China Water &Environment:PPP for water,quality plays are key

We conducted an Education Edge lunch seminar on PPP (private-publicpartnerships) and meetings with experts in water pollution prevention recently.

Key takeaways: (i) Investment on water pollution prevention and curing is set tomore than double in the 13th Five-Year Plan (13th FYP); (ii) a new focus area willbe treatment of black and odorous water (projects will be in PPP form); (iii) thereis considerable scope for improvement in the legal framework, financing andrisk-sharing mechanisms in China’s PPPs. As such, ability to select qualityprojects, ability to attract limited partners (LPs) to go asset-light with sensiblerisk-sharing mechanisms and track record in environmental renovations areimportant criteria to gain from PPP development. We continue to favour BEW.

Investment in water pollution prevention and curing will more than doubleduring 13-FYP: Environmental-related investment will increase from RMB3.4tnin 12-FYP to Rmb6tn-10tn during 13-FYP, according to Dr. Jiang of the ChineseAcademy for Environmental Planning (CAEP) of MEP. Of this sum, about halfwill be water-related, a doubling of investment in this segment. In addition tomunicipal wastewater treatment, a new action area is the treatment of black andodorous water (aka river clean-up and involves environmental renovation works).

Given their capex-heavy nature and the lack of a commercial business model,we think project opportunities will come in the form of availability payment PPPs.

PPP still in early stages; river clean-up projects are complex (EE lunchwith Mr Neil Johnson of MIRA). The government’s recent PPP push isintended to mobilize private capital for China's huge infrastructure investments;MOF’s PPP database has RMB12tn worth of projects. PPP development inChina is still relatively new, with considerable scope for improvement in legal,financing, and risk pricing frameworks. The complexity of river clean-up projects,in particular, may result in higher execution risk. Asset-light participation (ifguarantee provision is provided) may also change the risk profiles of listedcompanies.

Against this backdrop, an emphasis on quality is particularly important.

We reckon water and environment projects account for 15% of the MOF’s PPPprojects database, making for significant PPP opportunities in the segment.

However, these opportunities are not without risk. We think selecting companieswhich can mitigate project selection, execution and collection risks is important.

Due to heavy capex and long payback periods, access to competitive financecost is important if a company invests using its own capital. In addition, ability toattract LPs (limited partner) to go asset-light can enhance ROE.

Stocks implication: BEW best-positioned. Among stocks in our coverage,BEW (371 HK), CEI (257 HK), GDI (270 HK) and Kangda (6136 HK) have PPPproject exposure. We think BEW is among the best-positioned, given its strongtrack record in environmental renovation projects. This, together with its strongSOE background, should make it relatively easier to attract LP investors to goasset-light. We like BEW’s current plan is to establish a PPP fund withoutundertaking guarantee provisions for limited partners. In our earlier report (ChinaWater & Env - 2016: positioning for the 13-FYP), we identified environmentalrenovation and black & odorous water treatment to be a key thesis during the 13-FYP, and BEW is a strong play in this segment.