Action

Beijing Capital Eco-Environment Protection Group (Beijing Capital) announced its 3Q21 results: Revenue rose 42.8% YoY to Rmb6.6bn, and attributable net profit dropped 3.37% YoY to Rmb485mn. In 1-3Q21, revenue rose 31.5% YoY to Rmb15.23bn, and attributable net profit increased 106.2% YoY to Rmb1.91bn, in line with our expectations. We maintain our target price of Rmb4.2, and upgrade the stock to OUTPERFORM.

Reasoning

Why an OUTPERFORM rating:

Stepping up efforts in water supply; likely to see valuation re- rating amid market-based water pricing reform. On October 2, the National Development and Reform Commission released Guidelines for Urban Water Supply Price Management to propel the establishment of a pricing mechanism focusing on “costs plus reasonable returns” (with costs including depreciation and amortization charges for fixed assets). We expect the market-based water pricing reform to bolster water supply companies’ earnings growth. Beijing Capital focuses on the coordinated development of water supply and sewage treatment businesses. It has over 340 water plants, water supply pipeline networks totaling around 10,000km and drainage pipeline network of 1,000km nationwide. In addition, its sewage treatment capacity has reached 30.47mnt/d. We think the firm has ample capacity in reserve and will likely see valuation re-rating as a beneficiary of market-based water pricing reform.

Reducing cost and enhancing efficiency; expense ratio optimizing. In 1-3Q21, the firm’s expense ratio dropped 3.01ppt YoY to 16.66%. Specifically, G&A, financial and selling expense ratios fell 1.61ppt, 1.37ppt and 0.04ppt YoY to 8.73%, 7.8%, and 0.13%. We think its operating and management efficiency is improving.

Technological breakthroughs at jointly established research center to bolster long-term growth. According to Chinanews, Beijing Capital, Beijing University of Civil Engineering and Architecture, and Delft University of Technology in the Netherlands jointly announced their results of their phase I sewage treatment technology R&D project in October. In addition, the three parties have signed a memorandum of understanding in terms of phase II cooperation. In the next 5 years, the three parties will continue to work together in fields such as sewage treatment, sewage resources and energy recycling, sludge treatment, and other resource recycling. We believe that strategic cooperation between China and the Netherlands will help China learn advanced sewage treatment technologies and enable Beijing Capital to strengthen its competitive advantages.

How do we differ from the market　　 We expect the improvement of Beijing Capital’s earnings from the water supply business to accelerate amid market-based water pricing reform.

Potential catalysts: The market-based water pricing reform proceeds faster than expected.

Earnings forecast and valuation

We keep our 2021 and 2022 net profit forecasts at Rmb2.36bn and Rmb2.12bn. The stock is trading at 11x 2021e and 12x 2022e P/E. We upgrade to OUTPERFORM rating and maintain our target price of Rmb4.2, implying 13x 2021e and 14x 2022e P/E with 25% upside.

Risks

Progress in market expansion and reform disappoints.