1H22 results in line with our forecast

Chongqing Water announced its 1H22 results: Revenue rose 8.6% YoY to Rmb3.45bn （-15.3% HoH） and net profit attributable to shareholders dropped 11.3% YoY and 8.5% HoH to Rmb936mn （Rmb0.19/sh）， largely in line with our expectation.

Trends to watch

Increased sales volume boosts revenue growth; growth of production capacity slows amid COVID-19 resurgence. In 1H22, revenue of the sewage treatment business rose 12.6% YoY to Rmb2.07bn, and revenue of the water supply business increased 2.73% YoY to Rmb829mn. The firm kept water prices unchanged in 1H22, and increased sales volume boosted its revenue growth. As of June 30, 2022, the firm had 25 water supply systems, with production capacity reaching 3.12mn cbm/day （up 96,000 cbm/day at end-2021）； it had 106 sewage treatment plants, with treatment capacity reaching 4.26mn cbm/day （up 10,000 cbm/day from end-2021）。 Growth of its production capacity slowed due to COVID-19 resurgence. We expect the firm to accelerate the construction of new projects in 2H22 as the impact of COVID-19 diminishes. We are optimistic about its full-year earnings in 2022.

GM of the sewage treatment business rises amid headwinds; recurring attributable net profit increases more than 9% YoY. In 1H22, the firm's gross margin （GM） rose 0.24ppt YoY to 44.2%. Specifically, GM of the water supply business dropped 3.05ppt YoY to 26.32%, and GM of the sewage treatment business increased 1.40ppt YoY to 50.27%. The firm's GM rose YoY in 1H22 as its strong management competency offset the impact of increased costs. Attributable net profit declined due to non-recurring gains and losses. Non-recurring gains dropped YoY in 1H22 due to high base in 1H21 （in 1H21, the municipal water supply company in Chongqing sold water supply assets in Caogu, resulting in a high non-recurring gain at Chongqing Water）。 In 1H22, the firm's recurring attributable net profit grew 9.35% YoY to Rmb846mn.

Advancing the construction of smart water supply projects; operating efficiency to continue to rise. Chongqing Water continues to implement its innovation-based development strategy, focusing on digitization and AI-enabled transformation and increasing the use of big data and cloud computing in its smart water supply projects. The company has improved the equipment management and control model throughout the entire lifetime of equipment to make equipment more durable and enhance the utilization rate of its manufacturing facilities. It has also improved the management mechanism for subsidiaries and branches so as to enhance the competitive advantages of its water testing, education and technology, telecommunication electronics, water supply design, and customer service subsidiaries and branches. Such moves will lay a solid foundation for the firm’s high-quality development, in our view. We believe the firm's management and operating efficiency will continue to improve, and the company could also improve its expense control and profitability going forward, in our view.

Financials and valuation

We maintain our net profit forecasts at Rmb2.26bn for 2022 and Rmb2.48bn for 2023. The stock is trading at 11.4x 2022e and 10.4x 2023e P/E. We maintain an OUTPERFORM rating, but cut our target price 10% to Rmb7.2 to reflect lower sector valuation. Our TP implies 15.3x 2022e and 13.8x 2023e P/E, offering 34.1% upside.

Risks

Decline in wastewater treatment fees; project progress disappoints; volatile foreign exchange rates.