China Water Affairs Group Limited — Growth story continues

China Water Affairs Group (HK: 855)

Last close As at 28/03/2024

6.11

0.00 (0.00%)

Market capitalisation

9,684m

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Research: Industrials

China Water Affairs Group Limited — Growth story continues

China Water Affairs (CWA) delivered a CAGR of 24.7% in top-line growth and a CAGR of 23.4% in EBITDA in FY12-17. We expect its growth story to continue with volume/price increases in the Chinese market and the opportunity to acquire underperforming assets from local governments. We forecast revenue to increase 25% in FY18 and 20% in FY19 (vs consensus of 19% and 14%, respectively), on the back of a 50% increase in capex in FY17 under service concession contracts. Its net debt of HK$6.2bn and net debt to equity ratio of 70% are at a historical high. The management of capex spending and the pace of acquisitions will be a delicate balancing act against the level of leverage. We reduce our fair value by 6% from HK$7.12/share to HK$6.71/share based on sum-of-parts EV/EBITDA valuation as we lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively (given CWA’s reported FY17 sales were 9% below our previous estimates).

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Industrials

China Water Affairs Group

Growth story continues

Outlook for FY18e

Utilities

13 September 2017

Price

HK$4.77

Market cap

HK$7,675m

Net debt (HK$m) as at 31 March 2017

6,232

Shares in issue

1,609m

Free float

47%

Code

855

Primary exchange

HK

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

9.2

4.4

0.6

Rel (local)

4.9

(4.1)

(16.2)

52-week high/low

HK$6.0

HK$4.2

Business description

China Water Affairs (CWA), a mid-sized private water company, is a pioneer in the privatisation of water supply assets in China. The company seeks to create growth via volume/price increases and asset acquisitions. It is a constituent of the FTSE Environmental Opportunities Asia Pacific Index.

Next events

H1 results

November 2017

Analysts

Emily Liu, CFA

+44 (0)20 3077 5700

Jamie Aitkenhead

+44 (0)20 3077 5746

China Water Affairs Group is a research client of Edison Investment Research Limited

China Water Affairs (CWA) delivered a CAGR of 24.7% in top-line growth and a CAGR of 23.4% in EBITDA in FY12-17. We expect its growth story to continue with volume/price increases in the Chinese market and the opportunity to acquire underperforming assets from local governments. We forecast revenue to increase 25% in FY18 and 20% in FY19 (vs consensus of 19% and 14%, respectively), on the back of a 50% increase in capex in FY17 under service concession contracts. Its net debt of HK$6.2bn and net debt to equity ratio of 70% are at a historical high. The management of capex spending and the pace of acquisitions will be a delicate balancing act against the level of leverage. We reduce our fair value by 6% from HK$7.12/share to HK$6.71/share based on sum-of-parts EV/EBITDA valuation as we lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively (given CWA’s reported FY17 sales were 9% below our previous estimates).

Year end

Revenue

(HK$m)

PBT*
(HK$m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

03/16**

4,740

1,505

40

8.0

11.9

1.7

03/17

5,708

1,963

55

20.0

8.7

4.2

03/18e

7,103

2,159

60

12.5

8.0

2.6

03/19e

8,526

2,536

70

15.0

6.8

3.1

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. **FY16 financials have been restated.

FY17: Growth and profitability on track

CWA posted 20% growth in revenue and 34% growth in EBITDA in FY17. Operating cash flows increased by 25% y-o-y to HK$1,454m. Meanwhile, capex increased 50% to HK$1,910m, mainly on water supply capacity expansion under service concession agreements as the sole water supplier in different regions. Net debt increased by 48% to HK$6.2bn, bringing CWA’s net debt to equity ratio from 50% in FY16 to 70% in FY17, a level comparable to HK-listed peers.

Acquisitions: Acceleration on the cards

CWA took a breather from asset purchases, with cash outflows for acquisitions down from HK$972m in FY16 to HK$286m in FY17. As the central government is pushing local governments to improve the efficiency of existing infrastructure, CWA intends to speed up acquisitions in central, eastern and southern China.

Valuation: Growth not priced in

We derive our fair value with a sum-of-parts EV/EBITDA valuation and lower our fair value by 6% from HK$7.12/share to HK$6.71/share (primarily as a result of our 6% and 7% downward revision of FY18e and FY19e revenue forecasts, respectively). Our net debt calculations are based on management’s guidance regarding the likely recovery of HK$860m loan to China City Infrastructure Group in FY18e and combined capex and acquisitions at c HK$2bn over the next three years.

Investment summary

Company description: Pioneer in water asset privatisation

CWA, a mid-sized private water company, is a pioneer in the privatisation of water supply assets in China (the so-called TOO model: transfer, own and operate). Currently, the company has extensive and exclusive water supply coverage in over 50 cities (mostly Tier 3/4) in 13 provinces, connecting to 2.9 million users. CWA is a constituent of the FTSE Environmental Opportunities Asia Pacific Index and is included in Shenzhen-Hong Kong Stock Connect.

Financials: Increased capex for future growth

CWA posted 20% top-line growth in FY17 (vs restated revenue for FY16), driven by a 24% increase in its water supply segment (85% of the total revenue) and 67% growth in its sewage treatment segment (contributing 9% of the total revenue).

With acquisitions slowing down from HK$972m in FY16 to HK$286m in FY17, the company upped its capex by 50% to HK$1,910m to maintain its growth engine. Net debt increased by 48% to HK$6.2bn, bringing its net debt to equity ratio from 50% in FY16 to 70% in FY17.

The financial restatement regarding the reclassification of property, plant and equipment to intangible assets in FY17 aims to bring the reporting of concession rights in line with Hong Kong-listed peers to facilitate like-for-like comparisons. Previously, the assets operating under the TOO model were recognised as property, plant and equipment. Under the new accounting policy, these assets are recognised as intangible assets (concession rights).

Exhibit 1: Change in estimates

Year end 31 March

Revenue (HK$m)

PBT (HK$m)

EBITDA (HK$m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

FY18e

7,535

7,103

(5.7%)

2,168

2,159

(0.0%)

2,796

2,831

(1.3%)

FY19e

9,114

8,526

(6.5%)

2,700

2,536

(6.1%)

3,425

3,283

(4.1%)

FY20e

10,542

9,976

(5.4%)

3,128

2,935

(5.1%)

3,973

3,767

(5.2%)

Source: Edison Investment Research

Valuation: EV/EBITDA multiples

We lower our fair value by 6% from HK$7.12/share to HK$6.71/share based on a sum-of-parts EV/EBITDA multiple. We think the sum-of-parts EV/EBITDA multiple can best reflect the immediate impact of our reduced revenue and hence EBITDA forecast and incorporate management’s guidance on capex/acquisitions and likely net debt positions. We lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively, as CWA’s reported FY17 sales were 9% below our prior estimates. CWA exited FY17 with net debt of HK$6.2bn, almost 30% higher than our prior forecast, as a result of 50% higher capex and an HK$860m loan to China City Infrastructure Group (currently 7.3% owned by CWA). We derive the fair value of HK$6.71/share based on 7.0x EV/EBITDA multiples for its water business, at a discount of approximately 50% to HK-listed peers, plus 1.3x FY17 book value of its property development and other segments. We assume minorities increase 12.7% from HK$3.35bn to HK$3.77bn as CWA continues to make acquisitions. We model its net debt to decrease by 5% from HK$6.23bn to HK$5.90bn from FY17 to FY18e based on management’s guidance of approximately HK$2bn capex and acquisitions (vs HK$2.2bn in FY17) and likely recovery of the HK$860m loan to China City Infrastructure Group.


Sensitivities: Policy and competition

Investors in CWA should take heed of the following risk factors.

Political issues: While it is the Chinese central government’s intention to deleverage local governments with public-private partnerships, the effectiveness of this policy remains to be seen. This may affect the size of the addressable market for CWA.

Competitive issues: CWA’s cash outflows for acquisitions in FY17 declined from FY16 by 70% due to increased competition in the secondary market for water infrastructure.

Leverage issues: CWA may continue to take advantage of its competitive funding costs and increase its net debt in absolute terms.

Company description: In pursuit of organic and inorganic growth

CWA is a listed company in Hong Kong offering pure equity exposure to tap water supply in China (with 87% of FY17 revenue from city water supply operation and construction). The company is a pioneer in the privatisation of water supply assets in China.

Opportunity: Under penetration of tap water outside cities

According to the National Statistics Bureau of the PRC, 98% of the city population was covered by the tap water supply network by the end of 2015. However, only 451 million people had access to tap water in 2015, slightly over 30% of the country’s entire population. In summary, tap water is under-penetrated especially in Tier 3/4 cities. CWA believes that these cities offer an attractive combination of growth potential and a lighter regulatory burden.

Business model: Asset privatisation as value driver

Management estimates that private enterprises account for only 20% of the water supply industry, and believes that the opportunity for privatisation remains significant. CWA prefers to have total control of its water networks, tariff negotiations and capital budgeting (the TOO model: transfer, own and operate). CWA seeks to acquire water networks at book value from often loss-making local governments, and create value with operational improvements and tariff negotiations. The basis for tariff determination is an ROE range of 8-12%, according to CWA. As a general rule, management hopes to make acquired assets accretive to earnings within two to three years.

Management: Experience and connections

Before founding Silver Dragon Group, the predecessor of CWA, in the 1990s, Chairman Duan Chuan Liang worked for the Ministry of Water Resources of the PRC for more than 10 years. The combination of his political connections and entrepreneurial approach was critical to the growth of the company, especially in the early days.

Shareholder returns: Low funding cost plus capital discipline

CWA indicates that its funding cost is approximately 2-3% offshore and 5-10% below benchmark borrowing rates onshore. Management seeks to create value for shareholders with a combination of competitive borrowing costs and, hopefully, a disciplined approach to capital deployment. For instance, CWA prioritises the project opportunities where it has existing customer service networks, to mitigate counterparty risks as a result of heavy leverage of local governments.


Business segment and operations

The majority of CWA’s water supply capacity is located in Tier 3/4 cities, under 30- to 50-year exclusive and renewable concession rights. It currently has daily capacity of 6.7m m3 for tap water. On top of its vertically integrated capabilities from raw water processing, tap water supply and sewage treatments, CWA is seeking to enter industrial wastewater treatment by targeting enterprise customers with specific technological requirements (evidenced by its long-term contract with China National Offshore Oil Corporation).

Exhibit 2: CWA’s geographic footprint

Source: China Water Affairs Group data

Water supply: Volume and pricing growth

City water supply business is bread and butter for CWA, accounting for approximately 85% of the firm’s revenue.

Exhibit 3: Revenue by segment in percentage terms

Exhibit 4: Revenue by segment in absolute terms

Source: China Water Affairs Group data

Source: China Water Affairs Group data

Exhibit 3: Revenue by segment in percentage terms

Source: China Water Affairs Group data

Exhibit 4: Revenue by segment in absolute terms

Source: China Water Affairs Group data

The volume of city water supply in China grew from 60bn tonnes in 2010 to 66.8bn tonnes in 2015, at a CAGR of 2.2% according to the data from the Ministry of Housing and Urban-Rural Development. Frost & Sullivan forecasts a CAGR of 2.2% for 2016-20e for the market to increase to 74.4bn tonnes by 2020.

Exhibit 5: City water supply in China

Exhibit 6: Retail/industrial water prices in China

Source: Ministry of Housing and Urban-Rural Development

Source: Ministry of Housing and Urban-Rural Development

Exhibit 5: City water supply in China

Source: Ministry of Housing and Urban-Rural Development

Exhibit 6: Retail/industrial water prices in China

Source: Ministry of Housing and Urban-Rural Development

Sewage treatment: Expanding market size

CWA entered the sewage water treatment market in 2012. This segment reports a CAGR of 82% in FY13-17 in terms of top-line growth from a small base.

Exhibit 7: Water supply revenue and EBITDA margin date

Exhibit 8: Sewage treatment revenue and EBIDTA margin

Source: China Water Affairs Group data

Source: China Water Affairs Group data

Exhibit 7: Water supply revenue and EBITDA margin date

Source: China Water Affairs Group data

Exhibit 8: Sewage treatment revenue and EBIDTA margin

Source: China Water Affairs Group data

The city sewage treatment market has been growing in size rapidly in China since the 1980s, with the city sewage treatment volume up from 35.5bn tonnes in 2010 to 50.7bn tonnes in 2015. The residential waste water processing fee went up from RMB0.76 per tonne in 2010 to RMB0.85 per tonne in 2015, and the industrial waste water processing fee increased from RMB1.08 per tonne to RMB1.16 per tonne during the same period.

Exhibit 9: Waste water treatment market in China

Exhibit 10: Waste water processing fees in China

Source: Ministry of Housing and Urban-Rural Development

Source: Ministry of Housing and Urban-Rural Development

Exhibit 9: Waste water treatment market in China

Source: Ministry of Housing and Urban-Rural Development

Exhibit 10: Waste water processing fees in China

Source: Ministry of Housing and Urban-Rural Development

As CWA does not disclose outputs, utilisation or average selling prices, we forecast its revenue based on the Chinese water market growth (in terms of volume and price), CWA’s current capacity and plans to continue with a similar rate of capex and acquisition. We forecast CWA’s water supply segment to grow 30% in FY18e and 22% in FY19e (vs the CAGR of 30% in FY13-17). We assume only 5% growth for the sewage business as the TOO model (ie asset acquisition) is generally not applicable. We also factor in potential valuation gains and profit realisation of CWA’s property development business, reported in ‘other’ segments. We are conservative about the profitability of the water supply segment in the mid-term as we think the competition in the secondary market may eventually increase acquisition costs for CWA (vs the acquisitions at book value in the past).

Exhibit 11: Segment revenue and EBITDA

HK$m

2013

2014

2015

2016

2017

2018e

2019e

2020e

CAGR

Revenue

Water supply

1,734

1,875

2,244

4,003

4,874

6,347

7,733

9,143

27%

Sewage treatment

51

82

170

339

531

581

610

640

44%

Others

466

789

444

397

303

175

184

193

-12%

Total

2,251

2,747

2,859

4,740

5,708

7,103

8,526

9,976

24%

EBITDA

 

 

 

 

 

 

 

 

 

Water supply

615

731

941

1,468

1,847

2,106

2,494

2,909

25%

Sewage treatment

21

31

56

184

208

215

226

237

41%

Others

212

125

153

105

289

227

235

245

2%

Total

848

887

1,150

1,757

2,343

2,548

2,955

3,391

22%

EBITDA margin

 

 

 

 

 

 

 

 

 

Water supply

35%

39%

42%

37%

37%

33%

32%

32%

 

Sewage treatment

42%

38%

33%

54%

38%

37%

37%

37%

 

Others

45%

16%

34%

26%

173%

130%

128%

127%

 

Total

38%

32%

40%

37%

41%

36%

35%

34%

 

Source: China Water Affairs Group data; Edison Investment Research. Note: segment-aggregated EBITDA is lower than firm-level EBITDA.

Growth, capex and acquisitions: A balancing act

We model CWA’s revenue to grow 25% in FY18 and 20% in FY19 (vs consensus of 19% and 14%, respectively) and operating margins to be 34% in FY18 and 33% in FY19 (vs 40% in FY17), after stripping out the HK$185m non-cash valuation gain in H117 and factoring in an increase in amortisation of concession rights due to higher capex in FY17. Management guides its FY18e revenue should increase by 20-30% year-on-year. In the absence of CWA’s disclosure on outputs and average selling prices, our assumptions for its revenue growth are based on the following:

a 2.2% CAGR in the volume of city water supply and a CAGR 2-3% in the price of residential and industrial water tariffs in 2011-2015 in China;

a 7.5% increase in end-of-year nameplate capacity of water supply from 6.23m cubic metres in FY16 to 6.7m cubic metres in FY17; and

a 50% increase in capex in FY17 under service concession contracts.

Exhibit 12: Revenue and EBITDA growth

Exhibit 13: Capex and acquisitions

Source: China Water Affairs Group data; Edison Investment Research

Source: China Water Affairs Group data; Edison Investment Research

Exhibit 12: Revenue and EBITDA growth

Source: China Water Affairs Group data; Edison Investment Research

Exhibit 13: Capex and acquisitions

Source: China Water Affairs Group data; Edison Investment Research

We view CWA’s acquisitions and capital expenditures as an integrated vehicle for growth. In FY14 and FY15, the company’s capex was close to HK$800m pa and acquisition cash outflows totalled HK$165m and HK$95m, respectively. The combined cash outflows for capex and acquisitions more than doubled in FY16/17 from the FY14/15 level. Understandably, the net debt to equity ratio also went up, from 57% in FY14 to 78% in FY17. CWA’s effective interest rate for borrowing also increased from 3.5% to 4.8% during this period, although its funding cost remains competitive in the industry.

Management

Executive Chairman Mr Duan Chuan Liang: After working for the Ministry of Water Resources of the PRC for more than 10 years, Mr Duan founded Silver Dragon Group in the 1990s, the predecessor of China Water Affairs. He is also the chairman and non-executive director of China City Infrastructure Group (2349.HK). He has a bachelor’s degree in water conservation and hydro power from the North China College.

Executive Director Ms Ding Bin: Ms Ding Bin has over 10 years of experience in financial management and tax planning. She graduated from Zhengzhou University of Technology in finance and computer management and is a certified public accountant in the PRC.

Executive Director Ms Liu Yu Jie: Ms Liu Yu Jie started her career in investment banking and progressed to corporate management roles. Prior to CWA, she was an executive director of Shanghai Industrial Investment (Holdings) Co and sat on the board of several environmental and resource management companies. She graduated from the University of International Business and Economics with a master’s degree in business administration.

Executive Director Mr Li Zhong: Mr Li Zhong is a member of the Standing Committee of the Shenzhen Municipal Committee of the Chinese People’s Political Consultative Conference. For more than 20 years, he has served in large state-owned enterprises and US-based corporations. He graduated from Saint Mary’s University of Canada with a master’s degree in business administration.

Sensitivities

Investors in CWA should be mindful of the following risk factors:

Political issues: While it is the Chinese central government’s intention to deleverage local governments with the PPP (public-private partnership) scheme, the effectiveness of this policy remains to be seen. This may affect the size of the addressable market for CWA’s acquisitions, but it is difficult to gauge the net effects of various moving parts in the policy landscape.

For instance, local governments are required to steer away from hiding debts via guaranteed purchases, because PPP projects are capped at 10% of the annual budgets for local governments and project development process is long and tedious. This could open up more opportunities for CWA, if more local governments are forced to divest loss-making assets in order to free up their balance sheets.

Competitive issues: CWA’s cash outflows for acquisitions in FY17 declined from FY16 by 70% due to increased competition in the secondary market for water infrastructure.

Technical issues: There are currently outstanding options for 10-20m shares according to management in September 2017, after most of the 110.7m options issued on 3 October 2014 (when the share price was HK$3.4) and 8m issued on 9 September 2015 (when the share price was around HK$3.4) have been exercised from April 2017.

Exhibit 14: Outstanding options granted to directors and employees up to end March 2017

Option holder

No. of options

Data of grant

Exercise price

Expiration

Chairman Mr Duan Chuan Liang

68,000,000

3 October 2014

HK$3.6

3 October 2017

Ms Ding Bin

5,000,000

3 October 2014

HK$3.5

3 October 2017

Ms Liu Yu Jie

3,000,000

3 October 2014

HK$3.5

3 October 2017

Mr Li Zhong

8,000,000

9 September 2015

HK$3.5

9 September 2018

Mr Zhao Hai Hu

2,500,000

3 October 2014

HK$3.5

3 October 2017

Ms Wang Xiaoqin

2,000,000

3 October 2014

HK$3.5

3 October 2017

Mr Zhou Wen Zhi

1,000,000

3 October 2014

HK$3.5

3 October 2017

Employees in aggregate

29,200,000

3 October 2014

HK$3.5

3 October 2017

TOTAL

118,700,000

Source: China Water Affairs Group data

Balance sheet issues: CWA may lever up its balance sheet to take advantage of its competitive funding costs. While high leverage is not uncommon in this sector, borrowing costs may eventually go up.

Valuation

We lower our fair value by 6% from HK$7.12/share to HK$6.71/share based on a sum-of-the-parts EV/EBITDA multiple, as we think this method can reflect the immediate impact of our reduced revenue forecast and the likely net debt positions based on guidance. We lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively, as CWA’s reported FY17 sales were 9% below our prior estimates. CWA exited FY17 with net debt of HK$6.2bn, almost 30% higher than our prior forecast, as a result of 50% higher capex and an HK$860m loan to China City Infrastructure Group (currently 7.3% owned by CWA). We derive the fair value of HK$6.71/share based on 7.0x EV/EBITDA multiples for its water business, at a discount of approximately 50% to HK-listed peers, plus 1.3x FY17 book value of its property development and other segments. We assume minorities increase 12.7% from HK$3.35bn to HK$3.77bn as CWA continues to make acquisitions and the original shareholders of the acquired assets typically retain 30-40% of the stakes. We model its net debt to decrease by 5% from HK$6.23bn to HK$5.90bn from FY17 to FY18e based on management’s guidance of approximately HK$2bn capex and acquisitions (vs HK$2.2bn in FY17e) and likely recovery of the HK$860m loan to China City Infrastructure Group.

Exhibit 15: EV/EBITDA and book value SOTP valuation

Sum of the parts

Current price (HK$)

4.77

 

 

 

 

Fair value per share (HK$)

6.71

 

Upside/(downside) to FV

40.6%

 

Dividend yield (FY18e)

2.6%

 

Total return

43.2%

 

Current number of shares (m)

1,609

 

Segment

Valuation method

HK$m

Multiple

Implied value, HK$m

HK$/share

City water supply operation and construction

FY18e EBITDA multiple

2,106

7.0

14,744

9.16

Sewage treatment operation and construction

FY18e EBITDA multiple

215

7.0

1,504

0.93

Property development and other segments

FY17 BV multiple

3,244

1.3

4,217

2.62

GROUP ENTERPRISE VALUE

 

 

20,465

12.72

Less: FY18e net debt

 

 

5,901

3.67

Less: FY18e minorities

 

 

3,773

2.35

SOTP VALUATION for Equity

 

 

 

10,550

6.71

Source: China Water Affairs Group data; Edison Investment Research

Exhibit 16: Peer comparison

Company

Ticker

Market cap (local)

Dividend yield FY1 (%)

P/E FY1
(x)

P/E FY2
(x)

P/E FY3
(x)

EV/EBITDA FY1 (x)

EV/EBITDA FY2 (x)

EV/EBITDA FY3 (x)

China Water Affairs

855:HK

7.7bn

2.6

8.0

6.8

5.9

4.9

4.2

3.7

Guangdong Investment

270:HK

73.0bn

4.3

14.6

14.8

14.1

9.3

9.2

8.7

Beijing Enterprises Water

371:HK

55.5bn

2.4

13.6

10.9

9.2

14.2

11.9

10.2

Tianjin Capital

1065:HK

24.7bn

1.6

12.4

11.7

18.0

17.0

Average HK-listed

 

2.8

13.5

12.5

11.7

13.8

12.7

9.5

Beijing Capital

600008 CH

33.3bn

1.4

45.8

40.2

34.2

21.9

19.9

19.2

Beijing Originwater Tech

300070 CH

58.9n

0.5

22.9

17.7

13.9

18.8

14.0

10.8

Chongqing Water Group

601158 CH

33.6bn

4.4

20.1

20.6

20.0

14.8

14.3

Average mainland China

 

2.1

29.6

26.0

22.7

18.5

16.1

15.0

Veolia Environment

VIE FP

11.3bn

4.1

19.5

16.6

15.1

6.4

6.1

5.8

Suez Environment

SEV FP

10.4bn

4.0

23.4

17.6

15.9

6.8

6.2

5.9

United Utilities

UU/ LN

6.1bn

4.3

19.6

17.3

16.1

13.0

12.3

11.9

Average Europe

 

4.1

20.8

17.2

15.7

8.7

8.2

7.9

Source: Bloomberg; Edison Investment Research. Note: prices at 12 September 2017. CWA forecasts based on Edison Investment Research estimates, and EV/EBITDA based on net debt exiting FY17, to be consistent with Bloomberg’s calculation.

Shareholder value: Low funding cost plus capital discipline

Management seeks to create value for shareholders with a combination of competitive borrowing costs and a disciplined approach to capital deployment.

Low borrowing cost

CWA indicates that its funding cost is approximately 2-3% offshore (outside China) and 5-10% below benchmark rates onshore (in China). In January 2017, the company issued a US$300m five-year senior note at face value and a coupon rate of 5.25% due in 2022.

Compared to Beijing Enterprises Water Group (371.HK), a Beijing government-owned water utility focusing on sewage water treatment, and Luzhou Xinglu Water (2281.HK), a Sichuan-based regional water company with a business model similar to CWA, CWA’s effective interest rates for bank loans look competitive. Among the three companies, Luzhou Xinglu Water is the least levered, but its borrowing cost is the highest, possibly due to a smaller scale. Luzhou Xinglu Water also prefers to have ownership of water supply assets. It is currently serving 0.26 million users vs 2.9 million users covered by CWA’s networks.

Exhibit 17: Effective borrowing cost

Exhibit 18: Net debt to equity ratios

Source: China Water Affairs Group data; Edison Investment Research. Note: CWA FY17 (ending in March) compared to Beijing Enterprise Water Group’s and Luzhou Xinglu’s FY16 (ending in December 2016).

Source: China Water Affairs Group data; Edison Investment Research. Note: CWA FY17 (ending in March) compared to Beijing Enterprise Water Group’s and Luzhou Xinglu’s FY16 (ending in December 2016).

Exhibit 17: Effective borrowing cost

Source: China Water Affairs Group data; Edison Investment Research. Note: CWA FY17 (ending in March) compared to Beijing Enterprise Water Group’s and Luzhou Xinglu’s FY16 (ending in December 2016).

Exhibit 18: Net debt to equity ratios

Source: China Water Affairs Group data; Edison Investment Research. Note: CWA FY17 (ending in March) compared to Beijing Enterprise Water Group’s and Luzhou Xinglu’s FY16 (ending in December 2016).

Capital discipline

It is worth noting that CWA holds the view that the quality of the currently available PPP projects in China is not consistent. While it is the intention of the central government to encourage local municipals to use JV/hybrid ownership structures in order to deleverage their own balance sheets and improve the operating efficiency of existing assets, the majority of PPP projects in water and sewage on the market are for new infrastructure, and the repayments primarily come from local governments. CWA indicates that it prioritises on the opportunities where it has existing customer care networks, to mitigate counterparty risks.

Shareholder value

Economic value added (EVA) spread, the delta between WACC (weighted cost of capital) and ROIC (return on invested capital) is a good metric for shareholder value. We think CWA’s competitive borrowing cost is a key contributor to its low WACC. Even compared to state-owned enterprises such as Beijing Enterprises Water Group (43.6% owned by Beijing Enterprises, essentially the Beijing city government), CWA’s borrowing cost looks competitive. We believe this is the result of CWA’s quality assets and stable cash flows. On the other hand, CWA’s cost discipline seems to pay off, reflected in a higher ROIC compared to Beijing Enterprises Water Group.

Exhibit 19: WACC, ROIC and EVA spread

Company

Ticker

WACC

ROIC

EVA spread

Comment

China Water Affairs

855.HK

5.08%

7.87%

2.79%

85% revenue from water supply, with ownership of operating assets

Beijing Enterprises Water Group

371.HK

6.61%

6.71%

0.10%

Focusing on sewage treatment; significant exposure to Beijing and Guangdong

Guangdong Investment

270.HK

7.52%

9.10%

1.58%

Conglomerate with water and other infrastructure assets in Guangdong

Tianjin Capital

1065.HK

9.31%

6.43%

(2.89%)

50% owned by Tianjin City Government; focusing on waste water treatment

China Water Industry

1129.HK

7.23%

2.30%

(4.93%)

20% revenue in water supply; 8% in sewage treatment; 50% in construction service; 22% in biogas power generation

Source: Bloomberg; Edison Investment Research

Financials: Earnings quality intact, but risk increases with higher gearing

We lower our revenue forecasts for FY18 and FY19 by 6% and 7%, respectively, as CWA’s reported FY17 sales were 9% below our prior estimates. We also revise EBITDA downward for FY18 and FY19 by 1% and 4%, respectively. We assume a certain degree of operating leverage.

Exhibit 20: Edison earnings versus consensus

HK$m

2018e

2019e

2020e

Edison revenues

7,103

8,256

9,976

Bloomberg revenues

6,796

7,781

9,058

± Edison vs consensus

4.6%

6.1%

10.1%

Edison EBITDA

2,831

3,283

3,767

Bloomberg EBITDA

2,539

2,980

3,335

± Edison vs consensus

11.5%

10.2%

13.0%

Edison EBIT

2,418

2,828

3,267

Bloomberg EBIT

2,292

2,732

3,121

± Edison vs consensus

4.1%

3.5%

4.7%

Edison net debt

5,901

6,052

5,976

Bloomberg net debt

6,148

6,022

6,163

± Edison vs consensus

(4.0%)

0.0%

(3.0%)

Source: Edison Investment Research, Bloomberg data (7 September 2017).

The quality of its earnings in FY17 is comparable to FY16, both with net operating cash flows as approximately 25% of revenues (vs 9% in FY15). CWA generated net operating cash flows of HK$1.45bn, 25% up year-over-year.

However, CWA’s net debt and leverage are at a historical high, with a net debt up 48% to HK$6.23bn in FY17 as a result of a 50% increase in capex to HK$1,910m and the HK$860m loan to China City Infrastructure Group (currently 7.3% owned by CWA). So far, the short-term debts remain at 30% or lower of the total interest-bearing debts.

Exhibit 21: Net debt and net debt to equity ratio

Exhibit 22: Short-term and long-term debt breakdown

Source: China Water Affairs Group data

Source: China Water Affairs Group data

Exhibit 21: Net debt and net debt to equity ratio

Source: China Water Affairs Group data

Exhibit 22: Short-term and long-term debt breakdown

Source: China Water Affairs Group data

A major change in CWA’s financial reporting in FY17 is the reclassification of the water supply infrastructure under the TOO model from property, plant and equipment to other intangible assets. Management indicates that this restatement is to bring its reporting in line with peers in Hong Kong, as recommended by its new auditor PwC, to facilitate like-for-like comparisons. This restatement has no retroactive impact on operating expenses or operating cash flows.

Revenue: Non-cash HK$700m increase in restated FY16 top line

In FY17, CWA restated its financials for FY15 and FY16 to bring its accounting policy in line with peers regarding the revenue and asset recognition of concession agreements. This restatement has no retroactive impact on operating expenses or operating cash flows.

On the income statement, a major change is a non-cash HK$700m increase in FY16 revenue, as a result of estimates on a cost-plus basis for construction services (vs percentage of costs incurred to date and a gross margin assumption). CWA believes that the gross margin assumption used for its estimates at 10.7% is lower than the 20% typically seen among its peers. Management also thinks that the non-cash HK$700m increase in FY16 revenue is evidence of its prior conservative revenue recognition policy.

Exhibit 23: Segment reporting FY16 before and after restatement

HK$m

Previous

Restated

Water supply connection income

1,179

797

Water supply construction services (intangible assets)

589

1,496

Water supply operation services

1,447

1,447

Sewage treatment and drainage operation services

279

279

Sewage treatment construction services (financial + intangible assets)

39

39

Sales of goods

354

354

Others

146

145

Total revenue

4,033

4,740

Source: China Water Affairs Group accounts; Edison Investment Research

Balance sheet: PPE reclassified into intangible assets

The water supply infrastructure previously classified as property, plant and equipment is now reclassified to intangible assets, as the amount to be received from end-users is uncertain. These intangible assets are amortised on a straight-line basis over the terms of remaining service concession periods.

Management indicates that its previous accounting policy should in theory result in a lower EBIT number (all else being equal) because depreciation of fixed assets is typically over 10-15 years (vs amortisation of intangible assets under concession contracts typically over 25-30 years of the contract period).

Exhibit 24: Key change in cash flows and balance sheet due to restatement

HK$m

Before restatement

After restatement

Year end 31 March

2015

2016

2015

2016

Property, plant & equipment

5,995

6,716

618

590

Other intangibles

176

764

6,526

8,041

Receivables from concession agreements

N/A

N/A

349

541

Depreciation of fixed assets

282

324

N/A

45

Amortisation of intangible assets

9

9

N/A

227

Cash flows from investing activities

Purchase of property, plant & equipment

(781)

(670)

N/A

(67)

Increase in concession rights for water supply and sewage processing

(6)

(601)

N/A

(1,206)

Source: China Water Affairs Group accounts; Edison Investment Research

Exhibit 25: Financial summary

HKDm

2016

2017

2018e

2019e

2020e

31-March

HKFRS

HKFRS

HKFRS

HKFRS

HKFRS

PROFIT & LOSS

Water supply revenue

3,922

4,874

6,347

7,733

9,143

Sewage treatment

318

531

581

610

640

Other segments

500

303

175

184

193

Revenue TOTAL

 

 

4,740

5,708

7,103

8,526

9,976

EBITDA

 

 

1,951

2,647

2,831

3,283

3,767

Operating Profit

 

 

1,647

2,271

2,418

2,828

3,267

Amortization

241

316

348

382

421

Depreciation

63

60

66

73

80

Net Interest expense

(171)

(251)

(289)

(332)

(382)

Profit Before Tax

 

 

1,505

1,963

2,159

2,536

2,935

Tax

(305)

(583)

(604)

(710)

(822)

Profit After Tax

1,200

1,379

1,554

1,826

2,113

Net profits contributable to shareholders

749

854

964

1,132

1,310

Average Number of Shares Outstanding (m)

1,508.5

1,541.2

1,609.0

1,609.0

1,609.0

EPS - normalised and fully diluted (c)

 

40.1

55.4

59.9

70.4

81.4

Dividend per share (c)

8.0

20.0

12.5

15.0

17.5

Water supply revenue growth (%)

78.4

23.9

27.9

21.8

18.2

Sewage treatment revenue growth (%)

99.5

63.1

5.0

5.0

5.0

EBITDA Margin (%)

41.2

46.4

39.9

38.5

37.8

Operating Margin (%)

34.7

39.8

34.0

33.2

32.7

BALANCE SHEET

Fixed Assets

 

 

13,005

15,689

16,735

17,838

19,042

Intangible Assets

8,041

9,630

10,682

11,742

12,807

Plant, property and equipment

590

1,127

1,171

1,231

1,310

Investment properties

908

1,173

1,056

845

676

Investment in associates

1,334

635

826

991

1,189

Other

2,132

3,124

3,000

3,030

3,060

Current Assets

 

 

6,966

9,942

9,949

10,060

10,408

Properties Under Development

 

 

524

690

621

559

503

Properties Held for Sale

 

 

273

289

290

290

290

Inventory

 

 

289

285

299

314

330

Trade and Bills Receivables

 

 

1,084

872

1,046

1,151

1,266

Due from Non-controlling Equity Holders of Subsidiaries

308

251

264

269

274

Due from Associates

 

 

403

409

400

400

400

Prepayments, Deposits and Other Receivables

970

1,743

1,300

1,500

1,700

Pledged Deposits

 

 

467

783

783

783

783

Deposits and cash

2,552

4,314

4,645

4,494

4,562

Other

98

306

300

300

300

Current Liabilities

 

 

5,557

7,393

7,017

6,884

6,772

Trade and Bills Payables

 

 

855

1,097

1,119

1,175

1,234

Accrued Liabilities, Deposits and Other Payables

1,782

2,102

1,892

1,703

1,532

Short-term Borrowings

2,156

3,206

3,206

3,206

3,206

Other

764

988

800

800

800

Long Term Liabilities

 

 

5,967

9,275

9,962

10,286

10,790

Long-term Borrowings

5,076

8,123

8,123

8,123

8,123

Other long term liabilities

891

1,152

1,839

2,163

2,667

Shareholders' Equity

 

 

8,446

8,963

9,705

10,729

11,888

1

-

-

-

-

CASH FLOW

Net Cash Flows from Operating Activities

1,163

1,454

1,776

2,132

2,494

Purchase of property, plant and equipment

(67)

(92)

(110)

(132)

(159)

Increase in concession rights for water supply and sewage processing

(1,206)

(1,818)

(1,400)

(1,442)

(1,485)

Acquisitions/disposals

(972)

(286)

(572)

(601)

(631)

Increase in prepayements and other receivables

0

(1,226)

0

0

0

Repayment of HK$860m loan from China City Infrastructure Group

860

0

0

Others

578

(120)

0

0

0

Net Cash Flows from Investing Activities

(1,667)

(3,542)

(1,222)

(2,175)

(2,275)

Net Cash Flows before Financing Activities

(504)

(2,088)

553

(43)

219

Dividends

(106)

(136)

(302)

(193)

(241)

Shares issue and/or options exercised

149

84

80

85

90

Net Cash Flow

(673)

(2,019)

331

(151)

68

Opening net debt (CWA definition)

 

3,541

4,213

6,232

5,901

6,052

Closing net debt/(cash)

 

 

4,213

6,232

5,901

6,052

5,984

Net debt to equity ratio (CWA definition)

 

50%

70%

61%

56%

50%

Source: China Water Affairs Group data; Edison Investment Research.

Contact details

Revenue by geography

China Water Affairs Group
Suite 6408, 64/F, Central Plaza
18 Harbour Road,
Wanchai,
Hong Kong
+852 3968 6666
www.chinawatergroup.com

Contact details

China Water Affairs Group
Suite 6408, 64/F, Central Plaza
18 Harbour Road,
Wanchai,
Hong Kong
+852 3968 6666
www.chinawatergroup.com

Revenue by geography

Management team

Executive chairman: Mr Duan Chuan Liang

Executive Director: Ding Bin

Mr Duan Chuan Liang is a water industry veteran, having worked previously for the Ministry of Water Resources in China for over 10 years. He serves as a director of numerous other enterprises in PRC. He graduated from the North China College of Water Conservancy and Hydro Power with a bachelor’s degree, specialising in irrigation and water conservancy works.

Ms Ding Bin joined the group in 2007. She has over 10 years of experience in financial management and tax planning. She graduated from Zhengzhou University of Technology in finance and computing management. Ms Ding is a certified public accountant in the PRC and a member of the Chinese Institute of Certified Public Accountants. Ms Ding was the general manager’s assistant and general manager of the finance department prior to her appointment as executive director.

Executive Director: Ms Liu Yu Jie

Executive Director: Mr Li Zhong

Ms Liu Yu Jie joined the group in 2014. She graduated from the University of International Business and Economics in Beijing and also obtained an MBA. She has worked in Hong Kong, Singapore and the PRC.

Mr Li Zhong joined the group in 2015. He graduated from the Beijing University of Chemical Technology and from Saint Mary’s University in Canada with an MBA in 1997. He holds registered engineer certifications from both mainland China and Canada, and has served in large state-owned enterprises, US-based corporations and global enterprises in mainland China and Hong Kong for over 20 years.

Management team

Executive chairman: Mr Duan Chuan Liang

Mr Duan Chuan Liang is a water industry veteran, having worked previously for the Ministry of Water Resources in China for over 10 years. He serves as a director of numerous other enterprises in PRC. He graduated from the North China College of Water Conservancy and Hydro Power with a bachelor’s degree, specialising in irrigation and water conservancy works.

Executive Director: Ding Bin

Ms Ding Bin joined the group in 2007. She has over 10 years of experience in financial management and tax planning. She graduated from Zhengzhou University of Technology in finance and computing management. Ms Ding is a certified public accountant in the PRC and a member of the Chinese Institute of Certified Public Accountants. Ms Ding was the general manager’s assistant and general manager of the finance department prior to her appointment as executive director.

Executive Director: Ms Liu Yu Jie

Ms Liu Yu Jie joined the group in 2014. She graduated from the University of International Business and Economics in Beijing and also obtained an MBA. She has worked in Hong Kong, Singapore and the PRC.

Executive Director: Mr Li Zhong

Mr Li Zhong joined the group in 2015. He graduated from the Beijing University of Chemical Technology and from Saint Mary’s University in Canada with an MBA in 1997. He holds registered engineer certifications from both mainland China and Canada, and has served in large state-owned enterprises, US-based corporations and global enterprises in mainland China and Hong Kong for over 20 years.

Principal shareholders

(%)

Executive chairman Mr Duan Chuan Liang

28.4%

Orix Corporation

18.7%

Norges Bank

4.6%

Citi

3.6%

International Finance Corporation

2.6%

Executive director Li Zhong

1.9%

Vanguard

1.5%

Blackrock

0.9%

Companies named in this report

Guangdong Investment (270.HK); Beijing Enterprises Water Group (371.HK); Tianjin Capital (1065.HK); Beijing Originwater Technology (300070.CH); Chongqing Water Group-A (601158.CH); Veolia Environment (VIE.FP); Suez Environment (SEV.FP); United Utilities (9UU/.LN); Luzhou Xinglu Water (2281.HK) ; Beijing Capital (600008.CH); China Water Industry (1129.HK)

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by China Water Affairs Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers’ exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by China Water Affairs Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers’ exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

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Triton Minerals — Industry interest in Ancuabe increases

Critical to the development of any opaquely traded commodity project is establishing an end-customer network. To this end, Triton Minerals (TON) has forged a number of pre-commercial agreements covering up to 80% of the output from its future Ancuabe graphite mine in Mozambique. This note highlights these memorandums of understanding (MoUs), as well as some background to the companies with which the MoUs were signed. We also consider the effect of mining higher grades for longer from the company’s T16 deposit – a key future catalyst to our valuation.

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