2021 results missed our expectations

EIT Environmental Development announced its 2021 earnings: Revenue grew 12.01% YoY to Rmb4.83bn; attributable net profit reached Rmb473mn, implying an EPS of Rmb1.71 (down 25% YoY), missing our expectations. We believe the firm’s 2021 earnings declined mainly because: 1) COVID-19 preferential policies in 2020 pushed up the earnings base, and the cancellation of the policies in 2021 pulled earnings back to their pre-pandemic levels, and 2) labor costs increased.

Steady order growth drove up revenue; profit margin pulled back on cancellation of preferential policies. In 2021, the firm’s revenue from　municipal sanitation and property-cleaning businesses grew 11.52% and 14.98% YoY to Rmb3.76bn and Rmb1.07bn, thanks to steady growth of its orders on hand. Gross margin (GM) and net margin fell 7.3ppt and 4.8ppt YoY to 22.2% and 9.8%, mainly due to full withdrawal of preferential policies in 2021 and rising labor costs (up 22.2% YoY) on the back of the firm’s expansion. The firm’s GM and net margin in 2021 grew 1.11ppt and 1.31ppt compared with 2019. Its profitability in 2021 slightly improved excluding impact of cancellation of preferential policies.

Expense ratio decreased; operating cash flow grew steadily. In 2021,　the firm’s selling, G&A, financial and R&D expense ratios reached 0.92%, 6.90%, 0.19% and 1.02%, with expense ratio at 9.03% (down 0.2ppt YoY).In addition, its net operating cash flow in 2021 rose 18.6% YoY to Rmb620mn.

Trends to watch

New projects bolstered earnings growth; equity incentive boosted　confidence. In 2021, the firm made steady progress in market expansion and won bids for 12 projects, including the market-oriented urban management project in Bincheng, market-oriented sanitation procurement project in Zhangwu county and domestic waste handling and transportation service project in Baisha Li autonomous county. The firm boasts extensive experience in project management and deep client insights, and has assisted many local governments in their market- oriented reforms. We expect the firm to secure more orders to bolster earnings growth on the back of its strong expertise and reputation. In addition, the firm launched its equity incentive plan in 2021 to further motivate its management and core employees, laying a solid foundation for business expansion to support steady growth of operating cash.

Financials and valuation

Considering the firm’s rising labor costs still weighed on earnings, we lower our 2022 net profit forecast 16% to Rmb549mn and introduce our 2023 earnings forecast at Rmb637mn. We maintain OUTPERFORM rating and the stock is trading at 12.0x 2022e and 10.4x 2023e P/E. We cut our TP 23% to Rmb31, implying 15.7x 2022e and 13.5x 2023e P/E and offering 30% upside.

Risks

Market-oriented sanitation services disappoint; labor costs increase significantly; receivables collection risks.