<Earnings analysis>: FY21 results flat growth, below expectation
- Flat growth in FY21 attributable profit, below expectation, due to lower gross margin and higher administrative expenses
- Continue to grow market share from estimated 6.2% in 2021 to 10% in 2025 and further to 15% in 2030
- Expect cashflow from operation to turn positive in FY22
- Fine-tuned FY22/23 earnings estimates; maintain BUY on improving earnings quality and financials; TP unchanged at HK$3.60
Beijing Enterprises Water (BEW) reported a flat growth in FY21 attributable profit to HK$4.2bn, below our expectation. The major discrepancies were low gross margin of 37.5% (vs. our estimate of 40.5%) and higher administrative expenses. Turnover climbed around 10% to HK$27.9bn, slightly ahead of our projection. In particular, revenue growth of sewage treatment in China and sewage technical services were strong at about 30% and 25% respectively. Sewage treatment volume was also strong at 16%. However, gross margins of BOT and technical services dropped 5ppts and 3ppts respectively, leading to a 0.9ppt drop in the overall gross margin. The drop in gross margin was due to absence of COVID subsidies and higher costs from inflation. Adjusted net debt-equity ratio declined 15ppts to around 117%. Final dividend of HK$0.067 was declared, with full year payout ratio of around 38%, slightly lower than 39% in FY20.
For a sustainable business development, BEW has two major strategies. First, it will continue to secure more water projects, including sewage treatment and water supply, to increase market share from around 6.2% in 2021 to 10% in 2025 and further to 15% in 2030. This will be done through M&A, entrusted operation and investment through JVs or associated companies. In particular, government has issued policies to regulate water tariff of water supply operations. There is increasing demand from inefficient water plants for efficiency enhancement. Thus, BEW has many business opportunities to capitalize on its expertise in water industry and it has raised is target for additional capacity from 3m ton/day to 4m ton/day for FY22, compared with net increase was <3m tons/day in FY21.
Second, BEW has stepped up R&D efforts in technology enhancement to provide more value-added services which can command high margins and stronger growth. These services include O&M services and inspection for pipe network, sewage treatment for industrial users, intelligent water system, etc. Some of these services can have gross margin as high as 80%. Although these value-added services account for a very small percentage in turnover, it can enhance earnings quality and gross margin in the long run.
In the short term, BEW continues to pursue its asset-light strategy with further decline in construction revenue in FY22. We expect construction revenue to decline 8.7% with percentage of total revenue dropping from 45% in FY21 to 39% in FY22. As BEW grows its project portfolio, we estimate revenue growth of sewage treatment and technical services to be stronger at >20% and 15% respectively. As these are cash generating businesses, earnings quality will be enhanced with improved cashflow. In fact, cashflow from operation already improved from -HK$3.7bn in FY20 to -HK$1.6bn in FY21. With the current momentum, management is optimistic to have a positive cashflow from operation in FY22. We expect net debt-equity ratio to continue its downtrend and improving financials will be a major share price catalyst.
We have fine-tuned our earnings estimates. We re-iterate our BUY rating as BEW is gradually improving earnings quality with increasing turnover percentage from cash-generating operations, increasing operating cashflow and strengthening balance sheet. Our TP remains unchanged at HK$3.60, based on i) 14x rolling 12-month forward adjusted PE (stripping out contribution from construction services) for sewage treatment and water supply and ii) 8x for remaining operations.