abnormally high cancer rates along the Huai River and its tributaries. Regardless of environmental protection laws and discharge standards, a lack of enforcement and execution of water pollution has been the main problem with China’s environmental control, as coordination between many government institutions from central to provincial and local levels is essential, but in many cases their interests are not aligned. Local officials are supposed to support local enterprises and at the same time uphold environmental laws, yet with economic targets of local areas that are usually measured by their GDP, the environment has been seriously (and it would appear intentionally) neglected.

0%

25%

50%

75%

100%Ya

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iver

Yello

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iver

Pear

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er

Song

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Grade I - III Grade IV - V Lower than grade V

(% of length)


- 46 -

Secular growth underpinned by policy reform

Over the past few decades the government has made considerable efforts to ease China’s water scarcity and reduce water pollution, but much remains to be done. So far, the focus has been placed on combatting water pollution by improving the WWT rate. During the next 5-7 years, we believe more action needs to be undertaken in the WWT market, not only to reach a full treatment rate, but also to improve treatment standards in order to reduce water pollution more effectively. Based on our research regarding the recent policy trend and the potential policies to be released during the next 2 years (2015 and 2016), we believe water reclamation is likely to be the next focus of the government’s policies for the country’s water industry. 1) Revise Environmental Protection Law China released the new Environmental Protection Law (EPL) in April 2014, which will come into effect on 1 January 2015. The EPL will provide clearer legal guidance to the authorities and empower them to implement stricter legal charges against violators: 1) violators/polluters may be put in prison for up to 15 days and may face large fines charged on a daily basis, 2) litigation in the name of public interest will be permitted with a retroactive period of 3 years, 3) greater transparency regarding pollution controls will be required for local governments, and 4) civil or criminal actions may be taken against government officials who fail to comply. Though we do not expect this law to bring about significant near-term reduction in China’s water pollution, this law marks an important step being taken by China to address water pollution and environmental protection, and we expect it to make a positive long-term difference. 2) Raise pollutant surcharge The National Development and Reform Commission, Ministry of Finance and Ministry of Environmental Protection together announced on 1 September this year that they will adjust the pollutant emission surcharge standard. In the notice, the authorities intend to double the pollutant emission surcharges for certain pollutants in flue gas emissions and waste water discharges starting from 30 June 2015 from the current level (which has been in place since 1 July 2003). The total pollutant surcharges will be payable for the 3 largest pollutants in flue gas and waste water in terms of their pollutant-equivalent amounts.

The new surcharge for the concentration of chemical oxygen demand, ammonia, nitrogen and 5 major types of heavy metal (Lead [Pb], Mercury [Hg], Chromium [Cr], Cadmium [Cd], and metalloid Arsenic [As]) will be raised to CNY1.4/pollutant equivalent. A double surcharge will apply to companies whose discharged pollutant in waste water is more concentrated than the relevant national or local standard, as under the previous regulation. The announcement of higher pollutant surcharges is in line with China’s effort to fight environmental pollution and our expectation that it will continuously tighten environmental standards. We expect this to drive demand for a higher standard of WWT, both municipal and industrial, and benefit those along the value chain, including BEW for municipal WWT and CTE for industrial WWT. 3) New plan could generate extra investment of CNY2tn A Water Pollution Prevention and Control Plan, which we believe will aim to improve China’s overall water quality, ensure water safety and maintain the entire water eco-system, has been submitted to the State Council and we expect this to be issued during 4Q14-2015. This plan will likely set out detailed targets relating to China’s water industry for 2020. We forecast this plan to generate extra investment of CNY2tn for China’s water industry, which is CNY800m more than the planned investment during the 12th FYP period (2011-15). We expect the main focus areas of the plan to be as follows: 1) eliminate highly polluted water areas below the Grade V standard by 2017 (bringing forward the target year from 2020 previously), 2) improve WWT and sludge treatment rates and standards, 3) upgrade all WWT plants to comply with the Grade IA discharge standard, 4) raise the WWT discharge standard, 5) enhance the sewage pipeline network, 6) review and potentially raise WWT tariffs, and 7) enhance municipal water supplies. Potential hikes in the waste water discharge fee and municipal WWT tariff, and the potential inclusion of a sludge treatment cost in the WWT cost, would be a mid-term rerating catalyst for the China Water Sector, in our view. Specifically, if the Plan is implemented, we believe professional WWT, sludge treatment and water reclamation operators will enjoy significantly enhanced business growth prospects in the following few years. The government has a budget for an investment of around CNY1.2tn in China’s water industry during the 12th FYP period (2011-15). We expect the upcoming Water Pollution Prevention and Control Plan, which is

http://www.gov.cn/zhengce/2014-04/25/content_2666434.htm

http://www.sdpc.gov.cn/gzdt/201409/t20140905_624993.html

http://zfs.mep.gov.cn/gz/bmgz/qtgz/200302/t20030228_86250.htm


- 47 -

likely to herald the development trends for the country’s water industry during the 13th FYP period (2016-20), to focus on completing the centralised WWT and sludge treatment projects. Based on various news reports over recent months, we believe this plan could generate extra investment of CNY2tn. We believe that upgrade projects for municipal water supplies and municipal WWT could mean an investment of CNY98.6bn (of which CNY41.7bn is for WWT and CNY56.9bn for water supply). After China completes its water pollution and prevention control projects, we believe its next focus will be water conservation, given that water scarcity remains an acute problem. Thus, we expect budgets to go on water reclamation projects, upgrading existing water supply and WWT projects, and investment in water conservation technology for industrial and agricultural purposes. 4) Potential exchange of water rights As water resources are generally most of China’s water resources are owned by the central and local governments, we believe that exchanges of water rights in China will involve mainly exchanges of quotas to use water. The Ministry of Water Resources issued a 3-year pilot programme for water rights exchanges in 7 provinces in July this year, with a detailed plan to be confirmed at this year-end. Shanghai Securities News (cnstock.com) has reported that 3 supporting policies, namely “water resources registration plan”, “control measures on the right of water resources usage”, and “management measures

on the exchange of water resources extraction rights”, may be released at the end of 2015. We expect a nationwide water rights exchange to be established in 2016 or 2017. We believe that developing water rights exchanges has the potential to improve regional water insufficiencies throughout the country by utilising market leverage, similar to that seen for carbon emission rights exchanges in the utilities industry worldwide. Water rights exchanges should enable China to balance its water resource consumption and reduce the misuse of water, which should be ultimately beneficial for the country’s environment. Moreover, we see water rights exchanges as a positive move towards more the effective marketing and use of water. We expect it to bring about the following effects: 1) positive for water-saving equipment manufacturers, especially agricultural applications as agriculture accounted for 63% of China’s total water consumption in 2013, 2) positive for water reclamation and sea water desalination operators, as they operate methods to “create” water resources, 3) positive for WWT operators as the commoditisation of water should lead to an enhanced recognition of the value of WWT and thus result in WWT tariff hikes, and 4) neutral for water-supply operators given that potential hikes in water supply tariffs may be the result of higher water resources fees payable by water-supply operators, thereby limiting their scope to expand profit margins.


- 48 -

China: government’s key investment plans for water pollution prevention and control Policy Issuance date Issuing authority Key points Investment (CNYbn)12th FYP for municipal waste water treatment and water reclamation facilities

19-Apr-2012 State Council 2015 target: - Municipal WWT ratio to reach 85% in cities, 70% in counties and 30% in towns - Sludge non-hazardous treatment ratio reach 80% in major cities, 70% in other cities and 30% in counties and major towns - Wastewater reclaim rate reach 15%

429.8

Key rivers, lakes and reservoirs pollution prevention and control plan

12-May-2012 Ministry of Environmental Protection National Development and Reform Commission

Recognised 6,007 key projects with an estimated investment of CNY346bn during the 12th FYP, including - CNY190.7bn for 3,705 municipal WWT projects, increase sewage treatment capacity by 27.5mtpd, increase sewage pipeline length by 54,970km, increase water reclamation capacity by 9.5mtpd, upgrade sewage treatment capacity by 14.23mtpd and add sludge treatment capacity of 5.35ktpd - CNY42.5bn for 1,391 industrial WWT projects - CNY8.3bn for 221 water reservoir projects - CNY99bn for 1,057 environmental renovation projects - CNY5.5bn for 633 agricultural and fishing projects

346

12th FYP and long-term planning by 2020 for municipal water supply facilities construction and upgrades

25-May-2012 Ministry of Housing and Urban Rural Development of the People’s Republic of China National Development and Reform Commission

Target to reach tap water supply penetration rate of 95%, 85% and 75% for cities, towns and counties, respectively Reduce pipeline leakage The government expects investment of CNY410bn during the 12th FYP period

410

12th FYP for seawater desalination industry

21-Dec-2012 National Development and Reform Commission

Target to reach seawater desalination capacity of 2.2mtpd, contributing of 50% of new water supply in islands (eg, Hainan Province) and 15% of new industrial water supply in coastal areas with water shortage The government expects seawater desalination to be a CNY30bn industry The government expects investment of CNY21bn during the 12th FYP period

21

Major water pollution prevention and control investment plans

2012 State Council and related regulatory bodies such as National Development and Reform Commission

Total 1,206.8

Water pollution prevention and control plan (for 2015-17/20)

4Q14-2015 (expected)

State Council Total 2,000(Daiwa’s forecast)

Source: State Council, Ministry of Water Resources, Ministry of Industry and Information Technology, Ministry of Housing and Urban-Rural Development, National Development and Reform Commission, Ministry of Environmental Protection, The National People’s Congress, Daiwa

http://www.gov.cn/zwgk/2012-05/04/content_2129670.htm

http://www.mep.gov.cn/gkml/hbb/bwj/201206/W020120601534091604205.pdf

http://www.mohurd.gov.cn/zcfg/jsbwj_0/jsbwjcsjs/201206/t20120612_210246.html

http://www.sdpc.gov.cn/fzgggz/hjbh/hjjsjyxsh/201212/W020121225548583705452.pdf


- 49 -

China: recent government policies relating to the water industry Policy Issuance date Issuing authority Key points Investment (CNYbn)12th FYP for environmental protection

15-Dec-2011 State Council Specify the pollutant reduction target for 2015 COD discharge to decrease by 8% in 2015 compared with 2010 Add 42m tonnes of new sewage treatment capacity with a utilisation rate of >85% in cities and >80% nationally

3,400

12th FYP for utilisation of large solid waste

17-Dec-2011 Ministry of Industry and Information Technology

For large industrial solid waste treatment, target to reach annual utilisation of 1.6bn tonnes and utilisation rate of 50%

100

Specification of water functional areas in important lakes/rivers

28-Dec-2011 Ministry of Water Resources

Divide level I water resources into 4 types: protection, conservation, utilisation and buffer zone Divide level II water resources into 7 types: drinking, industrial, agricultural, fishing, entertainment and landscape, buffer zone, and pollution control zone The specification provides a path to achieve the target to reach 80% and 95% water-quality compliance ratios by 2020 and 2030, respectively

Opinions on implementing the strictest water resources management system

12-Jan-2012 State Council Set key targets and measures to solve the water shortage, low water utilisation efficiency and water pollution Water consumption to be within 635bn m3, 670m3 and 700bn m3 by 2015, 2020, 2030, respectively, with utilisation at or near leading world nations’ levels by 2030

The opinion on encouraging seawater desalination industry

6-Feb-2012 State Council Target to reach seawater desalination capacity of 2.2-2.6mtpd, contributing 50% to new water supply in islands (eg, Hainan Province) and 15% of new industrial water supply in coastal areas with water shortages

12th FYP for municipal wastewater treatment and reclamation facilities

19-Apr-2012 State Council 2015 target: - Municipal WWT ratio to reach 85% in cities, 70% in counties and 30% in towns - Sludge non-hazardous treatment ratio to reach 80% in major cities, 70% in other cities and 30% in counties and major towns - Waste water reclamation rate to reach 15%

427.1(for infrastructure

construction)2.7

(for construction of monitoring facilities?]

Key rivers, lakes and reservoirs pollution prevention and control plan

12-May-2012 Ministry of Environmental Protection National Development and Reform Commission

Recognised 6,007 key projects with estimated investment of CNY346bn during the 12th FYP, including - CNY190.7bn for 3,705 municipal WWT projects, to increase sewage treatment capacity by 27.5mtpd, increase the sewage pipeline length by 54,970km, increase water reclamation capacity by 9.5mtpd, upgrade sewage treatment capacity by 14.23mtpd and add sludge treatment capacity of 5.35ktpd - CNY42.5bn for 1,391 industrial WWT projects - CNY8.3bn for 221 water reservoir projects - CNY99bn for 1,057 environmental renovation projects - CNY5.5bn for 633 agricultural and fishing projects

346

12th FYP and long-term planning by 2020 for municipal water supply facility construction and upgrade

25-May-2012 Ministry of Housing and Urban Rural Development of the People’s Republic of China National Development and Reform Commission

Target to reach tap water supply penetration rate of 95%, 85%, 75% for cities, towns, counties, respectively Reduce pipeline leakage The government expects an investment of CNY410bn during the 12th FYP period

410

12th FYP for environmental service industry

16-Jun-2012 State Council Target to reach 40% CAGR for environmental service industry output value over 2011-15 Encourage the development of wastewater reclamation, rainwater utilisation and seawater desalination

12th FYP for seawater desalination industry

21-Dec-2012 National Development and Reform Commission

Target updated to reach seawater desalination capacity of 2.2mtpd, contributing 50% to new water supply in islands (eg, Hainan Province) and 15% to new industrial water supply in coastal areas with water shortages The government expects seawater desalination to be a CNY30bn industry The government expects investment of CNY21bn during the 12th FYP period

21

12th FYP for environmental protection standards

17-Feb-2013 Ministry of Environmental Protection

To implement stricter and more comprehensive environmental protection standards Opinion on enhancing utility infrastructure

6-Sep-2013 State Council Accelerate the construction and upgrade of city infrastructure To enhance water supply facility and pipeline To accelerate the construction of WWT and solid waste treatment facilities

National new urbanisation plan (2014-20)

16-Mar-2014 State Council Target to reach an urbanisation rate of 65% in terms of regular residents Target to reach a higher penetration rate in rural and urban areas for tap water supply and WWT

Environmental protection law (new)

25-Apr-2014 The National People's Congress

Higher fines for pollution Stricter enforcement of the law Government officials’ appraisal will include local environmental status

Notice on adjusting pollutant emission/discharge surcharges

1-Sep-2014 National Development and Reform Commission Ministry of Finance Ministry of Environmental Protection

Double the emission/discharge surcharges for certain pollutants in flue gas and wastewater from CNY0.6 and CNY0.7 per pollutant equivalent to CNY1.2 and CNY1.4 per pollutant equivalent, respectively

Water pollution prevention and control plan

4Q14-2015 (expected)

State Council Daiwa expects this to comprise the following aims: - Eliminate water body below grade V by 2017 - Improve WWT and sludge treatment ratio and standards - Upgrade all municipal WWT facilities to comply with Grade IA discharging standard - Raise WWT tariffs - Enhance municipal water supply - Improve sewage pipeline network

2,000 (Daiwa’s forecast)

Source: State Council, Ministry of Water Resources, Ministry of Industry and Information Technology, Ministry of Housing and Urban-Rural Development, National Development and Reform Commission, Ministry of Environmental Protection, The National People’s Congress, Daiwa


http://www.miit.gov.cn/n11293472/n11293832/n11293907/n11368223/14416612.html

http://www.mwr.gov.cn/zwzc/zcfg/jd/201202/t20120208_313579.html




http://www.mep.gov.cn/gkml/hbb/bwj/201206/W020120601534091604205.pdf

http://www.mohurd.gov.cn/zcfg/jsbwj_0/jsbwjcsjs/201206/t20120612_210246.html


http://www.sdpc.gov.cn/fzgggz/hjbh/hjjsjyxsh/201212/W020121225548583705452.pdf

http://www.mep.gov.cn/gkml/hbb/bwj/201302/t20130222_248380.htm




http://www.sdpc.gov.cn/gzdt/201409/t20140905_624993.html


- 50 -

Glossary of terms for the water industry BOO Build operate own BOT Build operate transfer BT Build transfer COD Chemical oxygen demand: commonly used to measure the amount of organic compounds in water, making it a useful measure of water quality Dark spread The dark spread is the difference between the price received by a generator for electricity produced and the cost of coal needed to produce that electricity. TOT Transfer operate transfer WWT Waste water treatment

Source: Daiwa


- 51 -

Appendix II: impact of floods and droughts China: people and livestock without enough access to clean water due to drought (2012)


China: people lacking access to clean drinking water as a result of drought

China: crops affected by drought

Source: Ministry of Water Resources Source: Ministry of Water Resources

0

1,500

3,000

4,500

6,000

7,500

Beijin

g

Tian

jin

Heb

ei

Shan

xi

Inne

r Mon

golia

Liao

ning Jilin

Hei

long

jiang

Shan

ghai

Jian

gsu

Zhej

iang

Anhu

i

Fujia

n

Jian

gxi

Shan

dong

Hen

an

Hub

ei

Hun

an

Gua

ngdo

ng

Gua

ngdx

i

Hai

nan

Cho

ngqi

ng

Sich

uan

Gui

zhou

Yunn

an

Tibe

t

Shaa

nxi

Gan

su

Qin

ghai

Nin

gxia

Xinj

iang

People Livestock

('000)

28

33

19

24 23 23 26

28

11

18

33

29

16

0

5

10

15

20

25

30

35

40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Drought-affected people Average

(m people) Average: 24m people lack access to clean drinking water 405,407

384,800

222,073 248,520

172,553

160,280

207,380

293,860

121,368

292,588

132,586 162,667

93,333

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Drought-affected crop areas Average

(square km) Average: 222,878 square km of crops affected by draught each year


- 52 -

China: direct economic loss from floods (2012)


China: number of people affected by floods China: number of people killed by floods


China: direct economic loss from floods China: crops affected by floods


0

10

20

30

40

Beijin

g

Tian

jin

Heb

ei

Shan

xi

Inne

r Mon

golia

Liao

ning Jilin

Hei

long

jiang

Shan

ghai

Jian

gsu

Zhej

iang

Anhu

i

Fujia

n

Jian

gxi

Shan

dong

Hen

an

Hub

ei

Hun

an

Gua

ngdo

ng

Gua

ngdx

i

Hai

nan

Cho

ngqi

ng

Sich

uan

Gui

zhou

Yunn

an

Tibe

t

Shaa

nxi

Gan

su

Qin

ghai

Nin

gxia

Xinj

iang

(CNYbn)

9

111

152

226

107

200

139

177

140

111

211

89

124

0

50

100

150

200

250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

No. people affected by floods Average

(m people) On average, 138m people are affected by floods each year

1,942 1,605

1,819 1,551

1,282

1,660

2,276

1,230

633 538

3,222

519 673

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

No. people killed by floods Average

On average, 1,458 people are killed by floods each year

71 6284

130

71

166133

112 96 85

375

130

268

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0

50

100

150

200

250

300

350

400

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Direct economic loss Direct economic loss as % of GDP

(CNYbn) (%)

90,450

71,378

123,842

203,657

77,819

149,675

105,219 125,489

88,678

87,482

178,667

71,915

112,181

0

50,000

100,000

150,000

200,000

250,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Flood-affected crop areas (km²) Average

On average, 114,342km2 of crop areas are affected by floods each year(square km)


- 53 -

Appendix III: BOT/TOT business model The most common business models adopted by local governments to run water plant projects are the BOT/TOT models. Under the TOT model, the owner of a project (normally the government) transfers the operating rights of an already built project to a water company for a negotiated contract price. The company then operates and manages the project for the duration of the contract period (usually 20-30 years], and transfers the project back to the owner upon expiration of the contract. Under the BOT model, the water company is also responsible for the construction of the project, and is therefore entitled to both construction income and operating income. The contract period for a BOT project is also usually 20-30 years. For BT projects, the water company mainly provides construction services and builds water facilities for local governments. It then receives a lump-sum payment following construction completion, but generates no sustainable operational revenue. Comparison of BOT, TOT and BT projects BOT BOO TOT BT

Greenfield/existing project

Greenfield Greenfield Existing Greenfield

Contract period 20-30 years n.a 20-30 years 1-3 years Construction income

Yes No No Yes

Operation income Yes Yes Yes No Capex Construction

cost Construction cost

Contract consideration

Construction cost

Payback period 7-10 years 5-6 years 7-10 years 3 years Pros - 20-30 year

stable cash stream - Contract allows for cost pass-through - Minimum water intake guarantee (for WWT)

- Shorter payback period - Shorter receivable days

- 20-30 year stable cash stream - Contract allows for cost pass-through - Minimum water intake guarantee (for WWT)

- Shorter payback period

Cons - Longer payback period

- No guarantee of long-term cash stream - No guarantee for minimum water intake

- Longer payback period - Creditworthiness and political risk of local government

- No sustainable cash flow - Financial capability of local government - Lower gross-profit margin of 5-15%

Source: Daiwa

IFRIC 12 Service Concession Arrangements is the accounting standard that governs the revenue recognition for BOT/TOT projects. This accounting treatment strips the project cash flow streams into 3 types of revenue:

1) Construction revenue is recognised during the construction period of the project at the fair value of the construction services, based on construction progress. Accounts receivable are recognised on the balance sheet as financial assets instead of fixed assets, and are deducted by future cash payments received. Construction revenue is the major reason for lumpy earnings since it boosts accounting earnings without cash inflow.

2) Finance income is recognised during the operation period and can be seen as interest income on financial assets recognised, based on incremental borrowing costs. This is essentially an allocation of operating income.

3) Operating income is recognised as operating income during the operation period by stripping out: 1) allocated construction revenue for the year, and 2) finance income, from the cash received.

Due to the accounting recognition and one-off nature of construction revenue, earnings for water companies can be quite lumpy. Construction services yield a lower gross margin of around 5-15%, while that for operating services can be 30-50%; and this leads to margin volatility for water companies. Worth noting is that cash outflows for construction are recognised as part of operating cash flow instead of capex in investment cash flow, therefore water companies tend to have negative operating cash flows during the capacity expansion phase.


- 54 -

Accounting treatment for BOT projects

Build (1-2 years) Operate (20-30 years) Transfer

Impact on income statement:

• Construction revenue recognised based on construction progress

Impact on balance sheet:

• Accounts receivable for construction services are recognised as financial assets (instead of fixed assets), usually termed “gross amount due from customers for contract work”

Impact on cash flow statement:

• Cash outflow for construction services is recognised as operating cash flow instead of capex


• Finance income recognised – the interest income on the financial assets realised during construction period

• Operating income recognised – stripping out construction revenue and finance income, the remaining estimated future cash flow is recognised as operating income over the concession period

Impact on balance sheet:

• The financial assets (accounts receivable) recognised as reduced against payments received


• Cash payments for operation services is recognised as operating cash flow


• No impact Impact on balance sheet:

• The financial assets should be reduced to zero through the concession period; no more accounts receivable


• No impact

Source: Daiwa

IFRIC 12 vs. traditional accounting standard on a demonstration BOT WWT project

Source: Daiwa

General BOT project management process

Source: Companies, Daiwa

(6)(4)(2)

02468

1012

Year

1Ye

ar 2

Year

3Ye

ar 4

Year

5Ye

ar 6

Year

7Ye

ar 8

Year

9Ye

ar 1

0Ye

ar 1

1Ye

ar 1

2Ye

ar 1

3Ye

ar 1

4Ye

ar 1

5Ye

ar 1

6Ye

ar 1

7Ye

ar 1

8Ye

ar 1

9Ye

ar 2

0Ye

ar 2

1Ye

ar 2

2Ye

ar 2

3Ye

ar 2

4Ye

ar 2

5Ye

ar 2

6Ye

ar 2

7

(CNYm)

Net income (under IFRIC 12) Net income (before IFRIC 12)

Project selection

Project planning

Tender process; project agreement

negotiation

Signing the project agreements

Design planning and obtaining government

approvals

Testing, inspection and trial operation

Operation and maintenance during concession period

Transfer to the government

8-20 months

Procurement and construction

25-30 years15-30 days6-9 months30 days


- 55 -

Demonstration of a WWT project under IFRIC 12 (25-year BOT project)

Under IFRIC 12 Construction

Period

Operating Period

(CNYm) Year 1 Year 2 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 ….. Year 21 Year 22 Year 23 Year 24 Year 25P&L (IFRIC 12) ….. Construction revenue 83.33 83.33 - - - - - - - - - - ….. - - - - -Operating revenue - - 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 ….. 18.54 18.54 18.54 18.54 18.54Total revenue 83.33 83.33 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 ….. 18.54 18.54 18.54 18.54 18.54Construction cost (75.00) (75.00) ….. Operating cost - - (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) ….. (9.27) (9.27) (9.27) (9.27) (9.27)Gross profit 8.33 8.33 9.27 9.27 9.27 9.27 9.27 9.27 9.27 9.27 9.27 9.27 ….. 9.27 9.27 9.27 9.27 9.27Finance income - 4.17 8.54 8.36 8.17 7.98 7.77 7.55 7.32 7.08 6.83 6.57 ….. 2.62 2.15 1.65 1.13 0.58Interest expense (1.31) (3.94) (5.15) (4.94) (4.73) (4.52) (4.31) (4.10) (3.89) (3.68) (3.47) (3.26) ….. (0.95) (0.74) (0.53) (0.32) (0.11)PBT 7.02 8.56 12.67 12.70 12.72 12.73 12.73 12.73 12.71 12.68 12.64 12.58 ….. 10.95 10.68 10.39 10.08 9.74Income tax (1.76) (2.14) (3.17) (3.17) (3.18) (3.18) (3.18) (3.18) (3.18) (3.17) (3.16) (3.15) ….. (2.74) (2.67) (2.60) (2.52) (2.44)Net income 5.27 6.42 9.50 9.52 9.54 9.55 9.55 9.55 9.53 9.51 9.48 9.44 ….. 8.21 8.01 7.80 7.56 7.31 ….. B/S (IFRIC 12) ….. Debt schedule ….. BOY - 37.50 75.00 72.00 69.00 66.00 63.00 60.00 57.00 54.00 51.00 48.00 ….. 15.00 12.00 9.00 6.00 3.00- Addition 37.50 37.50 - - - - - - - - - - ….. - - - - -- Repayment - - (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) ….. (3.00) (3.00) (3.00) (3.00) (3.00)EOY 37.50 75.00 72.00 69.00 66.00 63.00 60.00 57.00 54.00 51.00 48.00 45.00 ….. 12.00 9.00 6.00 3.00 -Financial receivables ….. BOY - 83.33 170.83 167.25 163.50 159.55 155.41 151.06 146.49 141.69 136.65 131.37 ….. 52.48 42.98 33.01 22.54 11.54- Cash receipt - - (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) ….. (30.66) (30.66) (30.66) (30.66) (30.66)- Construction revenue 83.33 83.33 - - - - - - - - - - ….. - - - - -- Finance income - 4.17 8.54 8.36 8.17 7.98 7.77 7.55 7.32 7.08 6.83 6.57 ….. 2.62 2.15 1.65 1.13 0.58- Operating revenue - - 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 18.54 ….. 18.54 18.54 18.54 18.54 18.54EOY 83.33 170.83 167.25 163.50 159.55 155.41 151.06 146.49 141.69 136.65 131.37 125.81 ….. 42.98 33.01 22.54 11.54 (0.00) ….. C/F (IFRIC 12) ….. Cash receipt - - 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 ….. 30.66 30.66 30.66 30.66 30.66Construction cost (75.00) (75.00) - - - - - - - - - - ….. - - - - -Debt financing 37.50 37.50 - - - - - - - - - - ….. - - - - -Debt repayment - - (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) (3.00) ….. (3.00) (3.00) (3.00) (3.00) (3.00)Operating cost - - (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) (9.27) ….. (9.27) (9.27) (9.27) (9.27) (9.27)Tax expenses (1.76) (2.14) (3.17) (3.17) (3.18) (3.18) (3.18) (3.18) (3.18) (3.17) (3.16) (3.15) ….. (2.74) (2.67) (2.60) (2.52) (2.44)Interest expenses (1.31) (3.94) (5.15) (4.94) (4.73) (4.52) (4.31) (4.10) (3.89) (3.68) (3.47) (3.26) ….. (0.95) (0.74) (0.53) (0.32) (0.11)Net cash flow (40.57) (43.58) 10.08 10.28 10.49 10.69 10.90 11.11 11.33 11.55 11.77 11.99 ….. 14.71 14.98 15.27 15.56 15.85

Source: Daiwa

Assumption Construction (Years) 2Operation (Years) 25Unit capex (CNY/ton) 1,500Designed capacity (ktpd) 100Tariff (exclude VAT) (CNY/ton) 1.05Tariff (include VAT) (CNY/ton) 1.23Utilization (%) 80%Debt (%) 50%Finance cost (%) 7.0%Payment period (Years) 25Operating days per year (Days) 365Under IFRIC 12 Construction services margin (%) 10%Operating services margin (%) 50%Imputed interest rate (%) 5.00%Equity IRR 12.14%


- 56 -

Demonstration of a WWT project under IFRIC 12 (25-year TOT project, with upgrade of discharge standard to Grade I-A) Assumption Upgrade (Years) 1Operation (Years) 25Unit acquisition cost (CNY/ton) 1,500Unit upgrade capex (CNY/ton) 700Designed capacity (ktpd) 100Tariff (exclude VAT) (CNY/ton) 1.05Tariff (include VAT) (CNY/ton) 1.23Utilization (%) 80%Debt (%) 50%Finance cost (%) 7.0%Payment period (Years) 25Operating days per year (Days) 365Under IFRIC 12 Construction services margin (%) 10%Operating services margin (%) 50%Imputed interest rate (%) 5.00%Equity IRR 11.07%

Under IFRIC 12 Acquisition Upgrade Operating period (CNYm) Year 1 Year 1 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 ….. Year 21 Year 22 Year 23 Year 24 Year 25P&L (IFRIC 12) ….. Construction revenue 77.78 - - - - - - - - - - ….. - - - - -Operating revenue - 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 ….. 25.14 25.14 25.14 25.14 25.14Total revenue 77.78 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 ….. 25.14 25.14 25.14 25.14 25.14Construction cost (70.00) ….. Operating cost - (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) ….. (12.57) (12.57) (12.57) (12.57) (12.57)Gross profit 7.78 12.57 12.57 12.57 12.57 12.57 12.57 12.57 12.57 12.57 12.57 ….. 12.57 12.57 12.57 12.57 12.57Finance income - 3.89 3.81 3.72 3.63 3.54 3.44 3.33 3.23 3.11 2.99 ….. 1.19 0.98 0.75 0.51 0.26Interest expense (3.85) (7.55) (7.24) (6.93) (6.62) (6.31) (6.01) (5.70) (5.39) (5.08) (4.77) ….. (1.39) (1.08) (0.77) (0.46) (0.15)PBT 3.93 8.91 9.14 9.36 9.58 9.79 10.00 10.21 10.41 10.60 10.79 ….. 12.38 12.47 12.55 12.62 12.68Income tax (0.98) (2.23) (2.29) (2.34) (2.40) (2.45) (2.50) (2.55) (2.60) (2.65) (2.70) ….. (3.09) (3.12) (3.14) (3.16) (3.17)Net income 2.95 6.69 6.86 7.02 7.19 7.35 7.50 7.66 7.80 7.95 8.09 ….. 9.28 9.35 9.41 9.47 9.51 ….. B/S (IFRIC 12) ….. Debt schedule ….. BOY - 110.00 105.60 101.20 96.80 92.40 88.00 83.60 79.20 74.80 70.40 ….. 22.00 17.60 13.20 8.80 4.40- Addition 110.00 - - - - - - - - - - ….. - - - - -- Repayment - (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) ….. (4.40) (4.40) (4.40) (4.40) (4.40)EOY 110.00 105.60 101.20 96.80 92.40 88.00 83.60 79.20 74.80 70.40 66.00 ….. 17.60 13.20 8.80 4.40 (0.00)Financial receivables ….. BOY ….. - Cash receipt - 77.78 76.15 74.44 72.64 70.75 68.77 66.69 64.51 62.22 59.81 ….. 23.89 19.57 15.03 10.26 5.26- Construction revenue - (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) (30.66) ….. (30.66) (30.66) (30.66) (30.66) (30.66)- Finance income 77.78 - - - - - - - - - - ….. - - - - -- Operating revenue - 3.89 3.81 3.72 3.63 3.54 3.44 3.33 3.23 3.11 2.99 ….. 1.19 0.98 0.75 0.51 0.26EOY - 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 25.14 ….. 25.14 25.14 25.14 25.14 25.14 ….. C/F (IFRIC 12) ….. Cash receipt - 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 30.66 ….. 30.66 30.66 30.66 30.66 30.66Construction cost (70.00) - - - - - - - - - - ….. - - - - -Debt financing 110.00 - - - - - - - - - - ….. - - - - -Debt repayment - (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) (4.40) ….. (4.40) (4.40) (4.40) (4.40) (4.40)Operating cost - (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) (12.57) ….. (12.57) (12.57) (12.57) (12.57) (12.57)Tax expenses (0.98) (2.23) (2.29) (2.34) (2.40) (2.45) (2.50) (2.55) (2.60) (2.65) (2.70) ….. (3.09) (3.12) (3.14) (3.16) (3.17)Interest expenses (3.85) (7.55) (7.24) (6.93) (6.62) (6.31) (6.01) (5.70) (5.39) (5.08) (4.77) ….. (1.39) (1.08) (0.77) (0.46) (0.15)Net cash flow (75.00) 35.17 3.91 4.17 4.42 4.67 4.93 5.18 5.44 5.70 5.96 6.22 ….. 9.21 9.49 9.78 10.07 10.37

Source: Daiwa


- 57 -

Appendix IV: pollutant surcharges Pollutant surcharges are collected based on the amount of the top-3 pollutants contained in the wastewater, calculated in terms of pollutant equivalent, with the pollutant equivalent multiplier defined by the government as shown in the following table. The highlighted pollutants in the table are those with surcharges that are to be doubled to CNY1.40/unit effective July 2015, whereas the rest will continue to be levied at CNY0.70/unit. To illustrate, the pollutant surcharge (CNY) = ℎ ( ) ( ) × ℎ ( / )

China: pollutant equivalent multiplier standard for wastewater

Pollutant surcharges to be levied

Effective July 2015

Pollutant

Pollutant equivalent

(Kg)

Pollutant surcharges (CNY/unit of pollutant

equivalent)

Pollutant surcharges (CNY/Kg of pollutant

discharged)

Type I Pollutant Hg 0.0005 1.4 2,800Cd 0.005 1.4 280Cr 0.04 1.4 35Cr(VI) 0.02 0.7 35As 0.02 1.4 70Pb 0.025 1.4 56Ni 0.025 0.7 28Benzo(a)pyrene 0.0000003 0.7 2,333,333Be 0.01 0.7 70Ag 0.02 0.7 35Type II Pollutant Suspended Substance (SS) 4 0.7 0.2Biochemical Oxygen Demand (BOD5) 0.5 0.7 1.4Chemical Oxygen Demand (COD) 1 1.4 1.4Total Organic Carbon (TOC) 0.49 0.7 1.4Oil and Petroleum 0.1 0.7 7.0Fat and Grease 0.16 0.7 4.4Volatile Phenolic Compounds 0.08 0.7 8.8Cyanide 0.05 0.7 14.0Sulfide 0.125 0.7 5.6Ammoniacal Nitrogen 0.8 1.4 1.8Fluoride 0.5 0.7 1.4Formaldehyde 0.125 0.7 5.6Aromatic Amine 0.2 0.7 3.5Nitrobenzene 0.2 0.7 3.5Linear Alkylbenzene Sulfonates (LAS) 0.2 0.7 3.5Cu 0.1 0.7 7.0Zn 0.2 0.7 3.5Mn 0.2 0.7 3.5Color developer (CD-2) 0.2 0.7 3.5Total P 0.25 0.7 2.8P 0.05 0.7 14.0Organic Phosphorus Substrates (OPS) 0.05 0.7 14.0Dimethoate 0.05 0.7 14.0Parathion-methyl 0.05 0.7 14.0Malathion 0.05 0.7 14.0Parathion 0.05 0.7 14.0Pentachlorophenol 0.25 0.7 2.8Trichloromethane 0.04 0.7 17.5Adsorbable Organic Halogen (AOX) 0.25 0.7 2.8Carbon tetrachloride 0.04 0.7 17.5Trichloroethylene 0.04 0.7 17.5Tetrachloroethylene 0.04 0.7 17.5Benzene 0.02 0.7 35.0Toluene 0.02 0.7 35.0Ethylbenzene 0.02 0.7 35.0o-Xylene 0.02 0.7 35.0p-Xylene 0.02 0.7 35.0m-Xylene 0.02 0.7 35.0Chlorobenzene 0.02 0.7 35.01,2-Dichlorobenzene 0.02 0.7 35.01,4-Dichlorobenzene 0.02 0.7 35.0Nitrochlorobenzene 0.02 0.7 35.02,4-Dinitrochlorobenzene 0.02 0.7 35.0Phenol 0.02 0.7 35.0Cresol 0.02 0.7 35.02,4-Dichlorophenoxyacetic acid 0.02 0.7 35.02,4,6-Trichlorophenol 0.02 0.7 35.0Dibutyl Phthalate 0.02 0.7 35.0Dioctyl Phthalate 0.02 0.7 35.0Acrylonitrile 0.125 0.7 5.6Se 0.02 0.7 35.0

Source: Ministry of Environmental Protection, National Development and Reform Commission, Ministry of Finance


■ What's new CTE completed another industrial WWT acquisition (Zhongshan) in September 2014, which we expect to drive a 47% net profit CAGR (or 35% EPS CAGR) for 2013-16 (previous: 45%). By adopting a TOT, rather than BOO, model for the recently acquired Shunde project, CTE should mitigate against the risk of the project posting a low return in the initial period. Meanwhile, it also plans to enter the hazardous waste treatment field by acquiring the largest hazardous waste treatment facility in Guangdong (in Nansha). ■ What's the impact Strong capacity expansion of industrial WWT and sludge treatment. With its recent acquisitions and greenfield capacity pipeline, we forecast CTE to almost triple its WWT capacity, from 315ktpd in 2013 to 950ktpd in 2016,

and post a 10-fold increase in its sludge treatment capacity from 138ktpa to about 1.3mtpa over the same period. TOT minimises the risk of newly acquired projects posting initial low returns. CTE has revised the deal structure of its 60ktpd Shunde WWT plant to a TOT model instead of BOO. CTE believes it will take time for the plant’s utilisation and profitability to improve, and for the plant to be upgraded. According to management, it has taken 2 years for the profitability of Yinglong WWT (acquired in 2012) to improve. CTE expects to earn a similar project IRR (20%) from the Shunde project after changing the business model to TOT. ■ What we recommend We reaffirm our Buy (1) rating, and raise our 2014-16E EPS and DCF-based 6-month target price to HKD9.60 (from HKD8.88), after including the recently acquired Zhongshan project (note that the Nansha project is not yet reflected in our forecasts, but we estimate could enhance our 2015-16E EPS by 10.8% and 9.5%, respectively.) Our new target price implies a 0.7x PEG on our 2013-16E EPS, in line with China peers’ 0.6-0.8x. The main risk is greater-than-expected competition from major municipal players, and foreign enterprises.

■ How we differ Our 2015-16E EPS are 3-12% above consensus, as we have fully factored in the recent WWT acquisitions.

Utilities / China1363 HK

4 November 2014

CT Environmental Group

Of the first water

• A major consolidator of sludge and industrial WWT facilities; net profit CAGR for 2013-16E raised to 47%

• Combination of TOT for M&A projects and BOO for greenfield projects should guarantee a better project return

• CTE is driving consolidation of the sludge and industrial WWT sector; reaffirm Buy, target price raised to HKD9.60


Source: FactSet, Daiwa forecasts

Utilities / China

CT Environmental Group1363 HK

Target (HKD): 8.88 9.60Upside: 16.1%31 Oct price (HKD): 8.27

Buy (unchanged)

OutperformHoldUnderperformSell

1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 14E 15E 16ERevenue change 8.8 7.4 4.7Net profit change 1.4 3.9 2.7Core EPS (FD) change 1.4 1.7 0.5

50

146

243

339

435

1

3

5

7

9

Oct-13 Jan-14 Apr-14 Jul-14 Oct-14

Share price performance

CT Env Grp (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 1.96-8.27Market cap (USDbn) 1.513m avg daily turnover (USDm) 4.74Shares outstanding (m) 1,412Major shareholder Mr. Tsui Cham To (61.0%)

Financial summary (HKD)Year to 31 Dec 14E 15E 16ERevenue (m) 1,022 1,352 1,785Operating profit (m) 552 718 950Net profit (m) 395 527 718Core EPS (fully-diluted) 0.280 0.366 0.498EPS change (%) 40.2 30.7 36.2Daiwa vs Cons. EPS (%) 4.4 3.3 11.9PER (x) 29.6 22.6 16.6Dividend yield (%) 0.7 0.9 1.2DPS 0.056 0.073 0.100PBR (x) 6.6 5.3 4.2EV/EBITDA (x) 23.2 17.8 13.4ROE (%) 27.3 26.7 29.0





- 59 -

Growth outlook CTE: WWT capacity and group net profit growth

We now forecast CTE’s net profit to rise at a robust CAGR of 47% over 2013-16 (previously 45%). This new forecast is driven by our expectation for the company’s consolidated WWT capacity to increase at a 44% CAGR (previously 41%) over the period, and an 10-fold increase in its sludge treatment capacity from 138ktpa at the end of 2013 to c.1.3mtpa in 2016, on the back of its recently acquired 555ktpa sludge treatment capacity in Qingyuan, and 500ktpa of green-field sludge treatment capacity in Longmen.

Source: Company, Daiwa forecasts

Valuation CTE and China peers: PER comparison (2015E)

CTE is trading at a 23x PER on our 2015 EPS forecast, which is on a par with peer BEW’s 23x, but is at a premium to Kangda’s 14x. We believe CTE merits a premium valuation, as we forecast it to generate a higher 27% ROE for 2015 (peers: 14% on average). In addition, we believe CTE is a distinctive play on industrial WWT and sludge treatment, which has a higher gross margin (60-70%) than municipal WWTs (40-50%). In our DCF assumption, we trim our WACC from 8.6% to 8.3%, as we assign a lower beta given CTE’s share price has been less volatile recently after the company allayed market concerns about a new share placement.

Source: Bloomberg forecasts for BEW and CEI, Daiwa forecasts for CTE

Note: (*) - we have striped out the non-cash earnings from its BOT construction revenue in our 2015E PER calculation; share prices as of 31 October 2014

Earnings revisions CTE: consensus EPS forecast revisions (2014-15E)

The Bloomberg consensus has increased its 2014-15 EPS forecasts for CTE by 16-20% since the company was listed on 25 September 2013. We believe the consensus forecasts have not yet factored in CTE’s recent acquisitions (exceeding CNY900m), namely the 60ktpd Shunde industrial WWT plant, the 70ktpd Zhongshan industrial WWT plant Phases 1 and 2, and the 555ktpa sludge treatment facility in Qingyuan, and the stake increase from 49% to 95% in its 250ktpd Yinglong industrial WWT plant Phases 1 and 2.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

200

400

600

800

1,000

2010 2011 2012 2013 2014E 2015E 2016E

(’000tpd)

Total wastewater treatment capacity (LHS)

YoY net profit growth (RHS)

22.6x 23.5x 23.3x 24.8x

14.3x

19.6x

x

5x

10x

15x

20x

25x

30x

CT

Envi

ronm

enta

l

CT

Envi

ronm

enta

l (*)

Beijin

g En

terp

rises

Wat

er

Beijin

g En

terp

rises

Wat

er (*

)

Kang

da In

tern

atio

nal

Kang

da In

tern

atio

nal (

*)

0.200.220.240.260.280.300.320.340.360.38

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

(HKD)

2014E EPS 2015E EPS

Buy (unchanged)

OutperformHoldUnderperformSell

1

2

3

4

5


- 60 -

Key assumptions

Profit and loss (HKDm)

Cash flow (HKDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EYear-end WWT capacity (ktpd) n.a. 215 215 265 315 555 850 950WWT plant utilization rate (%) n.a. 57 95 81 87 78 69 92WWT services tariff (CNY/tonne) n.a. 4.1 3.8 3.6 3.4 3.2 3.7 3.6Sludge capacity (tonne/day) n.a. n.a. n.a. n.a. 400 1,898 3,268 3,556

Total sludge treatment fee and resales ASP (CNY/tonne)

n.a. n.a. n.a. n.a. 230 700 700 700

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EWastewater treatment under BOT n.a. 153 130 40 60 182 271 198Wastewater treatment under BOO n.a. 172 256 243 267 485 628 912Other Revenue n.a. 37 76 101 156 355 453 676Total Revenue n.a. 361 462 384 483 1,022 1,352 1,785Other income n.a. 15 4 0 20 0 0 0COGS n.a. (174) (195) (131) (179) (398) (541) (714)SG&A n.a. (31) (40) (22) (42) (72) (93) (121)Other op.expenses n.a. (2) (1) (3) (1) 0 0 0Operating profit n.a. 169 230 227 282 552 718 950Net-interest inc./(exp.) n.a. (18) (26) (37) (32) (80) (75) (75)Assoc/forex/extraord./others n.a. 0 0 23 23 10 0 0Pre-tax profit n.a. 151 204 213 272 482 643 875Tax n.a. (25) (38) (36) (49) (86) (115) (157)Min. int./pref. div./others n.a. (5) (1) (0) (0) (0) (0) (0)Net profit (reported) n.a. 121 165 177 223 395 527 718Net profit (adjusted) n.a. 121 165 177 223 395 527 718EPS (reported)(HKD) n.a. 0.119 0.161 0.174 0.199 0.280 0.366 0.498EPS (adjusted)(HKD) n.a. 0.119 0.161 0.174 0.199 0.280 0.366 0.498EPS (adjusted fully-diluted)(HKD) n.a. 0.119 0.161 0.174 0.199 0.280 0.366 0.498DPS (HKD) n.a. 0.000 0.000 0.000 0.037 0.056 0.073 0.100EBIT n.a. 169 230 227 282 552 718 950EBITDA n.a. 169 230 227 282 552 718 950

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax n.a. 151 204 213 272 482 643 875Depreciation and amortisation n.a. 9 13 17 22 40 143 160Tax paid n.a. (25) (38) (36) (49) (86) (115) (157)Change in working capital n.a. (271) 256 (148) 19 (88) (124) (110)Other operational CF items n.a. 146 (312) 233 (142) (10) 0 0Cash flow from operations n.a. 10 123 279 122 338 546 768Capex n.a. (14) (111) (61) (221) (548) (460) (541)Net (acquisitions)/disposals n.a. (0) 0 0 (41) (1,032) 0 0Other investing CF items n.a. (87) 103 (330) 55 0 0 0Cash flow from investing n.a. (101) (8) (392) (207) (1,580) (460) (541)Change in debt n.a. (99) (658) (328) (56) (781) (19) 0Net share issues/(repurchases) n.a. 0 0 0 478 345 0 0Dividends paid n.a. 0 0 0 0 (79) (105) (144)Other financing CF items n.a. 142 579 399 43 1,563 38 0Cash flow from financing n.a. 43 (79) 71 464 1,047 (87) (144)Forex effect/others n.a. 0 0 0 0 0 0 0Change in cash n.a. (48) 35 (41) 379 (195) 0 83Free cash flow n.a. (4) 11 217 (99) (210) 87 226


- 61 -

Balance sheet (HKDm)

Key ratios (%)


Company profile

CT Environmental (CTE) provides integrated wastewater treatment services for industrial and municipal sewage. Its consolidated treatment capacity totalled 315ktpd in 2013. Unlike with its peer, Beijing Enterprises Water, CTE mainly pursues a build-operate-own (BOO) model, and its facilities currently serve the textile, dyeing and paper industries.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment n.a. 16 52 10 446 251 251 334Inventory n.a. 0 1 1 1 2 3 3Accounts receivable n.a. 390 148 264 281 424 669 884Other current assets n.a. 13 21 21 22 22 22 22Total current assets n.a. 419 222 296 750 699 944 1,243Fixed assets n.a. 117 223 265 512 1,980 2,226 2,611Goodwill & intangibles n.a. 9 9 9 50 47 44 41Other non-current assets n.a. 170 430 571 580 784 812 792Total assets n.a. 715 884 1,141 1,892 3,509 4,026 4,687Short-term debt n.a. 18 68 82 52 82 82 82Accounts payable n.a. 119 134 101 138 194 315 421Other current liabilities n.a. 11 10 13 18 18 18 18Total current liabilities n.a. 147 212 196 208 294 416 521Long-term debt n.a. 302 417 517 501 1,282 1,301 1,301Other non-current liabilities n.a. 12 32 36 55 164 118 99Total liabilities n.a. 460 660 750 763 1,740 1,834 1,921Share capital n.a. 0 0 0 138 144 144 144Reserves/R.E./others n.a. 247 214 390 987 1,622 2,044 2,618Shareholders' equity n.a. 247 215 390 1,126 1,766 2,188 2,762Minority interests n.a. 8 9 1 3 3 4 4Total equity & liabilities n.a. 715 884 1,141 1,892 3,509 4,026 4,687EV n.a. 11,988 12,119 12,268 11,774 12,781 12,801 12,718Net debt/(cash) n.a. 303 432 589 107 1,113 1,132 1,049BVPS (HKD) n.a. 0.243 0.211 0.383 0.797 1.251 1.549 1.956

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) n.a. n.a. 27.9 (17.0) 25.9 111.5 32.3 32.1EBITDA (YoY) n.a. n.a. 36.2 (1.2) 23.9 95.8 30.1 32.3Operating profit (YoY) n.a. n.a. 36.2 (1.2) 23.9 95.8 30.1 32.3Net profit (YoY) n.a. n.a. 36.1 7.7 25.6 77.4 33.5 36.2Core EPS (fully-diluted) (YoY) n.a. n.a. 36.1 7.7 14.7 40.2 30.7 36.2Gross-profit margin n.a. 51.7 57.7 65.8 63.0 61.0 60.0 60.0EBITDA margin n.a. 46.7 49.8 59.2 58.3 54.0 53.1 53.2Operating-profit margin n.a. 46.7 49.8 59.2 58.3 54.0 53.1 53.2Net profit margin n.a. 33.4 35.6 46.2 46.1 38.7 39.0 40.2ROAE n.a. 97.7 71.2 58.6 29.4 27.3 26.7 29.0ROAA n.a. 33.8 20.6 17.5 14.7 14.6 14.0 16.5ROCE n.a. 58.8 35.9 26.7 21.1 22.9 21.4 24.6ROIC n.a. 25.3 30.7 23.1 20.8 22.0 19.0 21.8Net debt to equity n.a. 122.4 201.6 150.8 9.5 63.0 51.7 38.0Effective tax rate n.a. 16.5 18.9 16.9 18.1 17.9 17.9 17.9Accounts receivable (days) n.a. 196.8 212.5 196.0 205.7 125.9 147.6 158.8Current ratio (x) n.a. 2.8 1.0 1.5 3.6 2.4 2.3 2.4Net interest cover (x) n.a. 9.6 8.7 6.1 8.7 6.9 9.6 12.7Net dividend payout n.a. 0.0 0.0 0.0 18.6 20.0 20.0 20.0Free cash flow yield n.a. n.a. 0.1 1.9 n.a. n.a. 0.7 1.9


■ Investment case We initiate coverage of Beijing Enterprises Water Group (BEW), one of China’s top-3 municipal water-supply and wastewater treatment (WWT) operators by capacity, with an Outperform (2) rating. We forecast a solid net profit CAGR of 33% over 2013-16, driven mainly by new project wins.

Dominant WWT player. With BEW a major market consolidator, we forecast the company to expand its total capacity from 16.7mtpd in 2013 to 27.2mtpd by 2016, and thus more than double its market share from 2.5% to 5.6% over the period.

Strong management team, with resources from SOE. Backed by its SOE parent, BEW enjoys cheap financing costs that are on average 80-100bps lower than those of its privately owned peers. Also, most of BEW’s key managers are former

staff of private company Z.K.C. Environmental Group (ZKC), and do not have the “must win” approach often seen at SOEs when bidding for projects, which we think ensures their project return.

Stands to benefit from plant upgrades. We expect the government to order all municipal WWT plants to be upgraded to meet Grade I-A discharge standards over the next 1-2 years, while tightening standards at the same time. As such, we expect BEW to benefit from potential water tariff hikes and increased TOT project opportunities. ■ Catalysts BEW may surprise the market again by exceeding its capacity addition target for 2014, as it added 6.2mtpd in 2013. It has lifted its capacity addition target for 2014 from 2.0mtpd to 3.5mtpd, after winning 1.45mtpd new projects in 1H14.

■ Valuation We have a DCF-derived 6-month target price of HKD6.30, implying a 2015E PER of 26x, in line with the stock’s average 1-year forward trading PER over the past 5 years. We see modest near-term rerating potential for BEW, as it is trading at a rich valuation and we expect its scarcity premium to diminish as more water companies are listed. Still, we see BEW outperforming the

market by making the most of its leading position. ■ Risks We see the main risk to our view as slower-than-expected capacity expansion resulting from fiercer-than-expected market competition.


4 November 2014

Beijing Enterprises Water Group

Initiation: on a mission to snap up market share

• A major player in China’s wastewater treatment, BEW aims to double its share of the market over the next 3 years

• Strong financing resources from SOE parent and private-business management mindset look an ideal mix

• Net profit CAGR of 33% for 2013-16E, upside from plant upgrades on stricter discharge standards; initiate at Outperform


Utilities / China

Beijing Enterprises Water Group371 HK

Target (HKD): 6.30Upside: 13.5%31 Oct price (HKD): 5.55

BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5

90

113

135

158

180

3.0

3.8

4.5

5.3

6.0

Oct-13 Jan-14 Apr-14 Jul-14 Oct-14


Bj Ent Wat (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 3.41-5.73Market cap (USDbn) 6.193m avg daily turnover (USDm) 8.59Shares outstanding (m) 8,656Major shareholder Beijing Enterprises Holdings (43.9%)

Financial summary (HKD)Year to 31 Dec 14E 15E 16ERevenue (m) 8,723 11,037 12,567Operating profit (m) 2,466 3,557 4,294Net profit (m) 1,631 2,059 2,526Core EPS (fully-diluted) 0.193 0.238 0.292EPS change (%) 38.3 23.1 22.7Daiwa vs Cons. EPS (%) 2.8 (2.5) (3.4)PER (x) 28.7 23.3 19.0Dividend yield (%) 1.4 1.7 2.1DPS 0.077 0.095 0.117PBR (x) 3.4 3.1 2.8EV/EBITDA (x) 23.9 17.7 15.4ROE (%) 11.8 13.8 15.5





- 63 -

Growth outlook BEW: total operating water capacity and EPS growth

BEW expanded its total water treatment capacity, from 1.53mtpd in 2008 to 18.16mtpd in 1H14, representing a 57% capacity CAGR over this period. At 1H14, BEW had 333 water projects, comprising 271 WWT projects, 13 reclaimed water projects, 48 water-supply projects and 1 seawater desalination project. We forecast capacity additions of 3-3.5mtpd a year for BEW’s combined WWT and water-supply capacity in 2014-16, and expect BEW to more than double its operating-water project market share in China, from 2.5% in 2013 to 5.6% by 2016, after adding 6.2mtpd of capacity in 2013. With such aggressive capacity expansion, we forecast a 33% net profit CAGR for 2013-16.


Valuation China Water Sector: 1-year forward PER bands

Since 2013, BEW has traded at a 1-year forward PER that has been at the upper end of the China Water Sector’s trading PER range of 15-22x. Backed by its high business growth profile, leading position in the municipal water-services industry and longer listing history vs. peers, we believe BEW’s current valuation is justified. We also expect peers CTE and Kangda to deliver solid earnings growth (31-35% EPS CAGRs for 2013-16E, vs. 28% for BEW). As these companies build up their track records and establish investor confidence, BEW’s valuation premium to its peers could narrow. We see greater upside potential for peers that can deliver good earnings growth and trade currently at a discount to BEW.

Source: Bloomberg

Earnings revisions BEW: consensus EPS forecasts

Year-to-date, the Bloomberg consensus has revised up its 2014 and 2015 EPS forecasts for BEW by 4% and 12%, respectively, on the back of: 1) the company’s solid 2013 EPS, which beat the consensus forecast by 14%, and 2) the company’s decision to revise up its construction revenue gross-margin assumption for new BOT projects (from 11% to 23.9%) starting in 1H14. Our 2014-15 EPS forecasts are broadly in line with those of the consensus.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

-40%

-20%

0%

20%

40%

60%

80%

100%

0

5

10

15

20

25

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

(mtpd)

Sewage processing Reclaimed water

Water supply EPS YOY growth (RHS)

0

5

10

15

20

25

30

Jan-

13

Feb-

13M

ar-1

3

Apr-1

3

May

-13

Jun-

13

Jul-1

3

Aug-

13

Sep-

13

Oct

-13

Nov

-13

Dec

-13

Jan-

14

Feb-

14M

ar-1

4

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

(x)

CTE BEW Kangda Avg

0.15

0.20

0.25

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

(HKD)

2014E EPS 2015E EPS



1

2

3

4

5


- 64 -

Key assumptions

Profit and loss (HKDm)

Cash flow (HKDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E

Year-end operating WWT and water reclaim capacity (mtpd)

1.62 2.71 3.96 5.16 6.68 12.56 15.06 17.56

WWT plant utilization rate (%) 71.4 79.6 76.8 79.8 75.0 80.0 81.0 82.0WWT services tariff (HKD/ton) 1.07 1.07 1.15 1.16 1.22 1.23 1.24 1.26

Year-end operating water supply capacity (mtpd)

0.15 0.15 1.13 2.13 2.75 3.75 4.75 5.75

Water supply plant utilization rate (%) 63.2 86.9 38.6 42.8 41.5 44.0 46.5 49.0

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E

Sewage and reclaimed water treatment services

440 592 995 1,425 2,141 3,226 4,752 5,647

Construction services 1,066 5,432 1,365 1,974 3,764 4,647 5,040 5,193Other Revenue 225 325 295 328 501 851 1,245 1,726Total Revenue 1,730 6,348 2,654 3,727 6,406 8,723 11,037 12,567Other income 18 61 144 194 200 280 391 548COGS (1,214) (5,226) (1,746) (2,290) (3,901) (5,227) (6,215) (6,934)SG&A (127) (219) (301) (440) (775) (1,055) (1,334) (1,519)Other op.expenses (49) (96) (31) (197) (310) (507) (715) (881)Operating profit 392 906 768 1,064 1,743 2,466 3,557 4,294Net-interest inc./(exp.) (119) (212) 73 (27) (354) (389) (900) (996)Assoc/forex/extraord./others 5 1 21 55 108 103 110 111Pre-tax profit 277 695 861 1,092 1,497 2,181 2,767 3,409Tax (49) (131) (170) (225) (352) (458) (591) (741)Min. int./pref. div./others (36) (52) (90) (117) (61) (92) (116) (142)Net profit (reported) 193 513 601 750 1,084 1,631 2,059 2,526Net profit (adjusted) 193 513 601 750 1,084 1,631 2,059 2,526EPS (reported)(HKD) 0.061 0.107 0.089 0.109 0.140 0.193 0.238 0.292EPS (adjusted)(HKD) 0.061 0.107 0.089 0.109 0.140 0.193 0.238 0.292EPS (adjusted fully-diluted)(HKD) 0.061 0.107 0.089 0.109 0.140 0.193 0.238 0.292DPS (HKD) 0.000 0.000 0.031 0.042 0.055 0.077 0.095 0.117EBIT 392 906 768 1,064 1,743 2,466 3,557 4,294EBITDA 426 945 815 1,134 1,865 2,718 3,948 4,807

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 277 695 861 1,092 1,497 2,181 2,767 3,409Depreciation and amortisation 34 39 47 70 122 252 392 513Tax paid (49) (131) (170) (225) (352) (458) (591) (741)Change in working capital (143) (2,982) (100) 1,121 808 (444) (937) (805)Other operational CF items (1,252) (859) (2,836) (2,486) (3,011) (1,294) (1,048) (630)Cash flow from operations (1,132) (3,238) (2,198) (427) (936) 236 582 1,747Capex (107) (141) (204) (109) (70) (761) (735) (487)Net (acquisitions)/disposals (51) (75) (1,877) (407) (4,395) (4,314) (4,165) (4,379)Other investing CF items 23 (616) 584 (44) 1,607 0 0 0Cash flow from investing (136) (831) (1,496) (560) (2,857) (5,075) (4,900) (4,865)Change in debt 1,156 4,624 95 3,450 380 3,353 4,465 3,847Net share issues/(repurchases) 0 0 3,385 0 2,297 0 0 0Dividends paid (5) (6) (66) (2) 0 0 0 0Other financing CF items 159 483 162 (479) (763) 0 0 0Cash flow from financing 1,309 5,101 3,576 2,969 1,914 3,353 4,465 3,847Forex effect/others 0 0 0 0 0 0 0 0Change in cash 42 1,032 (118) 1,981 (1,879) (1,486) 147 729Free cash flow (1,239) (3,379) (2,402) (536) (1,005) (525) (153) 1,260


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Balance sheet (HKDm)

Key ratios (%)


Company profile

As the environmental water utilities flagship company under parent group Beijing Enterprises Holdings, Beijing Enterprises Water Group provides a full range of water services comprising water supply, sewage treatment, reclaimed water and seawater desalination. The company had treatment capacity of 11.53mtpd in operation and 6.45mtpd under construction at end-June, 2014. It is one of the top-3 water supply and sewage treatment companies in China in terms of total capacity.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 891 2,554 2,016 3,725 5,423 3,410 2,828 2,649Inventory 7 13 13 30 55 50 63 72Accounts receivable 287 4,885 4,018 2,800 3,172 3,422 4,469 5,177Other current assets 711 1,368 5,608 7,124 6,562 7,567 9,505 11,112Total current assets 1,896 8,820 11,654 13,679 15,212 14,450 16,864 19,011Fixed assets 259 46 233 528 379 400 418 432Goodwill & intangibles 1,579 1,585 1,650 1,779 2,539 2,537 2,535 2,533Other non-current assets 3,690 6,773 11,212 15,304 26,057 31,864 37,367 42,218Total assets 7,424 17,225 24,750 31,290 44,187 49,251 57,184 64,194Short-term debt 1,291 5,296 1,070 2,810 2,148 2,148 2,148 2,148Accounts payable 445 2,638 2,049 1,919 2,755 2,876 3,605 4,143Other current liabilities 515 683 3,552 4,529 6,748 7,434 8,765 9,747Total current liabilities 2,251 8,617 6,671 9,258 11,651 12,457 14,517 16,037Long-term debt 1,903 3,231 7,691 10,465 15,303 18,656 23,121 26,968Other non-current liabilities 258 309 678 836 1,308 1,121 1,178 1,162Total liabilities 4,412 12,157 15,039 20,558 28,262 32,234 38,816 44,167Share capital 348 457 691 691 844 866 866 866Reserves/R.E./others 2,275 3,436 7,391 7,776 12,454 13,432 14,668 16,184Shareholders' equity 2,623 3,893 8,082 8,467 13,298 14,298 15,534 17,049Minority interests 389 1,175 1,629 2,264 2,627 2,719 2,835 2,977Total equity & liabilities 7,424 17,225 24,750 31,290 44,187 49,251 57,184 64,194EV 50,731 55,068 54,402 57,434 59,668 65,023 70,077 74,134Net debt/(cash) 2,303 5,973 6,745 9,550 12,028 17,393 22,441 26,467BVPS (HKD) 0.753 0.852 1.170 1.225 1.576 1.652 1.795 1.970

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) 412.3 266.9 (58.2) 40.4 71.9 36.2 26.5 13.9EBITDA (YoY) 264.8 121.8 (13.8) 39.1 64.5 45.7 45.3 21.7Operating profit (YoY) 257.4 131.1 (15.3) 38.6 63.8 41.5 44.2 20.7Net profit (YoY) 522.0 165.9 17.2 24.9 44.5 50.4 26.3 22.7Core EPS (fully-diluted) (YoY) 59.9 75.9 (16.8) 21.5 28.7 38.3 23.1 22.7Gross-profit margin 29.8 17.7 34.2 38.6 39.1 40.1 43.7 44.8EBITDA margin 24.6 14.9 30.7 30.4 29.1 31.2 35.8 38.3Operating-profit margin 22.7 14.3 28.9 28.5 27.2 28.3 32.2 34.2Net profit margin 11.1 8.1 22.6 20.1 16.9 18.7 18.7 20.1ROAE 8.8 15.7 10.0 9.1 10.0 11.8 13.8 15.5ROAA 3.1 4.2 2.9 2.7 2.9 3.5 3.9 4.2ROCE 12.6 9.2 4.8 5.0 6.1 6.9 8.7 9.3ROIC 12.2 9.0 4.5 4.6 5.5 6.2 7.4 7.7Net debt to equity 87.8 153.4 83.5 112.8 90.4 121.6 144.5 155.2Effective tax rate 17.5 18.8 19.7 20.6 23.5 21.0 21.4 21.7Accounts receivable (days) 66.6 148.7 612.1 333.8 170.1 137.9 130.5 140.1Current ratio (x) 0.8 1.0 1.7 1.5 1.3 1.2 1.2 1.2Net interest cover (x) 3.3 4.3 n.a. 39.8 4.9 6.3 4.0 4.3Net dividend payout 0.0 0.0 34.5 38.9 39.3 40.0 40.0 40.0Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2.6


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On a mission to snap up market share

We initiate coverage of BEW with an Outperform (2) rating, backed by its favourable growth outlook for capacity and earnings.

Active market player looking to boost its market share

BEW stands out among its WWT peers in China as it has enhanced its leading industry position by acquiring several projects since 2008. The company started its water business in 2008 by acquiring ZKC Environmental, and has since carried out substantial M&A activity to expand its capacity and business coverage. BEW is 44%-owned by Beijing Enterprises Holdings BEHL) (392 HK, TP HKD75.0, HKD63.30, Outperform [2]). Their parent company, Beijing Enterprise Group, is one of the largest SOEs in Beijing with government support. This SOE background has given BEW: 1) an edge in carrying out acquisitions in and near Beijing city, and in acquiring other companies with non-SOE backgrounds, 2) higher bargaining power when negotiating concession agreements and JV agreements with other local governments, and 3) competitive bank borrowing rates, enabling it to generate better project IRRs. BEW’s listing status in Hong Kong serves as an international financing platform that enables it to have diverse financing methods, leading to lower financing costs. This affords BEW greater flexibility with its payment terms for large acquisitions. BEW has a strong track record of carrying out acquisitions, which have been a large contributor to its capacity and business-coverage expansion. The company’s major M&A moves have resulted in the contribution of a designed water project capacity of 8.8mtpd in total over 2008-1H14, accounting for about 53% of its incremental capacity over that period.

Among these, WWT capacity represents about 6mtpd and accounted for about 65% of WWT incremental capacity over 2008-1H14. Should more than double its capacity market share over 2013-16 We expect the privatisation and consolidation of the municipal water market to continue over the coming few years, and believe BEW will stand out as a successful market consolidator, especially in the WWT field. The municipal WWT industry in China is fragmented, with the top-5 players together accounting for only 11% of the market in terms of capacity, according to data for June 2013 from China Water Net. We forecast BEW to more than double its market share from 2.5% in 2013 to 5.6% in 2016, through annual water-capacity additions of 3.5mtpd during the period. We expect BEW’s additions of water projects to amount to 3.5mtpd for 2014, in line with management’s revised guidance after its 1H14 results release, and to be 3.5mtpd in each of 2015 and 2016. China: top-10 water companies (June 2013)

Company Ticker Capacity in and pending

operation (ktpd)* Market shareVeolia China VIE FP 14.41 2.77%Beijing Capital 600008 CH 13.99 2.69%Beijing Enterprises Water 371 HK 13.36 2.57%China Water Investment unlisted 7.5 1.64%Sino French Water unlisted 7.47 1.43%SIIC Environment SIIC SP 5.88 1.13%General Water of China unlisted 5.16 0.99%Xing Rong Group 000598 CH 4.95 0.95%Tianjin Capital Environmental Protection

1065 HK 4.84 0.80%

Sound Group 000826 CH / 967 HK 4.26 0.82%

Top-10 81.82 15.79%

Source: China Water Net

*Note: Represents total capacity at June 2013

Top 5 players11.1%

6th - 10th player4.7%

Others84.2%


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BEW: major acquisitions since June 2008

Date Target Stake Consideration Business Capacity Notes Acquisition PER

(historical)Acquisition PBR

(historical)13-Jun-08 BE-ZKC

Environmental 88.43% HKDm 1,370.7 WWT Designed capacity of

865ktpd 13 projects in Changsha, Qingdao, Chengdu, Guizhou, Guangzhou, etc

17.3x 2.7x

08-Sep-08 Shenzhen Hua Qiang Chuang Xin Investment

60% CNYm 235.4 WWT Designed capacity of 200ktpd for Shenzhen Huaqiang I Designed capacity of 400ktpd for Shenzhen Huaqiang II

The target is interested in: 1) Shenzhen Hua Qiang Feng Tai, 2) Binzhou Hua Qiang, and 3) Zhanhua Hua Qiang as to 80%, 83.8% and 55%, respectively

31.2x 1.3x

17-Nov-08 Guigang Water 80% CNYm 100 Water supply & WWT

Designed capacity of 100ktpd for WWT Designed capacity of 150ktpd for water supply

40-year JV with Guigang SASAC for the management of Guigang Water.

55.5x 1.7x

09-Nov-09 BE-ZKC Environmental

3.57% HKDm 55.3 WWT Designed capacity of 865ktpd

Through the 100% acquisition of Ever Huge

12.0x 1.7x

23-Dec-09 BE-ZKC Environmental

7.21% HKDm 111.8 WWT Designed capacity of 865ktpd

Through the 100% acquisition of Chinese Profit

12.0x 1.7x

23-Apr-10 China International Construction Investment

70% USDm 116.7 BT construction, Environmental

services

By 2009, target had net liabilities of UDS3.542m, and net loss of USD4m

n.a. n.a.

20-Jun-10 Beike (Dalian) Investment JV

60% USDm 58.8 BT construction BT project for the construction of the WWT and pipeline network, and infrastructures for the Water Supply Main Project Phase II for Changxing Dao, Jian Liu Island Sewage Treatment Station and Ancillary Pipeline Projects. After completion of the construction, the project will be transferred to the Liaoning Provincial Government

n.a. n.a.

25-Oct-10 Guiyang Water 45% CNYm 721 Water supply Designed capacity of 975ktpd

n.a. 1.1x

11-Jul-11 Shenzhen Bei Kong Chuang Xin Investment

11.03% CNYm 195.4 WWT 55.7x 4.8x

26-Sep-12 6-year income from Beijing Water Plant (No.9 water plant) ending 31st Dec 2018

100% HKDm 804.0 Water purification Asset injection. Expect annual income of CNY190m from Beijing Water Plant

3.4x n.a.

26-Sep-12 BE Water (Weifang) 100% CNYm 6.6 Water supply, WWT and

reclaimed water

Designed capacity of 40ktpd

Asset injection. n.a. 0.5x

26-Sep-12 Beijing Anling (including No.10 water plant)

33.8% HKDm 75.8 WWT and reclaimed water

Designed capacity of 1,000ktpd

Asset injection. Through the 100% acquisition of BE Water (BVI), which had a 50.5% stake in BJA Holding, which owned 100% of Beikong Jinzhou Water, which owned a 33% equity interest in Beijing Anling

n.a. 1.2x

26-Sep-12 BE Water (Hainan) 90% CNYm 157 Water supply Designed capacity of 250ktpd

Issue of 118,453,090 consideration shares at HKD1.62/share 2 WWT projects in Hainan

10.9x 1.3x

06-Feb-13 7 WWT companies in Guangdong province

100% CNYm 504.1 WWT Designed capacity of 580ktpd

8.8x 1.9x

21-Mar-13 CGEP (from Viola Water)

100% EURm 100.1 Mainly water supply

36ktpd Operates in Portugal 96.2x 5.7x

28-Jun-13 BCEG Environment Development

60% CNYm 270 WWT Designed capacity of 937.5ktpd

26 WWT plants in developed regions in China, including Beijing and Jiangsu

54.7x 1.4x

17-Jul-13 Crystal Water and China Water Holdings

100% CNYm 1,250 WWT Long-term design capacity of 2,026ktpd, of which 1,033ktpd in operation, 95ktpd under construction, 393ktpd in preparatory stage

36 water projects in Shandong, Hebei, Shaanxi, Jiangsu, Guizhou, Liaoning and Zhejiang

13.9x 2.4x

12-Sep-13 Salcon Companies 100% CNYm 955 Water supply & WWT

Designed capacity of 1,245ktpd, of which operating capacity of 1,055ktpd for water supply projects and 90ktpd for WWT projects

9 water projects in Jiangsu, Zhejiang, Shandong and Fujian

10.5x 1.1x

Source: Company

http://www.hkexnews.hk/listedco/listconews/SEHK/2008/0613/LTN20080613001.pdf



















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BEW expanded its water capacity by a CAGR of 57% over 2008-1H14, and added 6.2mtpd and 1.45mtpd in capacity in 2013 and 1H14, respectively. It secured 2.33mtpd of water projects in 8M14 and has 3mtpd of new capacity under negotiation. Given such a solid record, we expect BEW to add 3-3.5mtpd (company target: minimum 2mtpd) in annual capacity over 2014-16 and achieve a 5.6% market share in 2016. According to our sensitivity analysis shown in the following table, every 500ktpd increase in BEW’s capacity in 2015 would raise its NAV by 2.2% and lift our 2013-16E net profit CAGR by 1.4pp. BEW: sensitivity analysis of impact of increases in total water capacity on NAV, net profit, and ROE

2015E new water capacity additions (mtpd)

NAV (HKD)

2013-16E net profit CAGR 2015E ROE

(1.00) 2.50 6.19 32% 16.5% (0.50) 3.00 6.19 31% 16.3% Base case 3.50 6.30 33% 16.2% 0.50 4.00 6.44 34% 16.3% 1.00 4.50 6.59 35% 16.3% 1.50 5.00 6.75 37% 16.4%

Source: Daiwa estimates

BEW: sensitivity analysis on impact of increases in total annual water supply and WWT capacity on NAV, net profit, ROE (relative to base case)

2015E new water capacity additions (mtpd) NAV

2013-16E net profit CAGR 2015E ROE

(1.00) 2.50 -1.8% -0.7ppt .24ppt (0.50) 3.00 -1.7% -1.1ppt .12ppt Base case 3.50 - - - 0.50 4.00 2.2% 1.4ppt .04ppt 1.00 4.50 4.7% 2.8ppt .11ppt 1.50 5.00 7.2% 4.1ppt .19ppt


BEW: total water supply and WWT capacity, and market share in China

Source: Company, China Water Net, Daiwa forecasts

BEW has large exposure to China’s tier-1 and tier-2 cities. We prefer these municipal WWT projects in more economically developed cities as the local governments there are generally in a strong financial position, which potentially means the operators can be granted higher WWT tariffs, and shorter accounts

receivable periods, while the political or payment credibility risks for such projects are low. BEW: total operating water capacity


BEW: revenue from sewage and reclaimed water business


Overseas expansion BEW is active in seeking overseas opportunities. Apart from its WWT and water supply projects in Portugal, BEW secured a water supply project with capacity of 81ktpd in Indonesia in 1H14, and announced (on 18 September 2014) that it had won a government tender for the Second Changi NEWater Plant in Singapore. The Singapore WWT tender is a 25-year BOT project, with guaranteed capacity of 228ktpd and a first-year tariff of SGD0.276/m3. It should start operations in late 2016. BEW holds an 80% equity interest in the project. Expanding overseas brings geographical diversity to BEW’s core water business. This diversification should create more project opportunities for BEW, fuelling its future business growth (assuming BEW can ensure appropriate project execution).

0%

1%

2%

3%

4%

5%

6%

0

5

10

15

20

25

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

(mtpd)

Total water supply and WWT capacity (LHS) Market Share (RHS)

We expect BEW to double its market share from 2.6% to 5.6% during 2013-16E through annual capacity expansion of 3.5mtpd

0%

20%

40%

60%

80%

100%

0

5

10

15

20

25

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

(mtpd)

Sewage processing Reclaimed water

Water supply YoY (RHS)

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

1,000

2,000

3,000

4,000

5,000

6,000

2010 2011 2012 2013 2014E 2015E 2016E

(HKDm)

Revenue from sewage and reclaimed water treatment service (LHS)YoY (RHS)


- 69 -

SOE parent ensures financing ability

USD408m loan facility with ADB Having taken on a USD240m long-term loan agreement with Asian Development Bank (ADB) on 20 November 2013 (A/B loan of USD120m, respectively), BEW entered into another agreement with ADB on 9

October 2014 to raise the B loan facility to USD288m with a tenure of 7 years. In our view, the reasons BEW managed to secure the total USD408m loan facility with ADB were its SOE-backed financing ability and solid track record of project execution and operation. The loan will be used for further investment in the WWT business, according to the company. Competitive financing costs are crucial for a capital-intensive business We believe BEW’s war chest is well stocked to pay for capital-intensive BOT, BT, TOT projects and M&A opportunities. Backed by its SOE parent, BEW enjoys a competitive financing cost, at c.5%, compared with that for privately owned companies, such as CTE and Kangda, whose effective interest rates were 5.8% and 7.0% in 2013, respectively. As at 30 June 2014, BEW had HKD305.6m in bank borrowings. We believe the ADB loan should enable BEW to maintain its competitive financing cost (ADB is known for providing loans to companies at low interest rates).

BEW vs. CTE and Kangda: effective finance costs


For BEW to achieve our forecast of 3.5mtpd annual new water project capacity additions over 2014-16, we expect its net debt-to-equity ratio to increase from 90% in 2013 to 155% in 2016. Even though management said that its ideal gearing ratio is around 150%, we believe BEW will continue to undertake meaningful acquisitions if they are value-accretive. BEW has carried out a number of share issuances since 2011, through which it has strengthened its cash position by about HKD7.7bn. Although it has the ability to secure bank borrowings at competitive interest rates, we do not rule out the possibility of BEW carrying out equity financing to support its future business growth, especially given that the potential M&A/TOT opportunities far exceed its annual budget of 3.5mtpd capacity additions (this is similar to what happened in 2013, when the company added 6.2mtpd to total capacity).

BEW: share issuance since 2011 Announcement date

Shares issued (m shares)

% of enlarged share capital at time of announcement

Issue price (HKD)

% discount to share price on last full trading day before announcement Note

Share issue date

22-Dec-10 2,283 33.33% 1.485 46.00% 2-for-1 Open Offer 15-Mar-11

6-Jul-11 59 0.85% 2.134 8.40% Consideration shares for the acquisition of Shenzhen Bei Kong Chuang Xin Investment

7-Sep-11

18-Jul-12 658 9.53% 1.62 20% premium Consideration shares for the asset injection from BEHL 5-Feb-13

18-Jul-12 118 1.71% 1.62 20% premium Consideration shares for the asset injection from BEHL regarding the transfer of BE Water (Hainan)

24-May-13

26-Sep-13 400 4.95% 2.95 5.10% Subscriber was Mount Reskit Investment Ltd, a strategic investment fund owned by the Malaysia Government

16-Oct-13

17-Oct-13 350 4.15% 3.21 5.30% Top-up placement 30-Oct-13

17-Jul-13 220 3.20% 2.82 7.55% Consideration shares for the acquisition of Crystal Water and China Water Holdings, for which the companies entered into an MOU on 17 July 2013. The issue price was determined at a 5% discount to the volume-weighted average price for the 10 trading days prior to the announcement

19-Feb-14

Source: Company

2%

3%

4%

5%

6%

7%

8%

2010 2011 2012 2013

BEW (371 HK) CTE (1363 HK) Kangda (6136 HK)
















- 70 -

Good corporate governance ensures decent project returns

Unlike other SOEs, BEW is run by a well-experienced and efficient management team who used to run Z.K.C. Environmental Group (ZKC). ZKC was acquired by BEHL in 2008 and then became BEW. The company has been aggressive in terms of M&A over the past years. Apart from WWT and water-supply projects in China, BEW is also making an effort to expand its water business (along the value chain) into sludge treatment and seawater desalination, as well as exploring overseas projects opportunities. We are glad to see that the interests of management are aligned with those of the company’s shareholders. CEO Mr. Hu Xiaoyong and CFO Mr. Zhou Min hold a combined 7.1% stake in BEW. On 24 April 2013, the company granted a share option to BEW staff for a total of 400m shares at an exercise price of HKD2.24/ share, exercisable in batches between 2014 and 2018, and expiring in 2023. Of these shares, 291.2m share options were granted to BEW’s directors, of which 64m and 56m shares were granted to the company’s CEO and CFO, respectively. On 31 October 2014, these share options were HK$3.31/share (HKD1,324m in total) in the money based on a share price of HKD5.55. Therefore, in our opinion, BEW’s management is capable and has the incentive to boost the company’s profitability, and will likely only conduct value-accretive projects with equity IRRs of at least 10%. BEW: key management owning stakes in the company

Source: Company, HKEx

BEW: participants of share options announced on 24 April 2013 Grantees Number of share options (m shares)Mr. Hu Xiaoyong, CEO 64Mr. Zhou Min, ED 56Mr. Hou Feng (resigned) 32Mr. Li Haifeng, ED 29Mr. Li Li 19.2Mr. Tung Woon Cheung Eric 9Shea Chun Lok Quadrant 2Zhang Gaobo 2Guo Rui 2Hang Shijun 2Wang Kajun 2Other employees 180.8Total 400

Source: Company

Moreover, with its sound execution and experience in the water industry, BEW has been able to manage its widely spread water projects efficiently, such that their size has not resulted in any staff redundancies or cannibalization of operations. M&A, either in the form of acquisitions or TOT projects, is an important business growth driver for the company, not only because it brings about capacity additions, but also synergies and economies of scale. BEW operates its widely spread water businesses under 5 business units in China and 1 overseas – each of them operated independently (see Corporate business structure table on next page). After acquiring a new project, instead of hiring new staff to manage it, BEW operates it under an existing business unit, which allows for administrative cost savings and better management efficiency. As it owns a number of projects in a region, the business unit also has more flexibility in managing its capacity, as it tends to have more bargaining power with the local/ provincial governments, which enables it to reach favourable concession agreements, and higher WWT tariffs. BEW: SG&A cost as % of revenue

Source: Company, Daiwa estimates

0%

2%

4%

6%

8%

10%

12%

14%

16%

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

Signficant capacity additions on its small project portfolio resulted in rising SG&A costs in 2011-12.

SG&A costs, excluding share option expenses, fell by 1.8pp YoY for 2013 as projects matured.


- 71 -

BEW: corporate business structure

Source: Company

Riding the policy waves

BEW has benefited from favourable water-industry policies (eg, the 12th FYP plans relating to the water industry and the implementation of the new Environmental Protection Law). We expect BEW to further benefit from China’s upcoming water-pollution prevention and control plan, which is likely to be issued in late 2014 or early 2015, and is widely tipped to generate investment opportunities to the tune of CNY2tn for the whole water-related industry over 2016-20. Tariff adjustment Tariffs for both WWT and water supply have been on the rise over the past few years. China’s average residential tap-water tariff rose at a CAGR of 4% over 2002-1H14 to CNY2.05/tonne. Given the government’s determination to fight water pollution and preserve scarce water resources, we see upside potential for a further tariff hike. Although China’s per-capita water resources are equivalent to only one-third of the world’s average level, per capita spending on water in China represents only 0.6% of disposable income in the country,

compared with 3-5% for most Western European countries, according to the national Bureau of Statistics, the World Bank and the United Nations. We believe tariff hikes directly lead to improved profitability for the water-project operators, although the government caps a project’s IRR at 8-12%. According to management, 11 of BEW’s WWT plants implemented tariff increases (average of +15.3%) in 1H14. According to our sensitivity analysis, every additional 1% hike in the tariff for BEW’s water supply and WWT projects in 2015 would increase BEW’s ROE by 0.12pp and net profit by 1%. BEW: sensitivity of NAV, earnings, ROE to water supply and WWT tariff hike in 2015E

2015E WWTtariff (HKD/t)

2015E water supply tariff (HKD/t) NAV (HKD)

2015E Net profit (HKDm) 2015E ROE

-1% 1.23 2.37 6.22 2,042 16.1% Base case 1.24 2.40 6.30 2,059 16.2% 1% 1.26 2.42 6.38 2,077 16.3% 3% 1.28 2.47 6.54 2,113 16.6% 5% 1.31 2.51 6.71 2,149 16.8%


BEW: sensitivity of NAV, earnings, ROE to water supply and WWT tariff hike in 2015E (relative to base case)

2015E WWTtariff (HKD/t)

2015E water supply tariff (HKD/t) NAV (HKD)

2015E Net profit (HKDm) 2015E ROE

-1% 1.23 2.37 -1.3% -1% -.12pp Base case 1.24 2.40 - - - 1% 1.26 2.42 1.3% 1% .12pp 3% 1.28 2.47 3.9% 3% .36pp 5% 1.31 2.51 6.4% 4% .60pp


Plant upgrades and higher standards According to our market research, BEW has advanced technology which enables it to clean up wastewater to a standard that is higher than the national Grade I-A standard, before it sends the water back into the natural water supply. To improve the country’s water pollution situation, China has been strengthening its water-discharge standards, and we expect a revised set of standards to be released after the issuance of the water-pollution prevention and control plan (late 2014/early 2015), with WWT standards likely to be raised to the level of Grade IV/V Surface water. Tighter discharge standards not only call for plant upgrades and give room for further tariff hikes to reflect the extra cost that could be incurred as well as to incentivise the operators, but are also likely to result in more opportunities for large and experienced operators to acquire small players that usually lack the capital and technology to upgrade their WWT plants and water supply facilities.

Eastern China

Taizhou

Huangyan

Tongling

Xu Zhou

Xiangshui

Fu Ning

Zongyang

Huaining

Qianshan

Yatong Taizhou

Luoyang BCEG

Jiangsu Huitong

Yatong(Anqing)

Puyang

Shandong

Jiaonan

Heze

Qingdao

Shangma

Zhanhua

Jinan

Binzhou

Binhai

Weifang

Jiaozhou

Southern China

Zhongye

Nansha

Changsha

Sanshui

Shenzhen Feng Tai

Lei Yang

Shenzhen Chuang Xin

Quanzhou

Hengyang

Liuyang

Dongguan Houjie, Zhongtang

Hainan Baishamen, Changliu

Yongzhou

Hainan

Yueyang

Dongguan

Eastern China

Mianyang

Jiaoyou

Huayang

Shuangliu

Longquan

Pengzhou

Mianyang Nong Ke Qu

Qingbaijiang

Guizhou

Wulumuqi

Hu Tu Bi

Songming

Anning

Guigang

Hezhou

Guiyang Qingzhen

Guangan

Yunnan

Kunming Konggang

Getewin Taifu

Getewin Luqiao

Yuxi Getewin

Yuxi

Yibin

Zunyi

Guiyang

Eastern China

Qiqihar

Changping

Jinzhou

Dalian

Caofeidian

Beizhen

Linghai

Yixian

Goubangzi

Anling

Overseas

Malaysia Loyal BEWG

BEWG (M)

BEWG (PT)


- 72 -

Our on-the-ground research indicates that more than 50% of BEW’s WWT facilities were operating at the Grade I-A discharge standard by 2013. We see the potential for BEW to upgrade the rest of its projects to this standard in the next 3-5 years, as required by local governments and the new pollution-control policies. While we estimate that project upgrades in general require a unit capacity investment of c.CNY600k/tpd, our research reveals that after completing any upgrades, BEW could enjoy a WWT tariff hike of 35-40%, which would lead to improved profitability in the long term. BEW: treatment quality at WWT facilities (2013)

Source: Company, Daiwa estimates

BEW: WWT tariff (include VAT)


Sludge treatment market presents huge business potential Sludge is a by-product of WWT, suggesting that the sludge treatment market should at least grow in line with the WWT market. As an underdeveloped market largely because of the government’s vague policies to date, the sludge treatment industry is set for significant growth once comprehensive treatment standards and benchmark tariffs are clearly set. We expect accelerating investment in the sludge treatment market on the back of the launch of sludge treatment regulations and standards during the 13th FYP period.

BEW derived HKD37.9m in income from its sludge treatment business in 2013 (this is included in “other income”, accounting for 1.7% of BEW’s operating profit). But we do not see the sludge treatment business as being part of BEW’s strategic development focus. Wide geographical coverage gives BEW more flexibility in developing its business In the 12th FYP, the government targets to add to municipal WWT capacity, especially in the major cities, and to improve the pipeline network. While we do not rule out the possibility that several WWT operators will share the market in certain cities, we think BEW has an edge in securing more projects in a city where it already has a presence and has established cooperation with the local government. In our opinion, the company’s wide geographic coverage in China should allow it to continue cementing its leading market position. China: 12th FYP target for municipal WWT (ktpd) 2010 2012 Net additions during 12th FYP % of total FYP target

Beijing 3,647 4,005 1,196 3%Tianjin 2,158 2,572 600 1%Hebei 7,106 5,228 1,448 3%Shanxi 2,731 1,901 756 2%Inner Mongolia 2,131 1,674 1,049 2%Liaoning 5,367 6,709 1,815 4%Jilin 2,297 2,478 910 2%Heilongjiang 2,541 3,232 2,030 4%Shanghai 6,797 7,013 1,100 2%Jiangsu 10,101 15,645 2,930 6%Zhejiang 7,397 6,911 2,441 5%Anhui 4,470 5,114 2,270 5%Fujian 3,389 3,921 1,753 4%Jiangxi 2,829 2,260 2,080 5%Shandong 9,794 9,540 1,845 4%Henan 6,659 5,278 1,903 4%Hubei 4,524 5,570 2,470 5%Hunan 5,385 5,753 2,349 5%Guangdong 14,807 17,053 3,075 7%Guangxi 3,314 7,202 1,886 4%Hainan 760 739 774 2%Chongqing 2,383 2,384 1,063 2%Sichuan 3,962 4,031 1,934 4%Guizhou 1,705 1,248 1,246 3%Yunnan 2,367 2,297 1,126 2%Tibet 0 0 180 0%Shaanxi 2,353 2,272 1,305 3%Gansu 1,042 1,591 782 2%Qinghai 264 321 225 0%Ningxia 587 795 289 1%Xinjiang 1,893 2,142 860 2%Total 124,760 136,879 45,690 100%

Source: State Council, Ministry of Environmental Protection

Note: BEW operates water projects in all the provinces highlighted in blue

Grade I-A52%

Grade I-B46%

Others2%

1.00

1.05

1.10

1.15

1.20

1.25

1.30

2009 2010 2011 2012 2013 2014E 2015E 2016E

(HKD/ton)


- 73 -

Valuation

We initiate coverage of BEW with an Outperform (2) rating and DCF-derived 6-month target price of HKD6.30 (supported by our 33% net profit CAGR forecast for 2013-16, or 28% EPS CAGR during the same period). Given that we see predictable long-term cash flow for BEW’s municipal water supply and WWT BOT and TOT projects, on our new capacity addition and tariff forecasts, we value BEW with DCF methodology. We assume a WACC of 6.1% and a terminal growth rate of 2%. Our DCF-based valuation yields a fair value of HKD6.30/share, equivalent to a 2015E PER of 26x, in line with its PER valuation during the previous 12 months. We expect BEW to maintain its current rich PER valuation despite its diminishing scarcity premium as more water companies are listed, given its strong execution ability and rich financial resources, which we think will continue to be appreciated by investors. Our NAV estimate factors in only secured projects with an annual addition of 3.5mtpd of new water supply and WWT capacity over the 2014-16E period (including 2.5mtpd of new WWT projects). BEW’s future project wins, faster-than-expected capacity expansion and/or value-accretive M&A acquisitions could provide further upside to our earnings forecasts. BEW: 1-year forward PER

Source: Bloomberg

BEW: 1-year forward PER bands

Source: Bloomberg

BEW: 1-year forward PBR

Source: Bloomberg

BEW: 1-year forward PBR bands

Source: Bloomberg

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- 74 -

BEW: DCF valuation


BEW: our target price (HKD) sensitivity to WACC and terminal growth rate assumptions for DCF calculation

WACC 5.1% 5.6% 6.1% 6.6% 7.1%

Term

inal

G

row

th R

ate 3.0% 15.56 11.37 8.58 6.60 5.14

2.5% 12.45 9.42 7.28 5.70 4.48 2.0% 10.34 8.02 6.30 4.99 3.96 1.5% 8.81 6.95 5.53 4.42 3.52 1.0% 7.66 6.12 4.91 3.95 3.16


(HKDm) 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030EEBIT (IFRIC 12) 2,967 3,813 4,561 5,137 5,681 6,177 6,723 7,032 7,523 8,033 8,564 9,150 9,723 10,328 10,967 11,642 12,352 BOT construction revenue (1,188) (1,236) (818) (696) (691) (686) (681) - - - - - - - - - - BOT construction cost 974 941 623 530 526 522 518 - - - - - - - - - - Reinstatement of operation income (440) (207) (66) (45) 2 15 17 (2) (35) (73) (115) (162) (99) (37) 26 89 152EBIT (non-IFRIC 12) 2,313 3,310 4,300 4,926 5,518 6,029 6,578 7,030 7,488 7,960 8,449 8,989 9,623 10,291 10,993 11,730 12,504 Share of JVE/associates 103 110 111 113 115 118 120 99 101 103 105 107 110 112 114 117 119 Depreciation 252 392 513 625 658 688 714 737 673 614 560 511 466 425 388 354 323 Tax (413) (528) (698) (795) (917) (1,042) (1,180) (1,303) (1,441) (1,588) (1,743) (1,916) (2,059) (2,211) (2,372) (2,541) (2,719) Minority interest (92) (116) (142) (157) (176) (195) (215) (226) (245) (264) (285) (307) (330) (354) (380) (407) (435) Change in working capital (444) (937) (805) (524) (460) (335) (284) (235) (59) 84 (172) (181) (179) (177) (184) (192) (200) CAPEX and acquisition (5,075) (4,900) (4,865) (2,784) (2,763) (2,743) (2,723) (22) (21) (20) (18) (17) (16) (15) (14) (13) (12)Free cash flow (FCF) under IFRIC12 (3,356) (2,670) (1,586) 1,405 1,975 2,519 3,009 6,080 6,495 6,889 6,896 7,187 7,615 8,071 8,546 9,048 9,579 Sum PV Cash Flow 19,845 PV of Terminal Value 58,960 Minus net debt on Balance Sheet (24,273) Equity Value (HKD) 54,531 NPV/Share (HKD) 6.30 Valuation assumption China Risk Free Rate 4.0% Market Risk Premium 10.0% Beta 0.56 Cost of Equity 9.6% Yr n-1 Debt/Capitalisation 60% Pre-Tax Cost of Debt 5.0% After Tax Cost of Debt 3.8% WACC 6.1%


- 75 -

Key investment risks

Policy headwinds The strong performance of the water sector players over the past few years has mainly been driven by policy tailwinds via the government regulating, promoting and investing in the water industry. For example the government has allocated investments of CNY410bn and CNY427bn for the water supply and municipal WWT industries, respectively, during the 12th FYP period. Other financial incentives or preferential policies for the WWT operators include, but are not limited to, guaranteed returns of 8-12% on water-supply projects, water tariff reforms and the central government’s assessment of the local government’s work. Our investment case for BEW is built on the assumption that the China Water Sector will see continuous prosperity; and any negative changes in the supportive government policies could have a material impact on our view for the whole sector. Unexpected delays in announcing major favourable policies for the industry could also result in slower-than-expected industry growth. M&A BEW has a good track record of securing M&A deals and usually achieves synergies for each acquisition through its ability to cut costs within 2 years of the acquisition. It is critical that BEW acquires M&A targets without overbidding for them, while improving operating and cost efficiencies to ensure project IRR. Market competition Fiercer-than-expected market competition could lead to a slowdown in capacity expansion, and could even result in lower-than-expected project returns. Nevertheless, we believe BEW will continue to stand out as a leading China water company, given its SOE parental support, competitive borrowing costs and solid management team. We expect BEW to expand its market share from 2.5% for 2013 to 5.6% by 2016E. The credibility of the local government Many of BEW’s projects are operated under concession rights agreements (BOT/BT/TOT), for which BEW collects construction and/or sewage treatment fees from local government. If the local government’s balance sheet deteriorates, it may postpone or default on payments. If the local government provided any misleading information when transferring the plant to BEW, the company could be affected by lower-than-expected project returns. BEW’s seawater desalination

project in Caofeidian is barely running, and the local government has failed to stick to its guaranteed utilisation for the plant, due partially to insufficient demand at the current tariff of CNY5.99/tonne (compared with the national average tap water tariff of CNY2.0/tonne). Nevertheless, as BEW operates mainly in the higher-tier China cities and is backed by its SOE parent, we think the company is not highly exposed to this risk. Overseas expansion BEW has been exploring overseas opportunities. Overseas project returns are not necessarily higher than domestic returns, because even though they carry higher tariffs or technical service fees, the related capex needed is also significantly higher, leading to high investment in the early years of operation and high depreciation costs in the years after. Overseas projects could also be affected by various political and financial risks. Although we regard geographical diversification as a positive business strategy that should likely lead to more opportunities, overseas projects do expose BEW to more risks in terms of execution and guaranteeing investors project returns. Equity dilution We expect BEW to be in a rapidly developing phase typified by high capex and negative FCF over the next few years. Although we think BEW should be able to fund its future projects through debt financing at a competitive borrowing rate of c.5%, and maintain an acceptable debt-to-equity position, we do not rule out the possibility that BEW may have to go through equity financing. If the company chooses equity financing, such as share placements and/or the issuance of convertible bonds, EPS growth would be diluted. We forecast BEW’s net debt-to-equity ratio to rise to 155% in 2016, slightly higher than the company’s threshold level. BEW: net debt and net-debt-to-equity ratio


0%

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90%

120%

150%

180%

0

5,000

10,000

15,000

20,000

25,000

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2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

(CNYm)

Net Debt (LHS)Net Debt-to-Equity (RHS)BEW's thershold net-debt-to-equity level (RHS)


- 76 -

Company profile

Serving as the environmental flagship under BEHL, BEW is one of China’s top-3 water companies in terms of total capacity, focusing on providing municipal water services. It engages in the investment, operation and construction of municipal WWT, water supply, and water reclaim projects. Having entered the water business in 2008, BEW has successfully expanded its water capacity from 1.53mtpd in 2008 to 18.16mtpd by 1H14, representing a 57% capacity CAGR over this period. By 1H14, BEW had 333 water projects, of which 271 were WWT projects and 48 were water supply projects. BEW: capacity expansion

Source: Company

BEW: water capacity additions (ktpd) WWT Supply Reclaim Desalination Total2008 1,480.0 50.0 - - 1,530.02009 1,662.5 100.0 212.0 - 1,974.52010 1,230.0 1,125.0 - 50.0 2,405.02011 1,405.3 1,239.2 175.0 - 2,819.52012 813.0 840.0 112.5 - 1,765.52013 3,591.7 2,521.0 101.0 - 6,213.71H14 477.7 880.2 90.0 - 1,447.9Total 10,660.15 6,755.4 690.5 50.0 18,156.052008-1H14 CAGR 43% 144% 30%* 57%

Source: Company

Note: * represents 2009-1H14 CAGR

BEW: number of water projects (1H14)

Source: Company

BEW has a wide geographical presence. By 1H14, it had water projects in 21 provinces in China, as well as overseas (ie, WWT and water-supply projects in Portugal, and water supply and an environmental renovation project in Indonesia). A lot of BEW’s capacity is concentrated along the coastal regions and in the wealthy central-to-southern China. In terms of both water project capacity and number of projects, Shandong, Guangdong and Jiangsu are BEW’s top operating provinces. In Yunnan Province, BEW owns 31 projects, of which 23 are WWT projects, yet as these projects are of a relatively smaller size – the WWT projects BEW entered into in 2010 have a capacity of just 10ktpd, compared with its average of 60ktpd per plant – BEW does not have much capacity allocated in this region. By 1H14, BEW had 10.66mtpd of WWT projects, accounting for 59% of BEW’s total water capacity. In Guangdong Province, with its tough enforcement and execution of environmental policies, BEW has its largest WWT exposure of 1.9mtpd, representing 18% of its total operating capacity.

0%

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80%

100%

120%

140%

0

3,000

6,000

9,000

12,000

15,000

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21,000

2008 2009 2010 2011 2012 2013 1H14

(ktpd)

Capacity addition YoY capacity growth

WWT271

Supply48

Reclaim13

Desalination1

Heating1


- 77 -

BEW: China water projects (1H14)

Source: Company

BEW: water capacity allocation (1H14) BEW: water project allocation (1H14)

Source: Company Source: Company

Beijing

Guangdong

Guangxi

Hunan

Hubei

Xinjiang

Qinghai

Ningxia

Jiangxi

Jiangsu

Shanghai

HebeiInner Mongolia

Shanxi

Shandong

Tibet

Sichuan

Yunnan

Guizhou

Henan

Heilongjiang

Jilin

Liaoning

Anhui

Zhejiang

Fujian

Gansu

Hainan

Taiwan

Hong KongMacau

Shaanxi

WWT

Water Supply

Water Reclaim

Seawater Desalination

Management Service

Water Environment Renovation

Waste & Sludge Treatment

Total water capacity (1H14)

0 ktpd

1 – 499 ktpd

500 – 1,499 ktpd

>1,500 ktpd

Tianjin

AnhuiWWT: 6

BeijingWWT: 11Supply: 2Reclaim: 4

FujianWWT: 2Supply: 2

GuangdongWWT: 20

GuangxiWWT: 2Supply: 4

GuizhouWWT: 10Supply: 3

HainanWWT: 4

HebeiWWT: 10Supply: 4Desalination: 1

HeilongjiangWWT: 2

HenanWWT: 7Supply: 2Reclaim: 1

HubeiWWT: 3

HunanWWT: 18Supply: 3

JiangsuWWT: 45Supply: 3

JilinSupply: 1

LiaoningWWT: 24Supply: 1Reclaim: 3

ShaanxiWWT: 9

ShandongWWT: 45Supply: 10Reclaim: 3

SichuanWWT: 16Supply: 2

XinjiangWWT: 3

YunnanWWT: 23Supply: 6Reclaim: 2

ZhejiangWWT: 9Supply: 3

Shandong2.3mtpd12.5%

Guangdong1.9mtpd10.6%

Jiangsu1.9mtpd10.5%

Guizhou1.8mtpd10.2%

Henan1.6mtpd

8.9%

Beijing1.3mtpd

7.0%

Others7.3mtpd40.4%

Shandong58 projects

17.4%

Jiangsu48 projects

14.4%

Yunnan31 projects

9.3%Liaoning28 projects

8.4%

Hunan21 projects

6.3%

Guangdong20 projects

6.0%

Sichuan18 projects

5.4%

Others109 projects

32.7%


- 78 -

BEW: water capacity allocation (1H14) BEW: water capacity distribution (1H14)


BEW: WWT capacity allocation (1H14) BEW: WWT project allocation (1H14)


BEW: business overview (1H14)

Source: Company

0

500

1,000

1,500

2,000

2,500

Anhu

iBe

ijing

Fujia

nG

uang

dong

Gua

ngxi

Gui

zhou

Hai

nan

Heb

eiH

eilo

ngjia

ngH

enan

Hub

eiH

unan

Indo

nesi

aJi

angs

uJi

linLi

aoni

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rtuga

lSh

aanx

iSh

ando

ngSi

chua

nXi

njia

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nnan

Zhej

iang

(ktpd)

WWT Supply Reclaim Desalination

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Fujia

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(ktpd)

WWT Supply Reclaim Desalination

Guangdong1.9mtpd17.6%

Shandong1.5mtpd13.7%

Jiangsu1.3mtpd11.6%

Liaoning0.8mtpd

7.1%

Sichuan0.7mtpd

6.5%

Hunan0.7mtpd

6.4%

Others4.0mtpd37.1%

Jiangsu45 projects

16.6%

Shandong45 projects

16.6%

Liaoning24 projects

8.9%

Yunnan23 projects

8.5%

Guangdong20 projects

7.4%

Hunan18 projects

6.6%

Sichuan16 projects

5.9%

Others80 projects

29.5%

Wat

er E

nviro

nmen

t R

enov

atio

n Se

rvic

es

Sewage treatment and reclaimed water services

A total of 167 sewage treatment plants with capacity of 7.64mtpd and 4 reclaimed water plants with capacity of 418ktpd are in operation in Mainland China. Average daily processing volume is 6.38mtpd with an average treatment rate of 79%.

Water distribution services

A total of 26 water plants with water supply capacity of 3.47mtpd are in operation in Mainland China. These plants are mainly located in Guizhou, Shandong, Henan and Guangxi provinces.

Water treatment services overseas

A total of 24 sewage treatment plants and 13 water distribution plants are located in Portugal with daily designed capacity of 55.2ktpd and 36ktp,d respectively.

Construction services for water

environmental renovation

Four comprehensive renovation projects were under construction in 1H14, located in Guangxi Guigang, Hunan Zhuhui, Kunming Yuxi and Malaysia Pantai.

A total of 50 water treatment plants with designed capacity of 4.53mtpd were under construction in 1H14, mainly located in Beijing, Sichuan, Shandong, Yunnan, Liaoning, Guangxi, Jiangsu, Shanxi and Hunan. Most of them are expected to commence operations in 2015.

Technical services for water

environmental renovation

BEW has a number of engineering consulting and design qualifications for water treatment plants. As an integrated water system solution provider, it has not only accumulated strong experience in bidding, construction and operation of sewage treatment projects, but also successfully promotes its processing technology and expertise in construction for other operators and constructors.

Wat

er T

reat

men

t Se

rvic

es


- 79 -

BEW: current shareholding structure

Source: Company, HKEx

BEW: management team Name Age Position Background Mr. LI Yongcheng

52 Chairman, ED

Mr. Li was appointed the chairman and executive director of the company in October 2014. Mr. Li has once assumed various positions of deputy general manager, vice chairman and general manager with Beijing Gas Group Co., Ltd., and was vice president of Beijing Enterprises Holdings Limited (392 HK). He is currently vice chairman and executive deputy general manager of Beijing Enterprises Group Company Limited and an executive director of Beijing Enterprises Holdings Limited (392 HK). Mr. Li is a senior engineer, graduated from Wuhan University of Science and Technology with a master's degree in environmental engineering, and subsequently obtained an EMBA degree from Guanghua School of Management of Peking University. Mr. Li possesses extensive experience and professional expertise in public utilities industry, and also has plenty of experience in enterprise operations and capital operations.

Mr. E Meng 55 Vice Chairman, ED

Mr. E was appointed as an executive director of the company in February 2008 and vice-chairman of the company in April 2013. He serves as a vice general manager and the CFO of Beijing Enterprises Group Company Limited. He is also an executive director and an executive vice president of BEHL (392 HK) and the chairman and an executive director of Beijing Development (154 HK). Mr. E is also an independent non-executive director of JLF Investment (472 HK). He graduated from China Science and Technology University with a master’s degree in engineering, and subsequently obtained an EMBA degree from the Hong Kong University of Science and Technology. From 1988 to 1997, he was the deputy director of Beijing New Technology Development Zone and concurrently acting as the director of the Department of Financial Auditing, the general manager of Investment Operation Company, the chief accountant of Beijing Tianping Accounting Firm and the deputy director of the State-owned Assets Management Office of Beijing Haidian District.

Mr. JIANG Xinhao

49 ED Mr. Jiang was appointed an executive director of the company in June 2008. He also serves as a vice general manager of Beijing Enterprises Group Company Limited, an executive director and vice president of BEHL (392 HK) and an executive director of Beijing Properties (925 HK). Mr. Jiang graduated from Fudan University in 1987 with a bachelor’s degree in law, and then in 1992 with a master’s degree in law. Mr. Jiang was a lecturer at Peking University between 1992 and 1994. From 1995 to 1997, Mr. Jiang was a deputy general manager of Jingtai Finance Company in Hong Kong, and subsequently a director and vice president of BHL Industrial Investment Company. From 1997 to February 2005, he was a director and the CEO of Tramford International (TRFDF US). Mr. Jiang was a manager of the investment development department of Beijing Holdings Limited and a general manager of Beijing BHL Investment Center between May 2000 and February 2005.

Mr. HU Xiaoyong

49 CEO, ED Mr. Hu was appointed an executive director and the CEO of the company in August 2008. He graduated with an EMBA from Tsinghua University. He was the vice-chairman of the China Environmental Service Industry Association (全國工商聯環境服務業商會). He is currently the chairman of BEWG Environmental Group Co., Ltd.

Mr. ZHOU Min

50 ED Mr. Zhou was appointed an executive director of the company in August 2008. Mr. Zhou graduated with an EMBA from Tsinghua University. He previously worked in the People’s Bank of China (Yongkang Branch of Zhejiang Province), the Industrial and Commercial Bank of China (Yongkang Branch of Zhejiang Province), and was the chairman of Beijing Jingsheng Investment Company Limited. Mr. Zhou is now a director and CFO of BEWG Environmental Group Co., Ltd.

Mr. LI Haifeng

43 ED Mr. Li was appointed an executive director and vice president of the company in August 2008. He graduated with a bachelor’s degree in Law from Peking University. He was an assistant to the president of Founder Group and the executive vice president of Founder Xintiandi Software Technology Co. Ltd. Mr. Li is now the chairman of the Supervisory Committee of BEWG Environmental Group Co., Ltd., responsible for exploring business opportunities in the China water market. He is currently the chairman and an executive director of Carry Wealth Holdings (643 HK).

Mr. ZHANG Tiefu

51 ED Mr. Zhang was appointed as executive director and vice president of the company in April 2009. He graduated from Jilin Industrial Institute with a bachelor’s degree in engineering in 1983. He then studied business administration at the University of International Business and Economics in 1998. He joined Beijing Enterprises Holdings Limited as a manager in 2001, and is concurrently acting as the director and a general manager of Beijing Bei Kong Water Production Co., Ltd. and a director of Beijing Yanjing Beer Co., Ltd.

Ms. QI Xiaohong

46 ED Ms. Qi was appointed as executive director of the company in May 2008. She graduated from Capital Normal University with a bachelor’s degree in legal studies and subsequently obtained a master’s degree in economic management from Capital University of Economics and Business. She has worked for the Beijing Municipal Government for many years. She is vice president of BEHL (392 HK), responsible for corporate administration and HR management.

Mr. KE Jian 45 ED Mr. Ke was appointed an executive director of the company in June 2011 and is the vice president of BEHL (392 HK) and an executive director of Beijing Development (154 HK).

Mr. TUNG Woon Cheung Eric

43 CFO, Company Secretary, ED

Mr. Tung was appointed an executive director of the company in August 2011. He is the CFO and company secretary, and also assistant president and general manager of the finance department of BEHL (392 HK), the company secretary of Biosino Bio-Technology and Science Incorporation (8247 HK) and an independent non-executive director of South China Financial Holdings (619 HK) and GR Properties (108 HK). Mr. Tung graduated from York University, Toronto, Canada with a bachelor’s honours degree in administrative studies. He is a Hong Kong Certified Public Accountant and a US licensed practice Certified Public Accountant.

Mr. LI Li 48 Senior Engineer, Senior Project Manager, ED

Mr. Li was appointed an executive director of the company in February 2014. He is a senior engineer and qualified senior project manager. Mr. Li joined the company in October 2010 and is currently an executive vice president of the company. He graduated from Xian Jiaotong University in mechanical engineering and is currently studying for a PhD in engineering at the School of Environment, Tsinghua University. Prior to joining the company, Mr. Li was a senior engineer, a technical quality director and vice president of the First Design & Research Institute. Mr. Li served in various key positions at Beijing Sound Environmental Group from 2001-10.

Source: Company


■ Investment case We initiate coverage of Kangda International Environmental (Kangda), a leading privately owned municipal wastewater treatment (WWT) player in China, with an Outperform (2) rating. We forecast a 31% recurring net profit and EPS CAGR for 2013-16E, driven by new project wins and WWT tariff hikes. At 1H14, Kangda had 58 projects with total designed capacity of 1.917mtpd on hand, of which 33, (with capacity of 1.46mtpd) were in operation. With: 1) Kangda’s ability to secure and execute WWT projects on the back of its expertise, 2) its strategic positioning in the mid-tier municipal WWT market, which is a healthier and less risky market than the rural WWT market, and which we expect to record more robust growth than more mature markets in higher tier cities, and 3) its active

exploration of M&A opportunities with its more flexible access to financing after becoming a listed company, Kangda should secure 2.6mtpd of WWT capacity over 2H14-2016, based on our forecasts. The company announced project wins of 360ktpd during July and August this year (following its listing on 4 July). We regard capacity additions and WWT tariff hikes as the key earnings drivers for Kangda. We expect the company to have accelerating capacity growth over the next few years, and believe it stands to benefit from potential WWT tariff hikes thanks to tighter discharge standards together with its project upgrades. ■ Catalysts Steady progress in securing new projects and successful execution of projects to build up a track record and investor confidence are the main share-price catalysts we see for Kangda. Also, we view a solid ramp-up of WWT projects and strong earnings delivery as key rerating catalysts. ■ Valuation We have a DCF-based 6-month target price of HKD4.10, implying a 16x 2015E PER, which looks undemanding, at a 20% discount to

the average trading PER of other WWT operators in China, reflecting mainly Kangda’s short track record and small project base. ■ Risks We see the main risk as slower-than-expected capacity expansion.


4 November 2014

Kangda International Environmental

Initiation: a running stream

• Focusing on mid-tier cities with its industry expertise, Kangda targets to double its capacity in the next 2-3 years

• WWT tariff hikes following project upgrades should be an earnings driver

• Recurring net profit CAGR of 31% for 2013-16E; initiate with Outperform (2); ramp-up of WWT projects a rerating catalyst


Utilities / China

Kangda International Environmental6136 HK

Target (HKD): 4.10Upside: 14.5%31 Oct price (HKD): 3.58



1

2

3

4

5

70

85

100

115

130

2.4

2.8

3.3

3.7

4.2

Jul-14 Oct-14


Kangda Int (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 2.51-4.12Market cap (USDbn) 0.953m avg daily turnover (USDm) 6.40Shares outstanding (m) 2,068Major shareholder Zhao Juanxian, Chairman (53.0%)

Financial summary (CNY)Year to 31 Dec 14E 15E 16ERevenue (m) 1,791 2,137 2,585Operating profit (m) 530 706 891Net profit (m) 293 408 490Core EPS (fully-diluted) 0.142 0.197 0.237EPS change (%) 34.9 39.4 20.1Daiwa vs Cons. EPS (%) (3.7) 0.1 (2.5)PER (x) 19.9 14.3 11.9Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 2.0 1.8 1.5EV/EBITDA (x) n.a. n.a. n.a.ROE (%) 13.9 13.2 13.9





- 81 -

Growth outlook Kangda: recurring net profit

We forecast Kangda’s recurring net profit growth to accelerate to a CAGR of 31% over 2013-16E, vs. a 20% CAGR for 2011-13. This reflects our view that Kangda’s status now as a listed company should enable it to gain better access to financing, which should support a greater increase in its capacity, and its move to actively secure and execute municipal WWT projects after its listing, with new BOT projects (contributing construction revenue) and mature projects (contributing a stable cash inflow). Kangda targets to add 1.5-2.0mtpd of projects over 2H14-2015, and we forecast 1.6mtpd of capacity additions for the period. It has secured 360ktpd of projects during July-August this year.


Valuation Kangda: 1-year forward PER bands

Kangda is trading currently at a PER of 15x based on our 1-year forward EPS forecast, and 14x based on our 2015E EPS, at a 25% discount to the average PER of other Hong Kong-listed China WWT operators. Our DCF-based target price of HKD4.10 implies a 2015E PER of 16x, which we argue is undemanding given this multiple is at a 20% discount to the average current trading PER of Kangda’s peer group. We expect Kangda’s valuation discount to other WWT operators in the China market to narrow if it is able to build up a track record of solidly ramping up WWT projects and delivering strong earnings, which we see as potential rerating catalysts.

Source: Company, Bloomberg, Daiwa forecasts

Earnings revisions Kangda: consensus EPS forecasts

Listed on the Hong Kong Stock Exchange on 4 July this year, Kangda is only covered by 2 brokers currently. Their EPS forecasts for Kangda have remained relatively stable over the past few months. Our 2014E and 2016E EPS are slightly lower than other brokers’ forecasts. We believe the difference may be due to: 1) our slightly lower forecast for construction revenue, or 2) a slightly later commencement times we assumed for some of Kangda’s pending operation projects.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

152 200 217 293 408 4900

100

200

300

400

500

600

2011 2012 2013 2014E 2015E 2016E

(CNYm)

2.3

2.8

3.3

3.8

4.3

Jul-14 Aug-14 Sep-14 Oct-14

(HKD)

Price 12x PER 13.5x PER15x PER 16.5x PER 18x PER

0.13

0.14

0.15

0.16

0.17

0.18

0.19

0.20

0.21

Aug-14 Sep-14 Oct-14

(HKD)

2014E EPS 2015E EPS



1

2

3

4

5


- 82 -

Key assumptions

Profit and loss (CNYm)

Cash flow (CNYm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ENumber of operating WWT projects n.a. n.a. 22 24 30 51 59 84Operating WWT capacity (ktpd) n.a. n.a. 1,160 1,200 1,390 1,991 2,603 3,558Annual WWT amount (mn tonnes) n.a. n.a. 337 409 451 532 764 932Average WWT plant utilization (%) n.a. n.a. 93.5 95.4 95.6 87.9 85.7 83.8Average WWT tariff (CNY/ton) n.a. n.a. 1.03 1.05 1.04 1.05 1.06 1.07

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E

Service concession arrangements - operating revenue & finance income

n.a. n.a. 366 441 499 604 825 1,107

Service concession arrangements - construction revenue

n.a. n.a. 179 263 532 1,068 1,247 1,445

Other Revenue n.a. n.a. 189 295 309 118 64 33Total Revenue n.a. n.a. 735 999 1,340 1,791 2,137 2,585Other income n.a. n.a. 13 8 27 8 8 8COGS n.a. n.a. (397) (558) (826) (1,121) (1,282) (1,512)SG&A n.a. n.a. (73) (81) (113) (148) (158) (190)Other op.expenses n.a. n.a. (3) (4) (5) (5) (6) (6)Operating profit n.a. n.a. 278 368 427 530 706 891Net-interest inc./(exp.) n.a. n.a. (97) (131) (164) (180) (213) (295)Assoc/forex/extraord./others n.a. n.a. 5 (4) 19 13 7 7Pre-tax profit n.a. n.a. 186 233 282 363 500 604Tax n.a. n.a. (29) (36) (49) (63) (90) (112)Min. int./pref. div./others n.a. n.a. 0 (1) (1) (1) (2) (2)Net profit (reported) n.a. n.a. 157 197 232 298 408 490Net profit (adjusted) n.a. n.a. 152 200 217 293 408 490EPS (reported)(CNY) n.a. n.a. 0.076 0.095 0.112 0.144 0.197 0.237EPS (adjusted)(CNY) n.a. n.a. 0.073 0.097 0.105 0.142 0.197 0.237EPS (adjusted fully-diluted)(CNY) n.a. n.a. 0.073 0.097 0.105 0.142 0.197 0.237DPS (CNY) n.a. n.a. 0.000 0.000 0.000 0.000 0.000 0.000EBIT n.a. n.a. 273 372 413 525 706 891EBITDA n.a. n.a. 276 376 418 530 711 898

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax n.a. n.a. 186 233 282 363 500 604Depreciation and amortisation n.a. n.a. 3 4 5 5 6 6Tax paid n.a. n.a. (10) (15) (16) (53) (25) (63)Change in working capital n.a. n.a. (421) (742) (627) (1,158) (1,257) (1,603)Other operational CF items n.a. n.a. 95 138 150 174 208 289Cash flow from operations n.a. n.a. (148) (382) (206) (669) (569) (767)Capex n.a. n.a. (27) (9) (12) (17) (17) (16)Net (acquisitions)/disposals n.a. n.a. 6 (37) (132) (395) (259) (386)Other investing CF items n.a. n.a. (68) 117 (80) 4 4 4Cash flow from investing n.a. n.a. (89) 71 (225) (408) (272) (398)Change in debt n.a. n.a. 249 515 327 0 1,035 1,430Net share issues/(repurchases) n.a. n.a. 0 601 0 1,244 0 0Dividends paid n.a. n.a. 0 (0) 0 0 0 0Other financing CF items n.a. n.a. (6) (504) (163) (182) (215) (296)Cash flow from financing n.a. n.a. 243 612 165 1,062 820 1,134Forex effect/others n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Change in cash n.a. n.a. 6 300 (266) (15) (21) (31)Free cash flow n.a. n.a. (218) (411) (776) (1,245) (1,248) (1,543)

Financial summary


- 83 -

Balance sheet (CNYm)

Key ratios (%)


Company profile

Kangda International Environmental (Kangda) was the largest privately owned WWT operator in China at the end of 2013 in terms of its total capacity of 1.46mtpd. Its projects are located in 27 cities or 9 provinces in China.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment n.a. n.a. 246 544 276 261 240 209Inventory n.a. n.a. 5 5 3 6 9 12Accounts receivable n.a. n.a. 252 366 309 260 306 369Other current assets n.a. n.a. 803 985 1,405 1,912 2,297 2,803Total current assets n.a. n.a. 1,306 1,900 1,993 2,440 2,852 3,393Fixed assets n.a. n.a. 68 73 80 92 103 113Goodwill & intangibles n.a. n.a. 1 1 1 1 1 1Other non-current assets n.a. n.a. 1,494 1,903 2,639 3,866 5,055 6,619Total assets n.a. n.a. 2,870 3,877 4,714 6,399 8,011 10,125Short-term debt n.a. n.a. 662 768 785 388 543 758Accounts payable n.a. n.a. 377 408 537 666 761 898Other current liabilities n.a. n.a. 37 46 58 59 60 62Total current liabilities n.a. n.a. 1,076 1,222 1,381 1,112 1,365 1,718Long-term debt n.a. n.a. 1,007 1,416 1,802 2,199 3,079 4,294Other non-current liabilities n.a. n.a. 98 123 178 191 261 315Total liabilities n.a. n.a. 2,181 2,761 3,361 3,503 4,705 6,327Share capital n.a. n.a. 0 0 0 16 16 16Reserves/R.E./others n.a. n.a. 686 1,109 1,340 2,866 3,274 3,763Shareholders' equity n.a. n.a. 686 1,109 1,340 2,882 3,290 3,780Minority interests n.a. n.a. 2 7 12 14 16 18Total equity & liabilities n.a. n.a. 2,870 3,877 4,714 6,399 8,011 10,125EV n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Net debt/(cash) n.a. n.a. 1,423 1,640 2,312 2,326 3,382 4,843BVPS (CNY) n.a. n.a. 0.332 0.536 0.648 1.394 1.591 1.828

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) n.a. n.a. n.a. 36.0 34.1 33.7 19.3 21.0EBITDA (YoY) n.a. n.a. n.a. 36.2 11.2 26.7 34.3 26.2Operating profit (YoY) n.a. n.a. n.a. 36.3 11.1 27.1 34.5 26.3Net profit (YoY) n.a. n.a. n.a. 31.9 8.4 34.9 39.4 20.1Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. 31.9 8.4 34.9 39.4 20.1Gross-profit margin n.a. n.a. 46.0 44.2 38.3 37.4 40.0 41.5EBITDA margin n.a. n.a. 37.5 37.6 31.2 29.6 33.3 34.7Operating-profit margin n.a. n.a. 37.1 37.2 30.8 29.3 33.0 34.5Net profit margin n.a. n.a. 20.7 20.0 16.2 16.3 19.1 18.9ROAE n.a. n.a. 44.3 22.3 17.7 13.9 13.2 13.9ROAA n.a. n.a. 10.6 5.9 5.1 5.3 5.7 5.4ROCE n.a. n.a. 18.2 12.8 13.4 15.0 17.4 17.9ROIC n.a. n.a. 11.1 12.8 11.0 9.8 9.7 9.5Net debt to equity n.a. n.a. 207.5 147.9 172.5 80.7 102.8 128.1Effective tax rate n.a. n.a. 15.4 15.3 17.4 17.5 18.0 18.5Accounts receivable (days) n.a. n.a. 62.6 112.9 92.0 58.0 48.3 47.7Current ratio (x) n.a. n.a. 1.2 1.6 1.4 2.2 2.1 2.0Net interest cover (x) n.a. n.a. 2.8 2.8 2.5 2.9 3.3 3.0Net dividend payout n.a. n.a. 0.0 0.0 0.0 0.0 0.0 0.0Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Financial summary continued …


- 84 -

A running stream

We initiate coverage of Kangda with an Outperform rating

Investment case

Kangda is the largest privately owned municipal WWT player in China in terms of operating capacity based on end-2013 data, according to Frost & Sullivan. The company was listed on the Hong Kong Stock Exchange on 4 July 2014. At 1H14, Kangda had 58 projects in hand, of which 33 projects with a capacity of 1.46mtpd were in operation, and 15 projects with a capacity of 457ktpd were pending operation. The company won a further 10 projects with a capacity of 360ktpd during July-August. Kangda’s WWT geographic footprint covers 27 cities in 9 provinces in China. We expect Kangda to be able to almost double its total WWT capacity from the current level in 2015 through 1.6mtpd of project wins during 2H14-2015. Overall, we expect Kangda to win a further 2.6mtpd of WWT capacity over 2H14-2016, on top of its contracted WWT capacity of 1.917mtpd as of 1H14, based on the company’s target to add 1.5-2.0mtpd of capacity during 2H14-2015. Kangda announced project wins of 360ktpd in July and August this year after it listed, demonstrating its capability in securing projects and its eagerness in M&A opportunities, as it is now a public company with more diversified access to financing. If the company is able to keep up this momentum, we see potential upside to our current capacity expansion forecasts.

Kangda: total capacity of projects


We regard capacity additions as the key earnings driver for Kangda. The other major factor that could boost its earnings is WWT tariff hikes, which we consider as likely after the company’s projects are upgraded to comply with Grade I-A discharge standards, and following the China Government’s more stringent policies as China fights pollution. While we prefer industrial WWT operators over municipal WWT operators, and we prefer leading market players, we like Kangda given its robust growth potential as a newly listed operator with a relatively small project base. We initiate coverage of Kangda with an Outperform (2) rating, premised upon: 1) our forecast for a solid 31% recurring net profit CAGR for 2013-16, 2) the company’s greater flexibility over financing arrangements following its listing on the Hong Kong Stock Exchange, and 3) we see Kangda as a good proxy in the mid-tier municipal WWT market. Our DCF-based 6-month target price for Kangda of HKD4.10 implies a 16x 2015E PER, which is at a 20% discount to the average trading PER of other China WWT operators at current share prices, which we believe reflects primarily Kangda’s short track record and small project base. We expect Kangda’s valuation discount to peers to narrow if the company is able to build up a track record of solid ramp-up of WWT projects and deliver strong earnings, which we regard as a potential rerating catalyst.

4,527

1,917 360

200

1,050

1,000

0

1,000

2,000

3,000

4,000

5,000

1H14 Jul-Aug2014E

Sep-Dec2014E

2014-2015E 2015-2016E 2016E

(ktpd)


- 85 -

Positioned in mid-tier cities around Shandong and Henan

Stands out for its expertise According to management, Kangda is one of the few private WWT operators in China that has been granted both the ‘Environmental Engineering (wastewater class A) Specialised Design Certificate’ and the ‘Qualification Certificate for Operation of Environmental Protection Facilities (municipal waste water and industrial wastewater Class A)’, thanks to its experience of more than 18 years in the WWT market. Kangda believes it is its own expertise that helps the company to stand out among its peers when bidding for government tenures, as it customises the treatment techniques taking into account the bio-chemistry characteristics of the wastewater in that local area. According to our research, there have been cases when Kangda was able to secure government tenures even when competing with leading WWT companies with SOE backgrounds, and even when it has quoted a higher WWT tariff. We believe Kangda’s expertise will continue to be its key competitive advantage as the company expands its business.

Leverage on regional familiarity Kangda has high project concentration in Shandong Province, with 36% or 12 of its operating WWT projects, and 32% or 460ktpd of its operating WWT capacity, located in this province. Furthermore, about 60% of its projects pending operation in terms of capacity are also located in Shandong Province. Shandong, Henan, Anhui and Jiangsu provinces together accounted for 84% of Kangda’s operating WWT capacity in 8M14, constituting a region where Kangda has high business exposure. Kangda has demonstrated good ability to win projects since listing, having acquired 8 projects and government tender wins for 2 projects, with a total designed capacity of 360ktpd. Seven of these new projects are operating now, with the remaining 3 BOT projects expected to commence operations in 2016. Notably, among the 10 new projects Kangda signed after listing, 7 are located in Shandong Province and 1 in Henan Province. Going forward, we expect Kangda to continue to secure additional WWT projects in or near these provinces, by leveraging on its familiarity with the region, the supply chain in the local market, its brand recognition and its established relationship with the local governments.

Kangda: projects obtained since listing in July 2014 Date Project Province Business model Designed capacity (ktpd) Stake Consideration (CNYm) 24-Jul-14 Puyang Second WWT plant Henan TOT Acquired 50 100% 56.88

10-Aug-14

Yanggu County WWT Phase I Shandong TOT Acquired 40 90%

270.9

Yanggu County WWT Phase II Shandong BOT Acquired 40 90% Xin County WWT Phase I Shandong TOT Acquired 20 90% Xin County WWT Phase II Shandong TOT Acquired 20 90% Xin County WWT Phase III Shandong BOT Acquired 30 90% Liaocheng WWT Shandong BOT Acquired 30 90% Jiaxiang Second WWT Shandong BOT Acquired 30 90%

19-Aug-14

Suihua WWT Phase I Heilongjiang TOT Public tender 50 100% 93

Suihua WWT Phase II Heilongjiang BOT Public tender 50 100%

Source: Company, Hong Kong Stock Exchange


http://www.hkexnews.hk/listedco/listconews/SEHK/2014/0810/LTN20140810003.PDF



- 86 -

Kangda: WWT projects allocation (8M14)


Strategically positioned in mid-tier cities Given that Kangda is a privately owned company without strong connections with, or bargaining power over local governments, and without the support of a parent company, both of which WWT players with SOE backgrounds are generally able to enjoy, Kangda develops its business in a scatter manner and positions itself strategically in mid-tier cities. Based on the 2014 city tier ranking released by China Business News, it appears to us that Kangda’s WWT projects are concentrated in 3rd and 4th tier cities, which together accounted for 71% of its operating capacity and 73% of its total capacity in 8M14. This strategy of focusing on mid-tier cities has shown to be a successful business plan for Kangda, and will likely enable the company to reap the benefits of its high exposure to the municipal WWT development market in small/medium cities going forward: we see a

high likelihood that mid-tier cities will usher in the next boom in the municipal WWT market over the coming few years, given the high penetration in major cities (target to reach 100% in 36 major cities by 2015, according to China’s 12th FYP) and the government’s continuous determination to fight water pollution, as discussed in the previous sector section. Mid-tier cities tend to see more significant increases in municipal WWT demand compared with more developed cities. Starting with 1 project in the city can lead to potentially more upgrade/expansion projects. For instance, starting from its 1st project in Gaomi in Shandong Province with capacity of 50ktpd, Kangda now has 5 projects in Gaomi with total designed capacity of 185ktpd, of which a project of 25ktpd is expected to commence operation in 2H14.

Beijing

Jiangsu

Hebei Tianjin

Shandong

Henan

Heilongjiang

Jilin

Anhui

AnhuiOperating project: 5Operating capacity: 225ktpdTotal project: 5Total capacity: 225ktpd

BeijingOperating project: 1Operating capacity: 15ktpdTotal project: 1Total capacity: 15ktpd

HebeiOperating project: 1Operating capacity: 15ktpdTotal project: 1Total capacity: 15ktpd

HenanOperating project: 8Operating capacity: 475ktpdTotal project: 12Total capacity: 610ktpd

HeilongjiangOperating project: 1Operating capacity: 150ktpdTotal project: 4Total capacity: 350ktpd

JiangsuOperating project: 3Operating capacity: 60ktpdTotal project: 4Total capacity: 62ktpd

JilinOperating project: 1Operating capacity: 30ktpdTotal project: 1Total capacity: 30ktpd

ShandongOperating project: 12Operating capacity: 520ktpdTotal project: 29Total capacity: 940ktpd

TianjinOperating project: 1Operating capacity: 30ktpdTotal project: 1Total capacity: 30ktpd

Core business areaAccount for 85% of total operating projects, 84% of total operating capacity by 8M14


- 87 -

Kangda: projects at Gaomi in Shandong Province

Source: Company

Focusing on potential opportunities in developing areas in China, Kangda also aims to diversify its capacity portfolio geographically. For instance, it is making efforts in northern China, with its projects in Heilongjiang Province accounting for 10% of the company’s total operating capacity and 15% of its total capacity for 8M14, of which 2 projects with designed capacity of 100ktpd were won in mid-August. Positioned in Shandong and Henan provinces where it has a long business history, Kangda plans to venture into the northern China market gradually, starting from Heilongjiang and Jilin provinces, and to expand its

business along the eastern coast of China from Jiangsu Province to Zhejiang and Guangdong provinces. In the sector section that accompanies this report, we expressed our concern over the municipal WWT market outside 1st-3rd tier cities, mainly regarding the higher risk associated with: 1) local governments’ payment ability, and 2) project profitability, as WWT projects of smaller size may not be able to reach economies of scale and may yield lower gross-profit margins. That said, we still prefer municipal WWT projects in cities than in rural areas, Also, we are pleased to see that Kangda has not experienced any significant delays or impairments of its accounts receivable – with turnover days for receivables for service concession arrangements at around 35 days – and that it has been able to maintain its gross-profit margin at around 48% for service concession arrangements over the past 3 years. According to Kangda, such efficient management is attributable to its stringent project selection criteria and attractive incentives for local project companies. Even so, going forward, as Kangda develops more aggressive business expansion plans following its stock market listing, we believe that whether it is able to maintain such timely receivables turnover and satisfactory margins will be a key consideration.

Kangda: operating projects by city tier (8M14) Kangda: operating capacity by city tier (8M14)

Source: Company, China Business News, Daiwa Source: Company, China Business News, Daiwa

Kangda: projects by city tier (8M14) Kangda: capacity by city tier (8M14)

Source: Company, China Business News, Daiwa Source: Source: Company, China Business News, Daiwa

50

50

60

25

0

50

100

150

200

2006 2008 2011 2H14E

(ktpd)

Capacity commenced during the year Operating capacity at the beginning of the year

Tier 12, 6% Tier 2

1, 3%

Tier 312, 37%

Tier 48, 24%

Below tier 410, 30%

Tier 145ktpd, 3% Tier 2

150ktpd, 10%

Tier 3455ktpd, 31%

Tier 4585ktpd, 40%

Below tier 4225ktpd, 16%

2 2

27

12 15

0

5

10

15

20

25

30

35

Tier 1 Tier 2 Tier 3 Tier 4 Below tier 4

(# of projects)

Operating Pending operation New projects after listing

45

250

872 785

325

0

200

400

600

800

1,000

Tier 1 Tier 2 Tier 3 Tier 4 Below tier 4

(ktpd)



- 88 -

Long-term perspective to penetrate into sludge treatment Kangda has disclosed that 11 of its 33 operating projects treat municipal WWT with industrial pollutants, and it is proud of its WWT expertise given industrial WWT requires more advanced treatment techniques than municipal WWT, as we discuss in the sector section. Management has expressed its preference for the BOT business model as under this model cooperation with the authorities seems to have less risk, and therefore it has not yet, and indeed does not intent to, expand its business into pure industrial WWT treatment. Kangda’s management stated to us that it plans to start evaluating and researching the sludge treatment market in 2H14, and is willing to penetrate into this market once it acquires the techniques and gets the related licences. We like Kangda’s ambition to diversify its business into more water-related sectors. We believe this potential new business can bring in synergies with its current municipal WWT business, and can strengthen its position as a leading private WWT player. That said, we do not expect Kangda to make any near-term material progress into these fields, and regard it only as a long-term potential business.

Higher tariff associated with project upgrades

According to our research, 38% of Kangda’s operating WWT projects have reached national Grade I-A discharge standards and 49% have reached Grade I-B. All of Kangda’s projects that have yet to commence operations are either Grade I-A or Grade I-B standard, and the company has expressed its enthusiasm to obtain/ acquire only projects with high discharge standards, in consideration of complying with China’s stricter policies, protecting the environment, and to enjoy the generally higher tariff associated with a high-standard WWT plant. Out of Kangda’s 905ktpd non Grade I-A operating WWT capacity, 6 projects with capacity of 275ktpd (all pre-2012 projects are located in Shandong Province with Grade I-B discharge standards) are undergoing upgrades. We see a trend for Kangda to gradually upgrade all of its projects to the Grade I-A discharge standard in 2015/2016 to satisfy the local government’s demand to meet local environmental performance requirements, which in turn is driven by the central government’s anti-pollution measures.

Kangda: capacity of projects potentially to be upgraded to higher discharge standards (8M14)


As confirmed by management, Kangda is entitled to a higher WWT tariff for its projects with higher discharge standards, according to its concession rights contract with the government. Management indicated that its Weifang Yuhe WWT project in Shandong Province, which is currently under trial operation after being upgraded to Grade I-A discharge standards, could enjoy a substantial WWT tariff increase from CNY1.28/tonne to CNY2.60/tonne. With 275ktpd of upgrading projects under way and a potential 630ktpd project-upgrading opportunity, Kangda may be able to enjoy increasing WWT tariffs over the next few years, which could translate directly into higher net profit. We have factored in an average 1% annual WWT tariff hike for Kangda for 2014-16. According to our sensitivity analysis of Kangda’s 2013-16E recurring net profit CAGR on its new WWT capacity additions and WWT tariff growth during 2014-16E, for every ±0.5% annual tariff change from our assumption of 1.0%, there would be ±0.31pp impact on our 2013-16 recurring net profit CAGR forecast for the company, which is 31% derived from our base-case scenario. We show this in the following table. Kangda: sensitivity of 2013-16E recurring net profit CAGR to capacity additions in 2H14-2016E and annual WWT tariff growth in 2014-16E Annual WWT tariff growth for 2014-16E -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%

New

cap

acity

dur

ing

2H

14-1

6E

1,610 22% 22% 23% 23% 23% 24% 24% 24% 24% 1,860 24% 24% 25% 25% 25% 26% 26% 26% 27% 2,110 26% 26% 27% 27% 27% 28% 28% 28% 29% 2,360 28% 28% 29% 29% 29% 30% 30% 30% 31% 2,610 30% 30% 31% 31% 31% 31% 32% 32% 32% 2,860 32% 32% 32% 33% 33% 33% 34% 34% 34% 3,110 34% 34% 34% 35% 35% 35% 35% 36% 36% 3,360 35% 36% 36% 36% 37% 37% 37% 38% 38% 3,610 37% 37% 38% 38% 38% 39% 39% 39% 40%


1,460

905 630

555

275

0

300

600

900

1,200

1,500

Total operatingcapacity

Grade I-A Non-Grade I-A Upgradingprojects

Projectspotentially to be

upgraded

(ktpd)


- 89 -

Kangda: operating projects by discharge standard (8M14) Kangda: operating capacity by discharge standard (8M14)


Kangda: projects by discharge standard, 8M14 Kangda: capacity by discharge standard, 8M14


Grade I-A14, 42%

Grade I-B16, 49%

Grade II2, 6%

Beijing Grade III1, 3%

Grade I-A555ktpd, 38%

Grade I-B710ktpd, 49%

Grade II180ktpd, 12%

Beijing Grade III15ktpd, 1%

36

19

2 1 0

10

20

30

40

Grade I-A Grade I-B Grade II Beijing Grade III

(# of projects)


1,197

885

180

150

200

400

600

800

1,000

1,200

1,400

Grade I-A Grade I-B Grade II Beijing Grade III

(ktpd)



- 90 -

More flexible financing following its listing

Kangda raised net proceeds of around HKD1.2bn from its public offering in July, of which 65% will be used to expand its WWT business, 20% to repay bank borrowings and 15% for general corporate purposes, according to the company. As such, we forecast Kangda’s net debt-to-equity ratio to come down from 173% at end-2013 to 82% at the end of 2014. Kangda: use of proceeds from public offering

Source: Company

Kangda had HKD264m of short-term bank borrowing as at June 2014, of which more than 80% is short-term borrowing from China Merchants Bank which carries an interest rate of 7.38%. Going forward, as the company repays part of the high-interest bearing bank loans, and with possible debt restructuring through offshore borrowing, as well as taking into account its newly acquired access to more flexible financing methods, such as equity financing and bond issuance, we believe Kangda should be able to lower its financing costs. In our view, access to competitive financing is a key factor for any leading player in China’s water industry that operates a capital-intensive business such as WWT, whether for business expansion through project wins or M&A. We believe Kangda should be able to finance its new projects at a more competitive interest rate. Thus, in our model we factor in a slight decrease in its finance cost to 6.8% by 2016E (from 7.0% currently). Any more effective efforts in reducing finance cost could improve Kangda’s margins further and provide upside to our current forecasts.

Kangda: net debt-to-equity ratio and effective finance cost


Expand BOT/TOT

project portfolio35%

Potential acquisition of WWT project

30%

Repayment of short-term debt

20%

Working capital, other general

corporate purpose

15%

6.0%

6.2%

6.4%

6.6%

6.8%

7.0%

7.2%

0%

50%

100%

150%

200%

250%

2011 2012 2013 2014E 2015E 2016E

Net debt-to-equity (LHS) Effective finance cost (RHS)


- 91 -

Valuation

We initiate coverage of Kangda with an Outperform (2) rating and a DCF-based 6-month target price of HKD4.10, which we derive by employing a WACC of 8.5% (with assumptions as set out in the following table). Our target price implies 14.5% upside potential from the company’s current share price. DCF-based valuation We derive our target price for Kangda by adopting a DCF-based valuation, which we believe is the most appropriate method given it takes into account the time value of potentially varied future cash flows that reflect Kangda’s capacity expansion plans. As Kangda is in a rapid growth phase, for which we expect the company to secure another 2.6mtpd of WWT projects in 2H14-2016, we expect its FCF to be negative in the near future. After these projects start operation, cash inflows should increase and thus we expect Kangda’s FCF to become positive starting in 2018. We have adjusted the FCF to exclude the effect of an IFRIC accounting basis for BOT projects, which alters the timing between earnings and cash flow.

Kangda: WACC assumptions WACC Calculation Equity beta 0.84 Risk-free rate 4.0%Equity risk premium 10.0%Cost of equity 12.4%Cost of debt 7.0%Debt/capital 55%Tax 25.0%WACC 8.5%Terminal growth rate 2%


The table below shows the sensitivity of our target price to variations in the WACC and terminal growth rate. For WACC, a ±1% change in our assumption would have an impact of -24%/+33% on our target price; for the terminal growth rate, a ±0.5% change in our assumption would have an impact of +9%/-8% on our target price. Kangda: target price (HKD) sensitivity to WACC and terminal growth rate assumptions for DCF calculation

Term

inal

gro

wth

rate

WACC 5.5% 6.5% 7.5% 8.5% 9.5% 10.5% 11.5%

0.5% 7.42 5.57 4.26 3.29 2.54 1.94 1.46 1.0% 8.24 6.08 4.60 3.52 2.70 2.06 1.55 1.5% 9.26 6.69 4.99 3.79 2.90 2.20 1.66 2.0% 10.57 7.44 5.46 4.10 3.11 2.36 1.77 2.5% 12.33 8.38 6.02 4.47 3.36 2.54 1.90 3.0% 14.81 9.58 6.71 4.89 3.65 2.74 2.04 3.5% 18.55 11.20 7.57 5.41 3.98 2.96 2.21


Kangda: FCF forecasts Non-IFRIC EBIT (CNYm) 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030EEBIT (IFRIC) 537 708 893 1,001 951 956 956 951 946 941 936 930 925 919 912 906 899Construction revenue (1,068) (1,247) (1,445) (886) - - - - - - - - - - - - -Construction cost 833 973 1,141 700 - - - - - - - - - - - - -Re-instatement of operational income (48) (18) (113) (64) 56 107 122 130 138 147 157 167 178 189 201 214 228Non-IFRIC EBIT 255 415 477 751 1,007 1,063 1,078 1,081 1,084 1,088 1,092 1,097 1,102 1,108 1,114 1,120 1,127YoY change 1.4% 63.2% 14.8% 57.5% 34.0% 5.6% 1.4% 0.3% 0.3% 0.3% 0.4% 0.4% 0.5% 0.5% 0.5% 0.6% 0.6%

FCF (CNYm) 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030ENon-IFRIC EBIT 255 415 477 751 1,007 1,063 1,078 1,081 1,084 1,088 1,092 1,097 1,102 1,108 1,114 1,120 1,127Share of associates 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7Depreciation/amortization 5 6 6 7 7 8 8 8 8 9 9 9 9 8 8 8 7Adjusted income tax (5) (21) (36) (78) (120) (131) (137) (142) (146) (149) (152) (154) (156) (158) (160) (161) (161)Change in working capital (99) (42) (46) 171 271 3 3 3 3 3 3 3 0 0 0 0 0Adjusted capex (includes BOT construction cost) (1,245) (1,248) (1,543) (865) (14) (13) (12) (12) (11) (10) (9) (7) (5) (3) (1) (1) (1)FCF (1,082) (883) (1,134) (6) 1,159 936 947 946 947 948 950 955 957 962 969 973 979



- 92 -

Key earnings driver: WWT capacity We believe Kangda’s earnings outlook depends largely on its capability to win and carry out new WWT projects. A hike in WWT tariffs would also be a major growth contributor. We have conducted a sensitivity analysis of our target price based on changes to Kangda’s future WWT capacity as well as WWT tariffs, as shown in the table below. Our base-case scenario employs a set of assumptions of 2.6mtpd of project wins during 2H14-2016E on top of the company’s 1.917mtpd capacity as of 1H14, and a 1% WWT tariff increment during 2014-16E. For capacity of new project wins, a ±250ktpd change in our assumption would have an impact of ±2.6%on our target price; for the WWT tariff growth rate, a ±0.5ppt change in our assumption would have an impact of ±1.0% on our target price. Given the company’s target to add 1.5-2.0mtpd of capacity in 2H14-2015, and taking into account its project wins of 360ktpd during July-August 2014, we argue that our current assumption of 2.6mtpd of project wins for 2H14-2016 is undemanding, and we see potential upside to our current estimate. Kangda: target price (HKD) sensitivity to capacity additions for 2H14-2016E and annual WWT tariff growth for 2014-16E Annual WWT tariff growth for 2014-16E -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%

New

cap

acity

dur

ing

2H

14-2

016E

1,610 3.55 3.58 3.62 3.65 3.68 3.72 3.75 3.78 3.82 1,860 3.65 3.68 3.72 3.75 3.79 3.82 3.86 3.89 3.93 2,110 3.74 3.78 3.82 3.85 3.89 3.93 3.97 4.01 4.04 2,360 3.84 3.88 3.92 3.96 4.00 4.04 4.08 4.12 4.16 2,610 3.94 3.98 4.02 4.06 4.10 4.14 4.19 4.23 4.27 2,860 4.04 4.08 4.12 4.16 4.21 4.25 4.30 4.34 4.39 3,110 4.13 4.18 4.22 4.27 4.31 4.36 4.41 4.45 4.50 3,360 4.23 4.28 4.32 4.37 4.42 4.47 4.52 4.56 4.61 3,610 4.33 4.38 4.43 4.47 4.52 4.57 4.63 4.68 4.73


Kangda: target price sensitivity to capacity additions for 2H14-2016E


Target price implies 20% PER discount to peer group’s current trading PER In the context of our valuation analysis for Kangda, as the company is a leading privately owned WWT player with long experience in the municipal WWT industry, we expect it to benefit from the booming WWT market in China and supportive government policies. Underpinned by more flexibility on financing after its listing, we project Kangda to record steady growth over the next few years and forecast a 31% recurring net profit CAGR for 2013-16E. Our target price for Kangda implies a 2015E PER of 16x, which represents a 20% discount to the average trading 2015E PER of other Hong Kong-listed China WWT operators at their current share prices (based on our EPS forecasts). We argue that such a discount reflects: 1) our sector preference for industrial WWT players over municipal WWT players, 2) as Kangda has been listed only since July this year it has a short track record as a public company so has yet to build up investor confidence, and 3) Kangda has a smaller project base compared with municipal WWT operators such as Beijing Enterprises Water Group (BEW). We see Kangda’s: 1) prospects for strong project wins over the next half year, 2) good project execution, and 3) potentially solid 2014 results, as rerating catalysts for the stock.

Target:HKD4.10

Current:HKD3.58

3.0

3.5

4.0

4.5

5.0

1610

ktpd

1860

ktpd

2110

ktpd

2360

ktpd

Base

cas

e:2,

610k

tpd

2860

ktpd

3110

ktpd

3360

ktpd

3610

ktpd

(HKD)


- 93 -

Kangda: 1-year forward PER Kangda: 1-year forward PER bands

Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Kangda: 1-year forward PBR Kangda: 1-year forward PBR bands

Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

10

11

12

13

14

15

16

17

18

19


(x)

18.1x Avg+2SD

16.6x Avg+1SD

15.0x Avg

13.4x Avg-1SD

11.8x Avg-2SD 2.3

2.8

3.3

3.8

4.3


(HKD)

Price 12x PER 13.5x PER15x PER 16.5x PER 18x PER

1.2

1.4

1.6

1.8

2.0

2.2


(x)

2.2x Avg+2SD

2.0x Avg+1SD

1.8x Avg

1.5x Avg-1SD

1.3x Avg-2SD 2.0

2.5

3.0

3.5

4.0

4.5


(HKD)

Price 1.3x PBR 1.5x PBR1.7x PBR 1.9x PBR 2.1x PBR


- 94 -

Investment risks

Slower-than-expected capacity expansion This constitutes the main risk to our investment case for Kangda. Our earnings forecasts for Kangda rely heavily on its ability to secure and execute new WWT projects, for which we expect the company to win 2.6mtpd of new projects during 2H14-2016E. We have conducted a sensitivity analysis of our earnings forecasts, which shows that a ±250ktpd new project during 2H14-2016 would have an impact of ±1.9pp on our forecast of 31% recurring net profit CAGR for 2013-16E. Kangda: sensitivity of 2013-16E recurring net profit CAGR to capacity additions in 2H14-2016E


Slower-than-expected capacity expansion at Kangda could result from: 1) adverse changes in government policies, which would affect the growth of the whole industry, 2) fiercer-than-expected market competition, which could lead to not only increased challenges in winning projects, but also lower project returns in order to be a competitive bidder, and 3) the company’s inability to carry out acquisitions at reasonable valuations. Even if Kangda is able to secure new projects at a rapid pace, some risk would still be associated with its ability to execute the projects, in our view. Whether the company could operate its enlarged project portfolio with possibly widened geographic coverage at high efficiency and create synergies with its existing projects would be an essential factor to evaluate. Increase in receivables turnover days We have talked with many industrial experts, most of whom said they were as impressed as us by Kangda’s management of its receivables– its turnover days for receivables for service concession arrangements was only around 35 days during the past 3 years. Kangda believes this is attributable to its stringent project

selection criteria and attractive incentives for local project companies; therefore is confident of maintaining its project receivable turnover days. As we expect Kangda to undergo accelerating business expansion in the next 2-3 years, and as the company is actively exploring M&A opportunities to increase its capacity, we are not sure if it will still be able to enjoy such well-managed receivables turnover. This exposes our perspective for Kangda to downside risk. Equity dilution We expect Kangda to be in a rapid developing phase typified by high capex and negative free cash flow over the next few years. We believe Kangda should be able to fund its future projects from the proceeds from its public offering and through debt financing. According to our forecasts, although Kangda’s gearing (net debt-to-equity ratio) should increase over 2014-16 to 128% at end-2016, the ratio should still be significantly below its level before Kangda became a listed company. That said, we do not rule out Kangda possibly choosing equity financing or conducting acquisitions with share considerations. If equity financing is selected, EPS growth would be diluted. We expect a comfortable gearing ratio to be 120%, which is lower than BEW’s of 150%. Kangda: net debt-to-equity ratio


20%

25%

30%

35%

40%

1610

ktpd

1860

ktpd

2110

ktpd

2360

ktpd

Base

cas

e:2,

610k

tpd

2860

ktpd

3110

ktpd

3360

ktpd

3610

ktpd

(2013-16E net profit CAGR)

0%

50%

100%

150%

200%

250%

2011 2012 2013 2014E 2015E 2016E


- 95 -

Company profile

Kangda was established in China in 1996. It obtained its first WWT BOT project in Jiangsu Province in 2003. With over 18 years of experience in the WWT business, Kangda is now the leading privately owned company in China that invests in and operates WWT facilities, with about a 1% market share in the municipal WWT market. Its expertise in WWT technology and project management are its core competitive advantages making it stand out among other privately owned municipal WWT players. By 1H14, the company had 58 WWT projects with a capacity of 1.917mtpd on hand (including 33 BOT projects and 15 TOT projects), located in 27 cities in 9 provinces in China, and 1 BOT tap water supply project. Among them, 33 WWT projects (19 BOT and 14 TOT) were operating with capacity of 1.46mtpd. After listing on the Hong Kong Stock Exchange on 4 July 2014, Kangda announced it had won 10 new WWT projects (5 BOT and 5 TOT) with a capacity of 360ktpd. Kangda targets to add 1.5-2.0mtpd of new projects during 2H14-2015. Given its fair corporate governance and good execution ability as a privately owned company, and supported by the 10 project wins since listing, we believe Kangda is highly likely to achieve such a target. We look for it to add 1.6mtpd of new projects over 2H14-2015. Kangda has a high project geographical focus in Shandong Province, with 36% or 12 of its operating projects, 32% or 460ktpd of its operating capacity located in the province. For Kangda’s projects pending operation and projects won after its listing, around 60% of the capacity is also in Shandong Province. Shandong, Henan, Anhui and Jiangsu provinces together constitute a region where Kangda has high business exposure. Going forward, we expect Kangda to continue to secure additional WWT projects in or near these provinces, by leveraging on its familiarity with the region, the participants in the local market, its brand recognition, and its established relationships with the local governments.

Notably, among the 10 new projects that Kangda has signed since its listing, 7 are located in Shandong Province and 1 in Henan Province. Kangda: projects in Shandong province (8M14)


Kangda: operating projects in Shandong province


Operating460ktpd

12 projects

Pending operation270ktpd

10 projects

New projects after listing

210ktpd7 projects

Gaomi

Gaomi

Linyi

WeifangDezhou Rushan

Haiyang

Dongying

HezeJiling

Wendeng

Liangshan

Liaocheng

2004

Gaomi

Linyi

WeifangDezhou Rushan

Haiyang

Dongying

HezeJiling

Wendeng

2013

Aug 2014


- 96 -

Kangda: operating projects by province (August 2013) Kangda: operating capacity by province (August 2013)

Source: Company, Daiwa Source: Company, Daiwa

Kangda: projects by province (August 2013) Kangda: capacity by province (August 2013)

Source: Company, Daiwa Source: Company, Daiwa

Kangda: revenue mix


Shandong12, 37%

Henan8, 24%

Anhui5, 15%

Heilongjiang1, 3%

Jiangsu3, 9%

Jilin1, 3%

Tianjin1, 3%

Beijing1, 3%

Hebei1, 3%

Shandong460ktpd, 32%

Henan475ktpd, 33%

Anhui225ktpd, 15%

Heilongjiang150ktpd, 10%

Jiangsu60ktpd, 4%

Jilin30ktpd, 2%

Tianjin30ktpd, 2%

Beijing15ktpd, 1%

Hebei15ktpd, 1%

29

12

5 4 4 1 1 1 1

0

5

10

15

20

25

30

35

Shan

dong

Hen

an

Anhu

i

Hei

long

jiang

Jian

gsu

Jilin

Tian

jin

Beijin

g

Heb

ei

(# of projects)


940

610

225350

62 30 30 15 150

200

400

600

800

1,000Sh

ando

ng

Hen

an

Anhu

i

Hei

long

jiang

Jian

gsu

Jilin

Tian

jin

Beijin

g

Heb

ei

(ktpd)


0%

20%

40%

60%

80%

100%

1H13 2H13 1H14 2H14E 2011 2012 2013 2014E 2015E 2016E

Service concession arrangements BT arrangements Others


- 97 -

Kangda: current management team

Manager Age (years) Position Date of appointment

Date of join Kangda Responsibility Background

Mr. Junxian ZHAO

61 Executive Director Chairman of the Board

22-Aug-11 Jul-1996 Strategic development and planning, overall operational management, market development and major decision making

Mr. Zhao graduated from the political administration at the elementary level (黨政幹部基礎

科專業) from Sichuan University and Sichuan Higher Vocational and Examination Committee in June 1988, and attended a one-month education programme for Sichuan foreign-related business at Shenzhen University in July 1988. Mr. Zhao has 25 years of experience in the environmental protection and wastewater treatment industry. Mr. Zhao served as the vice president of the 3rd and 4th Session of Chongqing Municipal Environmental Protection Industry Association in 2005 and 2012, respectively, and the vice president of the 3rd and 4th Session of China Association of Environmental Protection Industry in 2005 and 2009 respectively. Prior to joining Kangda, Mr. Zhao was in charge of operational management and business development at several environmental companies including Chongqing Environmental Protection Industrial Company during 1989-90, Chongqing Environmental Protection Engineering Design Institution during 1990-92, and Chongqing Transportation Environmental Protection and Technology Company over 1992-94.

Mr. Weizhong ZHANG

62 Executive Director Chief Executive Officer

15-Mar-13 Sep-2012 Overall management and operation

Mr. Zhang graduated from Sichuan Radio and TV University with a college degree in industrial accounting in July 1986. Prior to joining Kangda, Mr. Zhang was in charge of financial, operational and strategic management in several companies and has over 30 years of experience in corporate management. Mr. Zhang holds directorships in China Huandao (Group) Limited Company (中國寰島集團公司), Sea Master Finance Limited (海領財務

公司) and Cheer Harvest Industries Limited (資合實業有限公司). He is also the general manager and chairman of Huandao South Development Limited Company (寰島南方實業

發展有限公司), as well as the general manager and legal representative of Haikou Haidian Island Real Estate Development Limited Company (海口海甸島房地產開發總公司).

Ms. Zhiwei LIU

49 Executive Director 15-May-12 Jul-1996 Investor relationship and risk control matters

Ms. Liu has served various positions after joining Kangda, including chief accountant, chief officer of asset management department, deputy chief financial officer, audit director, and is currently responsible for the investor relationship and risk control matters. Ms. Liu has approximately 20 years of experience in the field of accounting. Prior to join Kangda, she was the financial manager at Chongqing Kangte.

Mr. Weiping GU

59 Executive Director 15-May-12 Jul-1996 The management of administrative and human resource affairs

Mr. Gu graduated from political management and administration at elementary level from Sichuan Radio and TV University in July 1986. He obtained the qualification of environmental engineer in China granted by the Chongqing Municipal Government in September 1993, and has over 35 years of experience in the environmental protection industry. Mr. Gu has served various positions after joining Kangda, including general manager assistant and deputy chairman. He has also served as a director of Hebi Kangda and Dongying Kangda since February 2012 and November 2012, respectively. Prior to joining Kangda, Mr. Gu was in charge of daily management and environmental monitoring at several environmental corporations including Chongqing Municipal Environmental Protection Bureau during 1991-1992, Chongqing Environmental Protection Engineering Design Institute in 1992 and Chongqing Kangte over 1994-96.

Mr. Litong WANG

45 Executive Director 30-Oct-13 Jan-2011 Marketing and business development

Mr. Wang graduated from Tianjin University of Technology major in mechanical design in July 1991. He has more than 20 years of experience in relation to municipal environmental protection and was involved in a number of projects in municipal environmental design engineering, sewage treatment, solid waste disposal and research work on environmental protection facilities. Mr. Wang obtained the qualification of senior engineer in the PRC granted by the Tianjin Human Resource and Social Security Bureau in December 2010, and has participated in the compilation of 10 sets of national standards in technology of construction. Prior to joining Kangda, Mr. Wang was in charge of project design and research at Tianjin Municipal Engineering Design & Research Institute.

Mr. Gang LI

37 Chief Financial Officer

11-Jul-12 Jul-2012 Finance, accounting and taxation affairs

Mr. Li obtained a bachelor’s degree in accounting from Beijing Technology and Business University in July 1998. Prior to joining Kangda, Mr. Li served as accounting manager in various companies including Ernst & Young over 2008-12.

Mr. Zuping LIANG

59 Head of the auditing department

28-Jul-11 Jul-1996 Internal auditing and risk control matters

Mr. Liang completed the education programmes on senior industrial accounting in Chongqing Staff Accountant Training College in 1983. He completed an economics and management program in Beijing Institute of Economic Management Correspondence College in 1989. He has over 20 years' experience in accounting, financing and auditing affairs. Mr. Liang has served as a director of Chongqing Zhongya, Tianjin Kangda, Harbin Kangda, Suzhou Water, Suzhou Kangda and Huadian Kangda since October 2007, December 2010, February 2011, February 2011, March 2013 and August 2013, respectively. Prior to join Kangda, Mr. Liang was the head of finance department at Chongqing Environmental Protection engineering Design Institution during 1990-96.

Source: Company


- 98 -

Kangda: shareholding structure

Source: Company, Hong Kong Stock Exchange, Daiwa


- 99 -

Appendix – Kangda’s project list

Kangda: operating projects (8M14)

Project name Phase Business Province Location Operation

startCap.

(ktpd)Utilisation

(2013) Concession

(no. of years) Concession

endEmission standard

Feng County WWT Phase I BOT-WWT Jiangsu Xuzhou Mar-06 20 100% 25 Dec-30 IAGaomi No. 2 WWT Phase I BOT-WWT Shandong Gaomi Apr-06 50 100% 25 Apr-31 IBBeijing Daxing District Caiyu Town Economic Development Zone WWT Phase I BOT-WWT Beijing Beijing Jul-06 15 67% 30 Jul-36 Beijing IIIGaomi No. 2 WWT Phase II BOT-WWT Shandong Gaomi Oct-08 50 100% 25 Oct-33 IBAnhui Jixi WWT Phase I BOT-WWT Anhui Xuancheng Jun-09 15 95% 30 Apr-38 IBFeng County WWT Phase II BOT-WWT Jiangsu Xuzhou Jul-09 20 100% 25 Jul-34 IAJiaozuo City WWT Phase II BOT-WWT Henan Jiaozuo Jul-09 100 100% 26 Jul-35 IALinyi Nanfang WWT Phase I BOT-WWT Shandong Linyi Aug-09 40 90% 25 Aug-34 IBJiaozuo City Industrial Park Wanfang WWT Phase I BOT-WWT Henan Jiaozuo Dec-09 25 100% 26 Dec-35 IBHebei Dacheng WWT Phase I BOT-WWT Hebei Langfang Jan-10 15 99% 25 Jan-35 IAAnhui Ningguo WWT Phase I BOT-WWT Anhui Ningguo Mar-10 40 100% 30 Mar-39 IBWeifang Yuhe WWT BOT-WWT Shandong Weifang Sep-10 100 100% 30 Sep-40 IBShangqiu WWT Phase II BOT-WWT Henan Shangqiu Oct-10 100 100% 30 Oct-40 IAAnhui Chaohu Economic Development Zone Huashan WWT Phase I BOT-WWT Anhui Chaohu Oct-10 10 77% 30 Oct-39 IAGaomi Third WWT Phase I BOT-WWT Shandong Gaomi May-11 25 102% 25 May-36 IBFeng County Economic Development Zone WWT Phase I BOT-WWT Jiangsu Xuzhou Jul-12 20 95% 29 Jul-41 IAShandong Yucheng No. 2 WWT Phase I BOT-WWT Shandong Dezhou Jul-13 30 89% 25 Jul-38 IAShangqiu Liangyuan Industrial Park WWT BOT-WWT Henan Shangqiu Jan-14 20 25 Jan-39 IAShandong Rushan Residential WWT Phase II BOT-WWT Shandong Rushan Jan-14 20 27 Dec-41 IAShandong Haiyang WWT TOT-WWT Shandong Haiyang Nov-05 20 100% 22 Nov-27 IBAnhui Suzhou Chengnan WWT 1 TOT-WWT Anhui Suzhou Oct-06 80 88% 28 IIJiaozuo City WWT Phase I TOT-WWT Henan Jiaozuo Nov-06 100 100% 26 Nov-32 IIShangqiu WWT Phase I TOT-WWT Henan Shangqiu May-07 80 100% 30 May-37 IAShandong Guangrao WWT Phase I TOT-WWT Shandong Dongying Sep-08 50 110% 26 Sep-34 IBLinying WWT TOT-WWT Henan Luohe Sep-08 30 99% 30 Sep-38 IBTianjin Ninghe WWT Phase I TOT-WWT Tianjin Tianjin Mar-11 30 98% 30 Mar-41 IBHeilongjiang Harbin Hejiagou Qunli WWT Phase I TOT-WWT Heilongjiang Harbin Sep-11 150 98% 30 Sep-41 IBGaomi City WWT TOT-WWT Shandong Gaomi Sep-11 35 95% 30 Sep-41 IBShandong Rushan Industrial WWT Phase I TOT-WWT Shandong Rushan Dec-11 20 74% 30 Dec-41 IBShandong Rushan Residential WWT Phase I TOT-WWT Shandong Rushan Dec-11 20 74% 30 Dec-41 IAWugang Zhulan WWT TOT-WWT Henan Wugang Nov-12 20 97% 30 Nov-42 IAAnhui Suzhou Chengnan WWT 2 TOT-WWT Anhui Suzhou Oct-13 80 50% 25 Oct-38 IAHua Dian WWT TOT-WWT Jilin Hua Dian Feb-14 30 30 Feb-44 IB

Source: Company

Kangda: projects pending operation (8M14)

Project name Phase Business Province Location

Expected operation

start Cap (ktpd)Concession

(no. of years) Concession

end Emission standard

Investment to be incurred

(CNYm, Apr-14)Shandong Guangrao WWT Phase II BOT-WWT Shandong Dongying Jul-14 25 21 Sep-34 IA 3Hebi Baoshan District Circular Economy Industrial Zone WWT Phase I BOT-WWT Henan Hebi Jul-14 15 30 May-44 IA 14Hebi Baoshan District Water Supply Project BOT-Tap Henan Hebi Aug-14 31 30 Jun-44 Tap water 4Shan County Industrial Park WWT Plant BOT-WWT Shandong Heze Aug-14 40 28 Jun-42 IA 20Shandong Jining Jibei Hi-tech Industrial Zone WWT BOT-WWT Shandong Jining Jul-14 25 30 Jun-43 IA 1Gaomi Third WWT Phase II BOT-WWT Shandong Gaomi Aug-14 25 25 Jul-39 IA 17Shandong Yucheng No.2 WWT Phase II BOT-WWT Shandong Dezhou Aug-14 30 25 Jul-39 IA 37Henan Jiyuan Yuchuan Industry Cluster District WWT for District A Phase I BOT-WWT Henan Jiyuan Sep-14 20 28 Jul-39 IA 3Shandong Haiyang Xingcun WWT BOT-WWT Shandong Haiyang Aug-14 20 30 Aug-44 IA 0Weifang Binhai Shuicheng WWT BOT-WWT Shandong Weifang Aug-14 10 30 Aug-44 IA 8Feng County Power Industrial Park Plant BOT-WWT Jiangsu Xuzhou Mar-15 2 25 Jan-40 IA 8Shandong Wendeng WWT BOT-WWT Shandong Wendeng Mar-15 25 30 Jan-45 IB 3Jiaozuo City WWT Phase II Expansion BOT-WWT Henan Jiaozuo May-15 50 26 Apr-41 IA 74Heilongjiang Harbin Hejiagou Qunli WWT Phase II BOT-WWT Heilongjiang Harbin Jan-16 100 30 Dec-45 IB 275Shandong Liangshan Economic Development zone BOT-WWT Shandong Liangshan May-15 20 30 Mar-44 IA 48Dongying Port North Economic Dev. Zone WWT TOT-WWT Shandong Dongying Jul-14 50 30 Jan-43 IA 126

Source: Company

Kangda: New projects won after stock market listing (8M14) Project name Business Province Location Cap (ktpd) Concession (no. of years) Concession end Emission standardPuyang Second WWT plant BOT-WWT Henan Puyang 50 30 Aug-44 IAYanggu County WWT Ph I TOT-WWT Shandong Yanggu 40 30 Jan-42 IAYanggu County WWT Ph II BOT-WWT Shandong Yanggu 40 30 Jan-42 IAXin County WWT Ph I TOT-WWT Shandong Liaocheng 20 30 Jan-43 IAXin County WWT Ph II TOT-WWT Shandong Liaocheng 20 30 Jan-43 IAXin County WWT Ph III BOT-WWT Shandong Liaocheng 30 30 Jan-46 IALiaocheng WWT BOT-WWT Shandong Liaocheng 30 30 Jan-41 IAJiaxiang BOT Second WWT BOT-WWT Shandong Jining 30 30 Jan-40 IASuihua WWT Ph I TOT-WWT Heilongjiang Suihua 50 30 Jan-44 IBSuihua WWT Ph II BOT-WWT Heilongjiang Suihua 50 30 Jan-44 IA

Source: Company


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Daiwa’s Asia Pacific Research Directory

HONG KONG

Hiroaki KATO (852) 2532 4121 [email protected] Regional Research Head

Kosuke MIZUNO (852) 2848 4949 / (852) 2773 8273

[email protected]

Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected] Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional)

Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Regional)

Junjie TANG (852) 2773 8736 [email protected] Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong, China); Broker (China); Insurance (China)

Anson CHAN (852) 2532 4350 [email protected] Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected] Gaming and Leisure (Hong Kong/China)

Lynn CHENG (852) 2773 8822 [email protected] IT/Electronics (Semiconductor) (Greater China)

Dennis IP (852) 2848 4068 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap

Joey CHEN (852) 2848 4483 [email protected] Steel (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional)

Carrie YEUNG (852) 2773 8243 [email protected] Transportation (Hong Kong/China)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES

Bianca SOLEMA (63) 2 737 3023 [email protected] Utilities and Energy

SOUTH KOREA

Sung Yop CHUNG (82) 2 787 9157 [email protected] Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Mike OH (82) 2 787 9179 [email protected] Capital Goods (Construction and Machinery)

Jun Yong BANG (82) 2 787 9168 [email protected] Oil; Chemicals; Tyres

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game

TAIWAN

Rick HSU (886) 2 8758 6261 [email protected] Head of Regional IT/Electronics; Semiconductor/IC Design (Regional)

Steven TSENG (886) 2 8758 6252 [email protected] IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected] IT/Technology Hardware (Handsets and Components)

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Head of India Research; Strategy; Banking/Finance

Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities

SINGAPORE

Ramakrishna MARUVADA (65) 6499 6543 [email protected] Telecommunications (China/ASEAN/India)

Royston TAN (65) 6321 3086 [email protected] Oil and Gas (ASEAN/China); Capital Goods (Singapore)

David LUM (65) 6329 2102 [email protected] Property and REITs

Evon TAN (65) 6499 6546 [email protected] Property and REITs

Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)


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This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000). Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions. Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in

the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.


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• For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.

• There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.

• There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants.

*The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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