WATER STOCKS REVIEW - Asian water in 2007 – the bull makes a splash
- From: Vol 9, Issue 1 (January 2008)
- Category: General
- Region: Asia
- Country: China
- Related Companies: Asia Environmental Holdings, Beijing Capital Group, Bio-Treat Technology, Boustead, Brite-Tech, Darco, Dayen Environmental, Eastern Water, Hyflux, Hyflux Water Trust, Jaks, JP Morgan, Manila Water Company, Qianjiang Water Resources, Quantum Hedge Fund, Ranhill Utilities, Reyphon Agriceutical, Shandong Tianli Biochemical, Shanghai Industrial Holdings, Sinomem Technology and Tianjin Capital Environmental Co
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Asia was again the pick of the bunch last year as far as listed water stocks were concerned. Those with Chinese exposure continue to look like a good bet, says Frédéric Blanc-Brude.
An investor holding a market cap-weighted portfolio of the 25 largest water companies in Asia (by market capitalisation) would have enjoyed gains of 98% last year. In 2006, the same portfolio would have returned just over 50%. Water stocks have exploded all over the region, but how much further will it go?
The big story this year is, again, China. Not because of potential prospects (new Chinese water deals are now so frequent
they hardly make the headlines), but following an unprecedented influx of cash into the Chinese stock market. While the
Shanghai Composite flew up by 93.6% in 2007 despite a sharp plunge in late October, the Shanghai SE Utilities index has been catapulted up by 153.7% over the past 12 months.
In this context, Chinese water stocks are doing well. Beijing Capital Group (BCG), one of the multiple financial arms of the
municipality of Beijing, is up 268%, while Tianjin Capital is up 156%, and Qianjiang Water Resources 233%. With price-to-book and price-to-cash flow ratios that have also skyrocketed, Beijing Capital tops the list of the highest-valued water stocks in the region, with a price-to-book ratio in excess of 10. Last reported year-on-year sales for BCG were also up 130%.
Hong Kong-listed Shanghai Industrial Holdings, the second big PRC player in the water and wastewater sector, also fared very well, especially considering that while the Hang Seng was up 38.8% in 2007 and the Hang Seng Utilities Index by only 18% over the same period, the stock saw a price increase of 105% last year.
Roaring in the lion city
The Singapore Straits Times Index only grew by 11.2% in 2007 and, in this context, the performance of the Singapore-listed water firms looks even better. Asia Environment and Dayen, with most of their BOT operations in China, show that the obesity of the Shanghai stock market is not the only driver of water stock prices in the PRC. The former even managed to emulate its Chinese peers with a 12-month price increase in excess of 100% (Dayen is up 70%).
After several years in the doldrums, AE is finally looking like a good prospect. In February, it signed a new BOT contract with Shanghai Jinshan Zone Industrial Park II to develop a 50,000m3/d wastewater treatment project, and in June, it won two wastewater BOTs representing a further RMB135 million of capex. Prior to that, the firm had increased its capital by 10% after issuing £15 million of new shares.
Following its many troubles last year (amongst other things, three of its officers are embroiled in a legal suit with the former chairman over allegations of share fraud), Bio-Treat’s performance seems good on paper (up 29%). Nevertheless, considering that it, too, operates in China, it obviously failed to convince like AE and Dayen, despite receiving a higher
proportion of ‘buy’ recommendations from analysts. In effect, the firm saw a 1.4% year-on-year drop in net profits in its first quarter due to higher costs and expenses, and the Chinese taxman also caught up with Bio-Treat as tax breaks expired and tax expenses surged 194% to RMB33.4 million in the July-September quarter. The group’s revenue is increasing, however, led by higher contributions from wastewater treatment service projects and discharging fees received from BOTs.
Coming of age
Not everyone performed that well in Singapore, however. Sinomem and Darco had a great first half of 2007 like their peers, but then collapsed to finish below their 1st January levels, by 11% and 14%, respectively. Darco stock surged in August and September when the company announced a new S$130 million water treatment deal in Indonesia, deals in Taiwan and Malaysia, and plans to set up a JV with the Qatari environmental agency. This was perceived as a ‘coming-of-age’ moment for Darco – from operator to owner.
But the benefits for Darco’s bottom line will not be seen for some time; initially, Darco will be spending money on studies and plans. While Darco is moving towards ownership, ePure is firmly lodged in the 25% gross margin bracket of the EPC market and is taking a very cautious approach to the hot Chinese BOT sector. For now, it is up 50% y-o-y, but the stock was up 200% y-o-y at the end of 2006.
Sinomem prefers to position itself as a membrane technology company, building its business in downstream applications for its technology outside the water sector. In August, Sinomem launched a subsidiary, Reyphon Agriceutical, a manufacturer of agriculture biotech products, on the Singapore stock exchange, and has similar plans for another – Shandong Tianli Biochemical. Sinomem’s own share price had a boost in the summer when it announced four new wastewater treatment and reuse projects in China, but has settled back since. Like Darco, however, it still has to show concrete results, and with an ever-expanding list of water stocks to pick from, investors gave Sinomem a pass in 2007.
Finally, the three big water stocks on the Singapore exchange are SembCorp, Keppel and, of course, Hyflux. The first two offered no surprises, and despite stock price increases of ‘only’ 50% in 2007, they attracted the most ‘buy’ recommendations from analysts, with Keppel even making it to the S&P Global 1200 index. Hyflux also had a very good year and is up 37% (it was down 8% at the end of 2006). The company has regained popularity this year, with recent ventures into oil recycling, water treatment in Algeria, and the listing of its water trust.
With a market capitalisation of US$165 million, the Hyflux Water Trust (HWT) has only been listed for a month, but has nevertheless seen its share price rise (supported, no doubt, by the fact that arranger JP Morgan bought 8% of the stock). HWT owns a portfolio of 13 water treatment or recycling plants in China, and has concessions to operate these for between 20 and 30 years, with minimum off-take agreements for 45% of the total output, which covers operating costs. The venture also secured a new RMB50 million 20,000m3/d 20-year BOT for a wastewater treatment plant expansion in Jiangsu Province in late December.
In Malaysia, water stocks have not all followed the same path. Three firms have been absorbed in the China orbit: Boustead, Jaks and Brite Tech saw price increases of 234%, 171% and 118%, respectively in 2007, while the Kuala Lumpur Composite was up 33.1% over the same period. The construction index for the KLSE, meanwhile, was up 60% in 2007. In this context, well-established concessionaires like Ranhill and PBA saw their share prices decline marginally last year. Why? They have not made the quantum leap and engaged with the Chinese market.
The amount of interest in water stocks did not strictly limit itself to China: while the PSE index up 15% in the Philippines in 2007, Manila Water is up 97% over the same period (compared with 83% last year). In Thailand, however, Eastern Water managed to dodge the market, and despite the Bangkok SET going up 33%, the stock was down 14% in 2007.
World’s greatest market
Can these staggering share price increases have anything to do with Jim Rogers’ advice in “A Bull in China: Investing Profitably in the World’s Greatest Market” to buy stocks like AE and Bio-Treat? Rogers co-founded the Quantum Hedge Fund with George Soros and retired at 37; no doubt others are hoping to cash in on the Asia stock market surge before it goes ‘splash’.
But will this end with a splash or a whimper? Water stocks outperformed the market almost consistently last year, and there are good reasons for that. Rogers is right – China is driving a huge business flow, so huge that even Chinese firms cannot keep up. When it comes to environmental projects, China is moving directly from the 1930s to 2015. Some 1,000 wastewater plants are to be built over the next five years, the government has pledged more than US$125 billion to address the problem, and much more is expected to come from the private sector. A recent report from Macquarie pegged earnings growth for Singapore-listed water treatment companies at between 37 and 40% over the next three years. Indeed, between 2001 and 2006, the number of Chinese households owning a dishwasher almost tripled, and the number owning a washing machine
increased by 25%. Over the same period, the number of bars of soap used in China also went up by 25%, and the quantity of shower gel by 40%. On a national scale, this is sufficient to generate enough wastewater for all the private operators in the Chinese sector to treat.
Still, one should not underestimate the ability of the Chinese to live without sufficient wastewater treatment (or sufficient water for that matter). Economic fundamentals are not enough to guarantee that Asian water companies are onto a good thing in China. The major story last year in the PRC was that central tax receipts had increased dramatically – by 30%. That was part of the bad news for Bio-Treat, but it is really good news: the central government is getting a firmer grip on the regulation of the market economy in China, and that means that its strong commitment to enforcing environmental regulation is increasingly likely to be met. This was not a given outcome even two years ago. In the depressed financial context which characterises early 2008, those Asian water firms that have the ability to service the Chinese market continue to look like a good bet.
The author is an economist and specializes in the Chinese infrastructure market (firstname.lastname@example.org).