China water: Flowing strongly

- Pressing water shortages raise awareness of conservation• "Severe drought in southern Chinese provinces has threatened rice crops and reservoirs."• "Macau and Zhuhai rely on the Xijiang River in Guangdong, and they experience salt tides."
- 12th Five-Year Plan to lend further support to the sector• "Continued focus on water conservation: bodes well for tariff hikes and privatisation, in our view."• "Investment of RMB700bn during 2011-15F (up from RMB330bn during 2006-10) in wastewater treatment industry is forecast by the Ministry of Construction."• "Opportunities in recycling water: target to recycle 10% of wastewater emission in urban area by 2015F, representing a CAGR of 24% from 2009."
- Tariff hikes should come in steeper and more widely• "Avg water tariffs in 36 major cities grew by 8%, from RMB1.7/m3 in Jun 2009 to RMB1.84/m3 in Jun 2010"• "Chinese water tariffs only account for 0.8% of disposable household income."
- Wastewater treatment: maturing, but growth will be sustained• "As the market matures, capacity growth should slow to 8% pa from 2010F, compared with 11-16% in 2006-08, by assuming a wastewater treatment ratio of 90% by end-2015F."• "But we are not close to over-capacity, given third- and fourth-tier cities and counties are still showing wastewater treatment ratios of 30-50%, compared with 73% in urban areas in 2009 and 80%-95% in OECD countries."

- Tap water supply remains a privatisation story
• "Management ability in M&A execution and track record are key success factors."
- Waste-to-energy is the next attraction
• "Industry is still in its infancy, though proper legislation should open up opportunities."

• "WTE should outshine other waste treatment projects in terms of capacity growth, at 17% CAGR versus 10% in overall waste treatment, given it has higher environmental standards and energy efficiency but accounts for less than 20% of China’s residential waste currently being treated, compared with 80% from landfill sites."

- Defensive against rising commodity prices and inflation
- Risks: intensifying competition, rising interest costs
- Our stock-picking criteria and preferences

• "Search for company-specific strengths to identify outperformers in the sector — solid track records and rich catalysts for growth in 2010-11F, followed by quality management, undemanding valuations, and healthy balance sheets."
• "Preferences for quality players: Guangdong Inv’t (270 HK, BUY), China Everbright Int’l (257 HK, BUY)."
• "Risks/rewards opportunities: Beijing Enterprises Water (371 HK, BUY), China Water Affairs (855 HK, BUY), Sound Global (SGL SP, BUY)."
• "NEUTRAL on Hyflux (HYF SP) due to financial risks as overhangs."
• "Avoid Tianjin Capital Environmental (1065 HK, REDUCE)."

Nomura China Water Environment Sep2010