• 17% growth in SIIC Environment's 1HFY19 net profit ahead of expectations, due to higher gross margin.
• Added 0.7m tons/day of water treatment capacity in 1HFY19; on track to achieve 1-1.5m tons/day target.
• Net debt-equity ratio to stay high at 100%.
• Maintain HOLD with Target Price lowered to HK$1.66 or S$0.265 to reflect weak investors’ appetite for high debt stocks.

No Excitement – Slow Growth in Operating Capacity

• We maintain our HOLD rating on SIIC ENVIRONMENT HOLDINGS LTD. (SGX:BHK) despite the better-than-expected 1HFY19 results.
• We reckon SIIC Environment is too conservative. While its strategy of focusing on upgrading projects is working well with strong growth in tariff hike, however, growth in operating capacity is slow with stable capex, leading to slow growth in treatment volume. The target for new capacity is maintained at 1-1.5m tons/day, representing < 10% growth in project portfolio.
• In addition, under the current macro situation, investors are concerned with its net debt-equity ratio of 100%.

Where We Differ

• Our FY19-21F earnings are 1-10% below consensus, as we have factored in lower turnover growth.

No Positive Share Price Catalyst in the Short Term

• In our view, faster progress in construction revenue or increase in capex with faster deal flow would be positive for SIIC Environment’s earnings growth as well as share price. However, we do not expect these factors to materialise in the short term.

What's New - Stronger Than Expected 1HFY19 Results

17% growth in 1HFY19 net profit.

• Despite 2.5% growth in total turnover, SIIC Environment’s earnings grew by a stronger 17.4% to Rmb300.2m in 1HFY19. The major discrepancy was better-than-expected gross margin.
• Stripping out construction revenue, gross margin of the remaining operations improved 1ppt to 45%, which we attribute to a 25% increase in tariff for waste water treatment (WWT) to Rmb1.34/ton. However, net debt-equity ratio climbed to 102.7%, up from 99% in FY18.

On track to achieve its new capacity target.

• During 1HFY19, SIIC Environment signed new contracts for 7 WWT plants with an aggregate designed capacity of 0.3m tons/, and one waste-to-energy (WTE) plant with designed capacity of 1,200 tons/day. In addition, it secured contracts to upgrade five WWT plants with an aggregate designed capacity of 0.4m tons/day. These new contracts bring total designed water treatment capacity and WTE treatment capacity to 12.4m tons/day and 6,200 tons/day respectively.
• SIIC Environment is on track to achieve its target of 1-1.5m tons of new daily capacity for water operation.

Tariff hike as the main growth driver.

• Although construction revenue declined 16.7% in 1HFY19, construction progress is likely to catch up in 2H and we maintain our full year estimate of flat growth for construction revenue. In 1HFY19, eight WWT plants with an aggregate treatment capacity of 0.2m tons, or only 2% of operating capacity, commenced operations.
• Thus, we estimate growth in treatment volume would be in the single digit. However, with more upgrade projects, the uptrend in treatment tariff will continue and this will be the main earnings growth driver.

More WTE projects.

• SIIC Environment set up the first JV to operate a WTE plant in Shandong with Canvest (1381 HK) in March 2019. Such strategic co-operation is a win-win for both parties. While Canvest can extend its geographical exposure, SIIC Environment can gain support in technical-know-how.
• In addition, Shanghai government is strictly implementing household waste segregation which is positive for WTE market. With support from Canvest, SIIC Environment intends to grab more market share in Shanghai WTE market.

Source: DBS Research - 8 Aug 2019