capital environment initiation of coverage emerging …...the hazardous waste treatment and...

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9 August 2017

Capital Environment – Initiation of Coverage CLEAN & GREEN

Emerging player in solid waste treatment BUY

Capital Environment Holdings Limited (“CEHL”) is a leading solid waste

management operator in China with a strong brand. It has 39 projects on hand with

attributable daily capacity of about 17.6k tons, of which about 2.7k tons are

currently in operation. We expect the company is going to experience a high

growth period in FY17-19E, as the operating capacity is expected to grow at a

CAGR of 73.5%, which we believe will result in its earnings taking off in FY18. We

initiate a BUY on CEHL with a target price of HKD0.40, based on 15.0x FY18 forward

PE valuation, implying a 33% upside potential.

74.2% CAGR revenue growth from domestic projects – Having a strong foothold in the

waste-to-energy business, CEHL has expanded its service coverage to the more

profitable hazardous waste and organic waste treatment business. Supported by its

accelerated progress of domestic projects and substantial increment in daily operating

capacity, we expect the domestic segment would fuel a CAGR of 74.2% in revenue to

about RMB3.2bn, constituting about 56% of FY19E’s revenue.

Strong brand to acquire high quality assets – CEHL has built up a strong brand and

reputation in aspects of both technical expertise and extensive network backed by its

parent Beijing Capital Group. It has advanced waste treatment technologies and its parent

has maintained a decent track record in environmental projects operation, which is

favorable for acquiring new projects and high quality assets. Last year, CEHL acquired a

51% interest in the largest urban waste operator BCG NZ from its parent, which is

expected to contribute some RMB182mn in profit in FY18E. Should CEHL consider

acquiring the remaining 49% stake in the future, it would further deliver an additional profit

of about RMB175mn, representing 52% of its attributable profit in FY18E.

Well-financed expansion plan – Anticipating the incremental capacity costs of about

RMB300k/ton, its annual Capex is estimated to be about RMB1.2bn. With PPP model

adopted in the projects and strong support from its parent, CEHL is capable of financing

its robust business expansion plan at a low funding cost of around 5%. We expect that

CEHL will further increase its net gearing to about 105% by FY18E, after which the Capex

required could be well financed by its internal resources.

Risk Factors – Execution of expansion plan; delay in greenfield projects construction;

change in government policies; devaluation of the NZD.

Key Financials – Fiscal Year Ended 31 Dec

(RMB’mn) FY15* FY16 FY17E FY18E FY19E Revenue 2,639 2,708 3,604 4,874 5,707

Growth (%) 2.6% 33.1% 35.2% 17.1% Operating profit 405 361 596 946 1,173

Growth (%) -10.7% 64.9% 58.7% 24.0% Attributable profit 158 44 113 334 478

Growth (%) -72.2% 158.8% 194.3% 43.0% CAGR FY17-19E 121.7% EPS (RMB fen) 1.29 0.31 0.79 2.34 3.34 P/E (x) 18.9 79.4 30.7 10.4 7.3 P/B (x) 0.93 1.12 1.11 1.01 0.90 Dividend Yield (%) N/A N/A N/A N/A N/A

Source: Company data, Quam Securities

Recommendation

Ticker 3989 HK

Quam's Rating BUY

Last Close HK$0.30

Target Price HK$0.40

Previous Target N/A

Up/(Down)side 33%

Previous Rating Initial Coverage

Share Information

52-week range (HK$) 0.20 – 0.33

ADT (3M) (HK$’mn) 2.06

Market Cap. (HK$’mn) 4,288.4

Shares outstanding (‘mn) 14,294.7

Free float 31.6%

SH-HK Stock Connect No

SZ-HK Stock Connect No

Major Shareholders

Beijing Capital Group Co. Ltd 66.9%

Share Price Performance

Source: Bloomberg

Li Yiming, Eric

: +852 2971 5433

: [email protected]

mailto:[email protected]

Capital Environment (3989 HK) 2

Table of Contents 1. Investment Highlights .......................................................................................................................................... 3

2. Valuation and Comparables ............................................................................................................................... 5

3. Business Overview ...................................................................................................................................... 7

3.1 Accelerated contribution from domestic segments ................................................................................................. 7

3.2 Strong brand for acquiring new projects .................................................................................................................. 14

3.3 Well-funded business expansion plan ......................................................................................................................... 15

3.4 Sound synergy from BCG NZ ........................................................................................................................................... 16

4. Industry Outlook ................................................................................................................................................. 17

4.1 Solid waste industry starting to drive revenue ....................................................................................................... 17

4.2 Waste-to-energy sector in China ................................................................................................................................... 19

4.3 Expanding demand on solid waste treatment ....................................................................................................... 20

5. Financial Analysis ............................................................................................................................................... 22

5.1 Revenue breakdown ........................................................................................................................................................... 22

5.2 Profitability ............................................................................................................................................................................ 23

5.3 Financial position ................................................................................................................................................................ 24

5.4 Operating efficiency ............................................................................................................................................................ 25

6. Company Background ....................................................................................................................................... 26

6.1 Key milestones ....................................................................................................................................................................... 26

6.2 Strong support from Beijing Capital Group ............................................................................................................. 27

6.3 Shareholding structure ..................................................................................................................................................... 28

6.4 Financial statements .......................................................................................................................................................... 29

Appendix: The existing solid waste treatment projects .................................................................................. 30


1. Investment Highlights

74.2% CAGR revenue growth from domestic market – CEHL has secured 39

domestic projects with attributable daily capacity of about 17.6k tons, of which about

2.7k tons are currently in operation. It has implemented its mature business model

as well as technical expertise in its core waste-to-energy treatment business, which

delivers stable income streams from both government subsidies and electricity sales

during the long concession period. Riding on the two successful waste-to-energy

projects, CEHL has been accelerating the construction progress of other committed

projects, attempting to replicate its success nationwide. Looking ahead, we expect a

CAGR of 74.2% in revenue contributed from domestic projects in FY17-19E,

supported by a 73.5% YoY growth of attributable daily operating capacity during the

period, reaching about 13.9k tons by FY19E.

Stable profit contribution from BCG NZ – CEHL acquired a 51% interest in the

largest urban waste management operator in New Zealand (“BCG NZ”) from its

parent company Beijing Capital Group in 2016, where BCG NZ retains over 30% of

market shares. BCG NZ has optimized its business and we expect it will contribute

to an attributable profit of about RMB182mn in FY18E. It does not only deliver stable

profit to the company, but also brings in practical experience in project operation and

integration. Previously, Beijing Capital acquired the entire interests of TPI NZ at

consideration of about NZD950mn and renamed it to BCG NZ. If CEHL were to

consider acquisition of the remaining 49% interest in BCG NZ from its parent, a

RMB175mn profit increment is expected, representing 52% of its attributable in

FY18E.

Lucrative GPM from new treatment technologies – In addition to its waste-to

energy treatment business, CEHL also introduced two new treatment technologies

with higher GPM in its service coverage, which will further improve its overall

profitability. The hazardous waste treatment and anaerobic treatment technology is

capable of achieving an excellent gross profit margin of about 60% and 25%

respectively with high treatment tariff. We anticipate revenue contribution from

anaerobic and hazardous waste treatment would commence in FY17-18E. Going

forward, we expect anaerobic and hazardous waste treatment attributable daily

capacity would reach about 3,688 tons and 1,608 tons respectively by FY21E,

representing a CAGR of 17% and 59% respectively during the period.


Strong brand to acquire high quality assets – CEHL has built up its strong brand

nationwide in the aspects of waste treatment technology as well as extensive

network backed by its parent company Beijing Capital Group. Supported by its

comprehensive solid waste treatment technologies, CEHL is capable of providing

services for all kinds of solid waste while controlling the operating costs with

advanced incineration technology from Japan. Given the reputation and extensive

network of Beijing Capital Group, which has already achieved success in wastewater

treatment business, CEHL could further expand its business via acquiring high

quality projects and assets on a larger scale.

Well-financed expansion plan with healthy financial position – Anticipating an

incremental capacity costs of about RMB300k/ton, we expect CEHL’s annual Capex

would be about RMB1.2bn given its robust expansion plan of reaching 21.9k tons by

FY21E. With the PPP models implemented in the projects as well as strong support

from its parent company, CEHL is capable of fulfilling the Capex requirements with

finance costs as low as around 5% during the period. It is estimated that the company

will further increase its net gearing to 105% by FY18E, after which its Capex could

be supported by its internal resources.

Key risks

(1) The execution of business expansion plan;

(2) Delay in construction of domestic projects;

(3) Change in government policies;

(4) Devaluation in NZD.


2. Valuation and Comparables

We initiate a BUY on CEHL with a target price of HKD0.40, based on 15.0x 2018

forward P/E on a fully diluted basis, implying a 33% upside potential. Anticipating

high revenue growth from waste-to-energy, anaerobic and hazardous waste

treatment, our target price represents about 10.4x FY19 forward PE.

Our target valuation is acquired from a comparable approach with other solid waste

operators in China. The companies in the sector are currently trading between 6.9

and 14.2x FY18 consensus P/E with an average of 11.0x PE. Compared with the

peers, CEHL is presenting a high growth potential in both its revenue and profit given

its accelerated progress of its domestic projects, as well as its ability in acquiring

new projects leveraging its strong brand and extensive network. The company is

expected to achieve a substantial growth in attributable profit to RMB478mn in FY19,

representing a CAGR of about 122% in FY17-19E.

Hence, considering the overall business expansion plan, profitability improvement

and expected earnings growth, we believe that CEHL should deserve a relatively

higher valuation of 15.0x FY18 forward P/E.

Figure 1. Valuation of CEHL

Company Ticker Closing Price

(HKD)

FY18E EPS

(HKD)

FY18E P/E

(x)

FY17E-19E

EPS (CAGR)

Capital Environment 3989 0.30 0.269 15.0 122%

Peer Group

China EB Int’l 257 10.36 0.903 11.5 18%

New Universe Environment 436 0.48 0.050 9.6 43%

Dongjiang Environment 895 10.50 0.818 12.8 11%

Dynagreen Environment 1330 4.20 0.604 6.9 19%

Canvest Environment 1381 4.34 0.306 14.2 45%

Peers range 6.9 – 14.2

Source: Bloomberg, Quam Securities


Figure 2. Peer Comparison Table

Last Price

Market Cap

P/E

Div Yield

Trailing 12 mth

EV / EBITDA GPM

Net Margin

EPS Growth

Hist Current Next P/B T/O Net

Profit ROE ROA

Company Name Ticker (HK$) (HK$'bn) (x) (x) (x) (x) (%) ('mn) ('mn) (x) (%) (%) (%) (%) (%) Currency

CAPITAL ENV 3989 HK 0.30 4.22 80.0 30.9 10.6 1.2 4.1 3,098 56 13.0 29.4 1.6 (76.0) 1.6 3.5 HKD

Peer Group

CHINA EVERBR INT 257 HK 10.36 46.44 16.7 13.5 11.5 2.7 2.0 13,971 2,785 11.4 38.0 19.9 33.6 16.6 10.4 HKD

NEW UNIVERSE ENV 436 HK 0.48 1.46 28.0 15.5 9.6 2.0 - 291 51 21.8 45.5 19.4 37.3 7.3 7.5 HKD

DONGJIANG ENV-H 895 HK 10.50 14.69 14.6 15.7 12.8 2.4 1.3 2,579 534 16.2 35.2 20.7 59.0 12.6 6.7 CNY

DYNAGREEN ENVI-H 1330 HK 4.20 4.39 10.5 8.1 6.9 1.4 1.7 1,874 356 8.4 - 19.0 54.5 13.8 9.6 CNY

CANVEST ENV 1381 HK 4.34 10.66 21.9 17.9 14.2 3.2 0.6 1,654 400 13.6 35.6 24.2 45.6 15.8 10.4 HKD

Simple Average 18.3 14.2 11.0 2.3 1.4 38.6 20.7 46.0

Source: Bloomberg


3. Business Overview

3.1 Accelerated contribution from domestic segments

CEHL is the solid waste treatment listed platform of Beijing Capital Group. It is

primarily engaged in a wide range of waste management services in China, including

waste collection and transfer, waste-to-energy, landfill, anaerobic treatment for

organic waste, hazardous waste treatment and dismantling services of electrical

appliances. It acquired a 51% interest in BCG NZ from its parent in Sep 2016.

Currently, the urban waste treatment accounts for about 78% of its total revenue.

Looking ahead, the company will kick start its domestic expansion plan in the waste-

to-energy segment. We expect that the company would achieve a substantial

revenue growth with a CAGR of 74.2% in the domestic segment in FY17-19E,

reaching about RMB3.2bn by FY19E, or 56% of its total revenue.

Figure 3. Revenue breakdown of CEHL

Source: Company data, Quam Securities. Data in FY15 is restated.

Furthermore, we believe there is a chance that the remaining 49% interest in BCG

NZ currently held by the parent group could be injected in the future. In FY18E, the

projected attributable profit of BCG NZ is about RMB182mn. Thus, the remaining

stake could provide an additional RMB175mn profit to the company, representing

52% of FY18E’s attributable profit.

1,960 2,101

2,248 2,383

2,502 2,602 2,706

680 607

1,356

2,491

3,205

3,796

4,400

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

2015* 2016 2017E 2018E 2019E 2020E 2021E

BCG NZ Domestic Projects

Rev

enu

e(R

MB

mill

ion

)


Figure 4. Segment revenue contribution in FY17E and FY18E


CEHL has formulated a robust business plan for its domestic projects. A total of 31

waste treatment projects are expected to be in operation by FY19 compared to the

current five. The waste-to-energy treatment sector, the company’s core revenue

driver, is expected to triple its current size to about 6,000 tons in operating capacity

by FY18. The anaerobic treatment and hazardous waste treatment business would

complete construction and a combined 2,300 tons of capacity would go into

operation in FY19. Going forward, we expect the company’s aggregate daily

operating capacity would achieve a CAGR of 45% in FY17-19E, reaching about

21.9k tons by FY21E.

Figure 5. Forecast of daily operating capacity of CEHL’s domestic projects

Segments Current FY17E FY18E FY19E FY20E FY21E

Anaerobic / 400 tons 1,200 tons 1,600 tons 2,000 tons 2,400 tons

Waste-to-energy 1,800 tons 2,766 tons 6,000 tons 8,000 tons 10,000 tons 12,000 tons

Collection and transfer 724 tons 724 tons 1,500 tons 2,400 tons 3,600 tons 4,800 tons

Landfill 874 tons 874 tons 1,000 tons 1,200 tons 1,400 tons 1,600 tons

Hazardous Waste / / 400 tons 700 tons 900 tons 1,100 tons

Total 3,398 tons 4,764 tons 10,100 tons 13,900 tons 17,900 tons 21,900 tons

Dismantling 3.2mn units 3.2mn units 3.2mn units 3.2mn units 3.2mn units 3.2mn units


BCG NZ, 62.4%

Construction, 20.8%

Anaerobic, 0.6%

Waste-to-energy treatment, 6.1%

Collection and transfer, 1.1% Landfill, 0.9%

Dismantling, 8.0%

Others, 0.2%

FY17E revenue segment contribution

BCG NZ, 48.9%

Construction, 18.5%

Anaerobic, 1.3%

Waste-to-energy treatment, 12.9%

Collection and transfer, 1.7%

Landfill, 0.7%

Dismantling, 6.2%

Hazardous, 9.6%

Others, 0.1%

FY18E revenue segment contribution


Utilizing the three common solid waste treatment technologies, namely landfill,

waste-to-energy and anaerobic treatment, CEHL is capable of providing waste

management services for all kinds of solid waste, including urban waste and

industrial hazardous waste. The company targets at providing comprehensive

solutions that minimize the waste size, while controlling the energy consumption,

operating costs and repeated pollution. Compared with traditional solid waste

treatment operators, CEHL aims to extend its services by integrating waste collection,

transfer and treatment, which would maximize its operating efficiency and market

share.

Figure 6. CEHL’s major business segments and capacity


Compared to the traditional landfill method, waste-to-energy treatment substantially

reduces the size of leftovers and delivers additional income from power generation.

Anaerobic treatment for organic waste, including kitchen waste, minimizes the

repeated post-treatment pollution. Incorporating these methods into its solutions,

CEHL is capable of handling all kinds of solid waste and building up its brand to

acquire new projects.


Figure 7. Solid waste treatment solutions

Treatment Method Energy Consumption Reduction of waste size Operating cost Repeated pollution

Landfill Low Minor (10%) Low High

Waste-to-energy High Substantial (80-90%) High High

Anaerobic Medium Standard (50-60%) Medium Low

Source: Company data

Waste-to-energy business to drive revenue – With mature business model and

booming demand ahead, CEHL strategically places its focus on waste-to-energy

projects that bring in stable profit from both government subsidies and electricity

sales. The Build-Own-Transfer (BOT) model has been widely adopted in its waste-

to-energy business, in which the company is eligible for stable subsidy income during

the long concession period of about 30 years upon completion of construction.

Government subsidy for its existing waste-to-energy projects stands at a wide range

of RMB65-146 per ton, varying among different locations, while power tariff remains

high at RMB0.65/kWh for the initial 280kWh per ton of waste. Going forward,

government subsidies would be further adjusted upward in line with the inflation of

its operating costs. Looking ahead, CEHL would gradually improve the gross profit

margin of the waste-to-energy business to about 20% with the scale up of operating

capacity.

Figure 8. Revenue streams of waste-to-energy treatment

Income Source Pricing standard

Government subsidy Price range from RMB65-146/ton

Power tariff

(State Grid)

Initial 280kWh/ton RMB0.65/kWh

From 281kWh/ton In line with coal-fired power tariff


As of Jul 2017, CEHL has signed 15 waste-to-energy projects with total daily

treatment capacity of about 13.65k tons, in which two projects with capacity of 1.8k

tons are currently in operation. The company has optimized its operation of the

Quanling waste-to-energy project located in Nanchang, Jiangxi, where it controls the

operating costs with advanced waste incineration technology from Japan. The

company aims at further replicating its successful formula in other sites. Looking

ahead, CEHL would continue to expand its waste-to-energy business. We expect

the attributable capacity would achieve a CAGR of 27% in FY17-21E, reaching about

25.6k ton by FY21E.


Figure 9. Waste-to-energy daily capacity projection

Segments FY16 FY17E FY18E FY19E FY20E FY21E

Attributable operating capacity 1,787 tons 2,766 tons 6,000 tons 8,000 tons 10,000 tons 12,000 tons

Attributable greenfield capacity 5,916 tons 8,837 tons 9,103 tons 10,603 tons 12,103 tons 13,603 tons

Attributable capacity 7,703 tons 11,603 tons 15,103 tons 18,603 tons 22,103 tons 25,605 tons

Total capacity 9,750 tons 13,650 tons 17,150 tons 20,650 tons 24,150 tons 27,650 tons


Figure 10. The Quanling waste-to-energy plant in Nanchang, Jiangxi


Anaerobic and hazardous waste treatment boosted overall GPM – CEHL has a

total of 7 projects in the more profitable anaerobic treatment for organic waste and

hazardous waste treatment businesses. Organic waste commonly include kitchen

food waste, paper products, garden waste, etc. Similar to waste-to-energy projects,

CEHL would collect government subsidies at a price range of RMB 85-230/ton for its

existing anaerobic treatment projects depending on location. In the industrial areas

with urgent demand for hazardous waste treatment such as Jiangsu and Shandong,

the treatment tariff stands at a high level at about RMB 3,200/ton. Looking ahead,

gross profit margin for hazardous waste treatment and anaerobic treatment could

reach about 60% and 25% respectively, which could become new revenue drivers

in the coming two years.


Figure 11. Government subsidies of anaerobic and hazardous waste treatment


Anaerobic Treatment Price range of RMB 85-230/ton

Hazardous waste treatment Price range at about RMB 3,200/ton


CEHL is currently participating in four anaerobic waste treatment projects with

attributable daily capacity of about 1,688 tons, where the first 400 tons is expected

to commence operation as early as this year. Looking ahead, CEHL would continue

to expand the segment size with a CAGR of about 17% in daily attributable capacity

in FY17-21E, reaching about 3,688 tons by FY21E.

Figure 12. Anaerobic treatment daily capacity projection


Attributable operating capacity / 400 tons 1,200 tons 1,600 tons 2,000 tons 2,400 tons

Attributable greenfield capacity 1,688 tons 1,288 tons 988 tons 1,088 tons 1,188 tons 1,288 tons




CEHL has engaged in three hazardous waste treatment projects, which are currently

at initial stage. As one of the strategic move of the company, an incremental daily

capacity of about 300 tons per annum is expected in the coming five years, in which

the first batch with daily capacity of about 400 tons would start operation in FY18E.

We expect CEHL’s attributable daily capacity would increase with a CAGR of about

59% in FY17-21E, reaching about 1,608 tons by FY21E.

Figure 13. Hazardous waste treatment daily capacity projection


Attributable operating capacity / / 400 tons 700 tons 900 tons 1,100 tons

Attributable greenfield capacity 158 tons 408 tons 308 tons 308 tons 408 tons 508 tons

Attributable capacity 158 tons 408 tons 708 tons 1,008 tons 1,308 tons 1,608 tons

Total capacity 158 tons 408 tons 708 tons 1,008 tons 1,308 tons 1,608 tons



Integrated project incorporating waste collection and transfer – Compared with

traditional waste management operators, CEHL is looking to integrate the upstream

waste collection and transfer business into its waste-to-energy projects, which could

effectively control its operating costs, receive additional subsidies and increase

market shares. CEHL currently owns 11 waste collection and transfer projects with

total capacity of about 3k tons, of which six of them are integrated with waste-to-

energy projects. CEHL would be eligible for additional government subsidies within

the range of RMB 93-279/ton for its existing projects.

Figure 14. Government subsidies of anaerobic and hazardous waste treatment


Waste collection and transfer Price range of RMB 93-279/ton


CEHL is anticipated to expand its waste collection and transfer business rapidly in

the coming five years. Based on the existing 11 projects, we expect its revenue will

start to contribute from FY17 with its first batch of projects put into operation. By

FY21E, CEHL would further enlarge its attributable capacity to about 9k tons at a

CAGR of about 45% in FY17-21E.

Figure 15. Waste collection and transfer daily capacity projection


Attributable operating capacity / 724 tons 1,500 tons 2,400 tons 3,600 tons 4,800 tons

Attributable greenfield capacity 1,386 tons 2,262 tons 2,986 tons 3,586 tons 3,886 tons 4,186 tons




Beneficiary of policy support and mature PPP models – CEHL is one of the

beneficiaries of the favorable policies in the solid waste sector, where the Chinese

government is shifting its focus to environmental protection in its 13th Five Year Plan.

As required by the government, the PPP model will be adopted in all waste treatment

projects, where the private firms are responsible for construction of new projects and

entitled to a long concession period upon completion. Private firms could leverage

and replicate their mature business models and be guaranteed of a stable cash flow

within the concession period, which would bring in considerable profit to the investors.


3.2 Strong brand for acquiring new projects

Build up brand for future bidding – CEHL has introduced various solid waste

treatment technology to control its operating costs and retain a high treatment quality

in compliance with the environmental standard. With advanced waste treatment

technology from EU and incineration technology from Japan, CEHL is capable of

providing treatment services for all kinds of solid waste, including the hazardous

waste that requires the most advanced technology to enter the market. CEHL is also

the first company to introduce anaerobic digestion technology in China. The

company is committed to building up its brand in the waste treatment industry to

increase its competiveness in future bidding.

Figure 16. CEHL’s comprehensive solid waste treatment technology


Extensive network and good track record to facilitate new acquisitions – With

strong support from its parent company Beijing Capital, CEHL has established an

extensive national network covering about 37 cities to acquire new projects with the

main focus on Henan, Jiangxi and Beijing-Tianjin-Hebei areas. Beijing Capital, one

of the largest SOEs under Beijing State-owned Assets Supervision and

Administration (SASAC), has been the controlling shareholder of Capital

Environment since 2011. Beijing Capital has already built up its reputation and

maintains an outstanding track record of wastewater treatment projects nationwide.

We anticipate that CEHL could easily facilitate the acquisition of high quality projects

taking advantages of its extensive network and experience.


3.3 Well-funded business expansion plan

Rapid capacity expansion with Capex budget of RMB1.2bn – CEHL has

formulated a robust business expansion plan, which we estimate that it would require

an annual Capex of about RMB1.2bn, based on an incremental operating capacity

costs of about RMB300k/ton as well as a daily operating capacity growth of 4k tons

per annum. As at Jul 2017, the company has signed 15 waste-to-energy projects,

11 waste collection and transfer projects, 4 anaerobic treatment projects, 4 landfills

and 3 hazardous waste treatment projects with attributable daily capacity of over 20k

tons, of which about 2,661 tons are currently in operation. CEHL has been

accelerating its progress in construction of new projects, in which the common

construction period for each of its existing projects would be less than one year and

a half. The Capex requirement of its expansion can be well financed at a low funding

cost of around 5%. Looking ahead, we expect the CEHL’s daily attributable waste

treatment capacity in operation could further increase to 21.9k tons by FY21E,

representing a CAGR of about 52.4% during the period.

Figure 17. CEHL’s incremental daily operating waste treatment capacity and Capex required


2,103

5,336

3,800 4,000 4,000

1.60

1.14

1.20 1.20 1.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2017E 2018E 2019E 2020E 2021E

Incremental attributable operating capacity (tons) (LHS) Capex Required (RMB'bn) (RHS)


3.4 Sound synergy from BCG NZ

CEHL acquired 51% interests of BCG NZ from its parent company Beijing Capital

Group in 2016 at equity consideration of USD234mn, issuing about 4.54bn new

shares at HKD0.40/share. In 2014, Beijing Capital Group acquired the entire

interests of Transpacific New Zealand (TPINZ) at consideration for a about

NZD950mn, equivalent to about RMB5bn, which was later renamed to BCG NZ.

BCG NZ is the largest waste management service provider in New Zealand retaining

over 30% market share, serving over 200k customers in the largest cities of New

Zealand, covering collection, transfer, treatment and recycling of residential,

commercial and industrial waste. This investment does not only deliver stable profit

and cash flow, but also brings in mature and profitable business models as well as

practical experience regarding project operation and integration. BCG NZ is currently

operated at an optimal level and generated an operating profit of about RMB265mn

in FY16. Should CEHL consider purchasing the remaining 49% stake from its parent,

there would be an additional profit of over RMB175mn, representing 52% of its

attributable profit in FY18E.

Figure 18. Comprehensive waste management service of BCG NZ

Services Highlights

Residential waste collection Collect and transfer residential waste to interchange station

Commercial waste collection Collect and transfer commercial waste to interchange station

Solid waste treatment Cover solid waste treatment, landfill and recycle services

Liquid waste treatment Cover liquid, medical and hazardous waste treatment services



4. Industry Outlook

4.1 Solid waste industry starting to drive revenue

In the 13th Five Year Plan, it is expected that the total investments in solid waste

sector would substantially expand to about RMB4.5trn during the period,

representing 26% of total investments in the environmental protection industry. The

latest budget is about 463% larger than in the previous Five Year Plan, reaching

about RMB4.5trn during the period.

Figure 19. Total investments in solid waste sector from 10th to 13th Five Year Plan

Source: Forward Institute

Solid waste comes from a variety of sources including industrial, urban and

agricultural. The entire solid waste treatment industry is currently at an initial

development stage being driven mainly by favorable policies. Thanks to the fast

industrialization and urbanization in China, treatment demand from urban and

industrial wastes continued to drive the sector growth during the past decades. Direct

landfill, requiring smaller amounts of investments and operating costs, still plays a

dominant role in solid waste treatment. Going forward, waste-to-energy treatment,

which minimizes the residue size and regenerates energy, is expected to see

accelerated growth and become the prevailing method in the coming five years.

0.12 0.21

0.8

4.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

10th 11th 12th 13th

RMB trn


Figure 20. Flow chart of solid waste treatment

Source: Quam Securities

Figure 21. Current solid waste treatment structure in China


64%

35%

1%

Landfill Waste-to-energy Others


4.2 Waste-to-energy sector in China

While the volume of municipal solid waste (MSW) treatment had maintained stable

growth in the past five years, the weight of waste-to-energy treatment has been

increasing steadily during the period. The improved technology has made waste-to-

energy treatment a better solution for MSW, which has smaller foot print, lower levels

of residues and more efficient power regeneration. In the 13th Five Year Plan, China

aims to further increase the weight of waste-to-energy treatment from the current

about 35% to over 50% by 2020, which implies great potential for future growth of

the WTE sector in the coming years.

Figure 22. Urban waste transferred volume and weight of waste-to-energy treatment


Compared with the traditional landfill business, waste-to-energy operators have two

major revenue streams, namely, subsidy income from local governments and power

tariff from the State Grid. With PPP models fully implemented in the business, which

better protects the profitability of operators within the concession periods, it is

expected that larger scale of funds would be attracted from the private sector to

invest in the industry.

164 171 172

179 184

21.9% 23.0%

27.5%

32.2%35.0%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0

20

40

60

80

100

120

140

160

180

200

2011 2012 2013 2014 2015

Urban waste transferred volume (mn tons) (LHS) Weight of WTE treatment (RHS)

mn tons


4.3 Expanding demand on hazardous waste treatment

Hazardous waste constitutes about 5% of overall industrial solid waste, and requires

a much higher environmental standard because of its corrosive, toxic, inflammable

or infectious characteristics. Although the growth in treatment capacity has been

catching up in the past five years, it is still far below the actual demands for

hazardous waste treatment, especially in the several eastern provinces with

intensive industrial zones such as Shandong, Jiangsu and Hunan. It is expected that

the hazardous waste treatment demand will maintain a stable double-digit growth in

the coming three years.

Figure 23. Hazardous waste actual generation and operating volume in China, 2011-2015


Figure 24. Hazardous waste treatment methods in China in 2016


34.31 34.6531.57

36.3439.76

10.1312.53 13.31 14.06 15.36

30%

36%42%

39% 39%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

5

10

15

20

25

30

35

40

45

2011 2012 2013 2014 2015Actual generation vol (mn tons)(LHS) Actual operating volume (mn tons) (LHS)

Treatment rate (RHS)

51%

29%

20%

Recycled Harmless Treatment In Storage

mn tons


Given the harmful characteristics of hazardous waste, it is a segment with a high

entry barrier, consisting of three aspects including qualification, technology and sites.

A long approval period and extremely high environmental standards are required in

license application for collection, transfer, storage and treatment of hazardous

wastes. Since there are various kinds of hazardous waste, it also requires advanced

harmless treatment technology and a relatively long time to find suitable sites for a

new hazardous treatment plant. PPP models are widely adopted in hazardous waste

treatment projects where its high profitability has been attracting more players from

private sector to enter the market. As such, the current decentralized sector has

begun to consolidate, mainly through M&As to bypass the high entry barriers.

Figure 25. Entry barrier of hazardous waste sector

Categories Entry barriers

Qualification Time-consuming and high costs required for license application

Technology Advanced technology required for harmless treatment

Sites Difficulties in finding suitable locations for hazardous waste treatment



5. Financial Analysis

5.1 Revenue breakdown

CEHL’s two major business segments: BCG NZ and domestic projects contributed

about 78% and 22% of its total revenue in FY16, respectively. CEHL has been

accelerating the construction of its committed domestic projects, where the

construction revenue would increase to about RMB900mn in the coming years. The

domestic segment is the core revenue driver and is expected to deliver substantial

growth with a CAGR of 74.2% in FY17-19E, accounting for about 56.2% of FY19E’s

total revenue. The BCG NZ, which has optimized its operation, will also maintain its

stable growth at about 5% YoY during the period, reaching about RMB2.50bn in

FY19E’s revenue. Anticipating a strong domestic growth as well as the stable

revenue contribution from BCG NZ, CEHL is expected to generate a CAGR of 29.3%

in revenue in FY17-19E, reaching about RMB5.71bn in FY19E.

Figure 26. Revenue forecast of segments

Source: Company data, Quam Securities.

2,708

3,604

4,817

5,707

6,398

7,106

33.1% 33.7%

18.5%

12.1%11.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2016 2017E 2018E 2019E 2020E 2021E

Revenue YoY Growth

Rev

enu

e(R

MB

mill

ion

)


5.2 Profitability

We expect the company to continue to improve its overall margins starting FY17E

with the introduction of the lucrative waste treatment business as well as the

normalized SG&A and the absence of costs related to the acquisition of BCG NZ. It

is estimated that revenue contribution from anaerobic and hazardous waste

treatment that will deliver a high gross profit margin of 25% and 60% respectively

will commence in FY17-18E, driving the overall gross profit margin to about 31.2%

by FY19E. With the effective costs control in project operation thanks to advanced

technologies as well as insignificant finance cost backed by PPP models and its

parent company, we anticipate that CEHL will further improve its operating margin

and net profit margin to about 20.5% and 11.8% respectively in FY19E.

Figure 27. Profit margins of CEHL


28.2%29.4%

27.7%

29.9%31.2% 31.7% 32.1%

15.3%13.3%

16.5%

19.4%20.5%

21.9%23.2%

11.3%

4.9%

7.5%

10.5%11.8%

13.2%14.5%

0%

5%

10%

15%

20%

25%

30%

35%

2015* 2016 2017E 2018E 2019E 2020E 2021E

Gross Profit Margin Operating Profit Margin Net Profit Margin


5.3 Financial position

CEHL has a healthy financial position with an adequate level of liquidity and

reasonable borrowings. As of 31st Dec 2016, it had net debt of about RMB2.94bn,

calculated from a cash balance of RMB771mn and interest-bearing debt of

RMB3.72bn, equivalent to net gearing ratio of about 69%. With strong support from

its parent Beijing Capital Group and PPP models adopted in the projects, CEHL had

well controlled its funding costs to about 4.9% in FY16.

Going forward, we anticipate that the company will further increase its financial

leverage to support its business expansion plan in FY17-18E, where its net gearing

ratio will reach about 105% in FY18E. After that, the company’s Capex from new

projects development could be well-financed by its internal resources. It is estimated

that CEHL will generate a strong operating cash flow of about RMB1.26bn in FY19E

with considerable profit from project operations. At an effective interest rate of about

5%, the finance costs in the coming years should remain insignificant.

Figure 28. Liquidity and solvency ratios


4.53%

4.91%

5% 5% 5% 5% 5%

37% 40%45% 46% 46% 43% 40%

43%

69%

100%105% 102%

91%

77%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

4.20%

4.30%

4.40%

4.50%

4.60%

4.70%

4.80%

4.90%

5.00%

5.10%

2015* 2016 2017E 2018E 2019E 2020E 2021E

Costs of borrowing (LHS) Total D/A Ratio (RHS) Net D/E Ratio (RHS)


5.4 Operating efficiency

With BOT and PPP models widely adopted in its business, CEHL could guarantee a

stable cash flow from government subsidies and collect electricity tariff from the State

Grid. The mature BCG NZ operated at an optimal level also contributed stable cash

flow to the company. As a result, CEHL has maintained its operating efficiency with

operating cycle and cash conversion cycle of about 92.5 days and 47.3 days

respectively. Since the government subsidies are included in the financial budget of

local governments, receivables should be well controlled within the concession

period of the projects. Looking ahead, we anticipate that the operating cycle and

cash conversion cycle of CEHL would remain stable at about 91 days and 46 days

in FY17-21E.

Figure 29. Operating Efficiency

Source: Company Data, Quam Securities. Data in FY15 is restated.

6.9 5.6 6.0 6.0 6.0 6.0 6.0

72.5

86.9 85.0 85.0 85.0 85.0 85.0

79.4

92.5 91.0 91.0 91.0 91.0 91.0

48.8 47.3

46.0 46.0 46.0 46.0 46.0

0

10

20

30

40

50

60

70

80

90

100

2015* 2016 2017E 2018E 2019E 2020E 2021E

Day

s

Days Inventory Days Accounts Receivable

Operating Cycle Cash Conversion Cycle


6. Company Background

6.1 Key milestones

CEHL is the leading solid waste management operator in China. Beijing Capital, one of

the largest SOEs under Beijing SASAC, has been the controlling shareholder of CEHL

since 2011. CEHL raised about HKD2.1bn in the 1-for-1 rights issue of HKD0.45/share

in June 2015. Its market capitalization reached HKD4.29bn as at 31st Jul 2017.

Figure 30. Key milestones


2011•Beijing Capital became controlling shareholder of CEHL

2012

•Disposed clothing business

•Stepped into solid waste treatment business

2013•Acquired high quality projects in Huizhou, Yangzhou and Huai'an

2014

•Changed name to Capital Environment

•Total daily treatment capacity reached over 6,000 tons

2015•Beijing Capital increased its shareholding to 51% with a 1-for-1 rights issue

2016•Acquired 51% interests of NZ urban waste treatment business


6.2 Strong support from Beijing Capital Group

CEHL is one of the four cornerstones of the Beijing Capital Group with a focus on the

solid waste management industry. Beijing Capital Group, one of the large SOEs of

SASAC, covers four major industries in China, namely environment, infrastructure, real

estate and financial services. With strong support and extensive national network of

Beijing Capital Group, CEHL is capable of acquiring high quality assets in China and

overseas.

Figure 31. Background of Beijing Capital Group



6.3 Shareholding structure

Figure 32. Shareholding structure as at 31st Jul 2017



6.4 Financial statements Income Statement (RMB mn) 2015* 2016 2017E 2018E 2019E

Revenue 2,639 2,708 3,604 4,874 5,707

Cost of goods sold (1,894) (1,913) (2,607) (3,415) (3,925)

Gross profit 745 795 997 1,459 1,783

Other income and gains, net 58 52 68 71 75

Operating expenses (399) (486) (469) (585) (685)

EBIT 405 361 596 946 1,173

Finance costs (65) (173) (236) (261) (276)

Profit before tax 340 189 360 685 897

Income tax expense (42) (55) (90) (172) (224)

Profit after tax 298 134 270 514 673

Minority interest 140 90 157 180 195

Attributable profit to shareholders

158 44 113 334 478

Per Share Items (RMB fen) 2015* 2016 2017E 2018E 2019E

EPS 1.29 0.31 0.79 2.34 3.34

Diluted EPS 1.29 0.31 0.79 2.34 3.34

DPS N/A N/A N/A N/A N/A

BVPS 26.1 21.7 21.9 24.0 27.2

Key Ratios 2015* 2016 2017E 2018E 2019E

Debt to equity 0.76 0.87 1.09 1.13 1.09

Net debt to equity 0.43 0.69 1.00 1.05 1.02

Current ratio (x) 1.92 1.27 0.72 1.13 1.18

Quick ratio (x) 1.89 1.25 0.70 1.10 1.14

Interest coverage (x) 7.13 1.48 2.53 3.63 4.25

Days inventory (days) 6.9 5.6 6.0 6.0 6.0

Days receivable (days) 72.5 86.9 85.0 85.0 85.0

Days payable (days) 30.6 45.2 45.0 45.0 45.0

Operating cycle (days) 79.4 92.5 91.0 91.0 91.0

Cash conversion cycle (days) 48.8 47.3 46.0 46.0 46.0

Cashflow Statement (RMB mn) 2015* 2016 2017E 2018E 2019E

Operating activities

EBITDA 646 627 924 1,438 1,746

Other gains/losses (141) (123) (120) (120) (120)

Operating cashflow before W/C 505 504 804 1,318 1,626

Change in working capital (392) (177) (124) (209) (140)

Tax paid (78) (76) (90) (171) (224)

Cash flow from operations 35 251 591 937 1,263

Investing activities

Capex (227) (419) (1,601) (1,140) (1,200)

Others (103) (96) (100) (100) (100)

Cash flow from investing activities

(330) (515) (1,701) (1,240) (1,300)

Financing activities

Change in bank borrowings (464) 334 1,000 500 300

Interest paid (57) (244) (236) (261) (276)

Others 1,617 (546) 0 4 0

Cash flow from financing activities

1,096 (456) 764 243 24

Net increase/decrease in cash and cash equivalents

801 (720) (346) (60) (13)

Cash and cash equivalents at beginning of the Year

646 1,441 756 410 350

Effect of foreign exchange rate (5) 35 0 0 0

Cash and cash equivalents at end of the Year

1,441 756 410 350 337

Ratio Analysis 2015* 2016 2017E 2018E 2019E

Growth (YoY%)

Revenue 2.6% 33.1% 35.2% 17.1%

EBIT -10.7% 64.9% 58.7% 24.0%

Attributable profit -72.2% 158.8% 194.3% 43.0%

Diluted EPS -76.2% 158.8% 194.3% 43.0%

Margins

Gross profit margin 28.2% 29.4% 27.7% 29.9% 31.2%

EBIT margin 15.3% 13.3% 16.5% 19.4% 20.5%

Net profit margin 11.3% 4.9% 7.5% 10.5% 11.8%

Other ratios

Return on assets 3.3% 1.4% 2.6% 4.6% 5.6%

Return on equity 6.8% 3.1% 6.2% 11.1% 13.2%

ROIC 3.9% 1.7% 3.0% 5.2% 6.4%

Dividend payout ratio N/A N/A N/A N/A N/A

Valuation measures

PER (x) 18.91 79.38 30.67 10.42 7.29

PBR (x) 0.93 1.12 1.11 1.01 0.90

Dividend yield N/A N/A N/A N/A N/A

Balance Sheet (RMB mn) 2015* 2016 2017E 2018E 2019E

Non-current assets

PPE 1,303 1,687 2,714 3,219 3,696

Intangibles 1,692 1,882 2,127 2,270 2,419

Goodwill 1,718 1,927 1,927 1,927 1,927

Non-current prepayments 1,766 2,064 2,064 2,064 2,064

Total non-current assets 6,479 7,560 8,833 9,480 10,107

Current assets

Inventories 36 29 43 56 65

Trade and bills receivables 524 644 839 1,135 1,329

Other receivables 77 106 106 106 106

Due from associates 36 39 39 39 39

Cash and cash equivalents 1,436 771 410 350 337

Other current assets 325 115 115 115 115

Total current assets 2,434 1,705 1,553 1,802 1,991

Total assets 8,913 9,265 10,385 11,282 12,098

Current liabilities

Trade and bills payables 159 237 321 421 484

Other payables and accruals 429 453 453 453 453

Bank borrowings 384 458 1,194 522 552

Shareholders’ loan 138 150 150 150 150

Other current liabilities 158 47 47 47 47

Total current liabilities 1,268 1,344 2,164 1,592 1,685

Non-current liabilities

Bank borrowings 2,935 3,257 3,522 4,694 4,964

Deferred tax liabilities 197 189 189 189 189

Other non-current liabilities 149 182 182 182 182

Total non-current liabilities 3,281 3,629 3,894 5,066 5,336

Total liabilities 4,549 4,973 6,058 6,657 7,020

Shareholders’ equity

Share capital 797 1,188 1,188 1,188 1,188

Reserves 2,403 1,914 1,949 3,238 3,691

Total shareholders’ equity 3,201 3,102 3,137 4,427 4,879

Minority interest 1,164 1,190 1,190 1,190 1,190

Total equity 4,365 4,292 4,327 4,625 5,078


Appendix: CEHL’s solid waste treatment projects Figure 33. CEHL’s current waste-to-energy projects

Project Location Equity Interest Total Daily Capacity Treatment Fees Development stage

Nanchang, Jiangxi 100% 1,200 tons RMB 78/ton In operation

Shenzhen, Guangdong 46% 900 tons RMB 128/ton Initial stage

Huizhou, Guangdong 97.85% 600 tons RMB 146/ton In operation

Ruijin, Jiangxi 51% 1,200 tons RMB 69/ton Initial stage

Gao’an, Jiangxi 60% 900 tons RMB 65/ton In construction

Xinxiang, Henan 70% 1,050 tons RMB 80/ton Initial stage

Xihua, Henan 100% 900 tons RMB 68/ton Initial stage

Qianjiang, Hubei 100% 600 tons / Initial stage

Linyi, Shanxi 100% 900 tons / Initial stage

Duyun, Guizhou 95% 900 tons RMB 132/ton In construction

Shicheng, Jiangxi 60% 600 tons / Initial stage

Suixian, Henan 100% 1,200 tons RMB 65/ton Acquired in 2017

Lushan, Henan 100% 1,200 tons RMB 60/ton Acquired in 2017

Qixian, Henan 100% 600 tons RMB 63/ton Acquired in 2017

Suichuan, Jiangxi 100% 900 tons RMB 62/ton Acquired in 2017

Total 13,650 tons RMB 60-146/ton


Figure 34. CEHL’s current anaerobic treatment projects


Dongcun, Beijing 20% 930 tons RMB 85/ton Initial stage

Yangzhou, Jiangsu 100% 200 tons RMB 202/ton Initial stage

Ningbo, Zhejiang 100% 1,200 tons RMB 198/ton Initial stage

Jinzhong, Shanxi 63.88% 160 tons RMB 230/ton Initial stage




Figure 35. CEHL’s current hazardous waste treatment projects


Yangzhou, Jiangsu 100% 930 tons RMB 3,200/ton Initial stage

Zibo, Shandong 100% 1,200 tons / Initial stage

Meishan, Sichuan 100% 160 tons / Initial stage

Total 2,290 tons RMB 3,200/ton


Figure 36. CEHL’s current waste collection and transfer projects


Nanyang, Henan 100% 724 tons RMB 279/ton In construction

Linyi, Shanxi 100% 260 tons RMB 160/ton Initial stage

Duyun, Guizhou 100% 150 tons RMB 150/ton In construction

Shicheng, Jiangxi 100% 252 tons / Initial stage

Xihua, Henan 100% / RMB 125/ton Initial stage

Qianjiang, Hubei 100% / RMB 93/ton Initial stage

Suixian, Henan 100% 400 tons RMB 100/ton Acquired in 2017

Lushan, Henan 100% / RMB 116/ton Acquired in 2017

Suiping, Henan 100% 300 tons RMB 113/ton Acquired in 2017

Qixian, Henan 100% 600 tons RMB 123/ton Acquired in 2017

Suichuan, Jiangxi 100% 300 tons RMB 120/ton Acquired in 2017




Figure 37. CEHL’s current landfill projects


Duyun, Guizhou 92% 300 tons RMB 125/ton In operation

Weng’an, Guizhou 80% 150 tons RMB 120/ton In operation

Huludao, Liaoning 100% 424 tons RMB 77/ton In operation

Zibo, Shandong 100% 100 tons / Initial stage

Total 974 tons RMB 77-125/ton


Figure 38. CEHL’s current worn electronic appliances dismantling projects

Project Location Equity Interest Total Annual Capacity Treatment Fees Development stage

Maanshan, Anhui 95% 1.2mn units RMB 135/unit In operation

Huai’an, Shandong 55% 2mn units RMB 135/unit In operation

Total 3.2mn units RMB 135/unit



Rating Definitions Disclaimer and Risk Statement BUY We expect the stock to have a total return of > 15% over the next

12 months This document is published by Quam Securities Company Limited (“Quam Securities”), a licensed corporation (central entity number AAC577) regulated by the Securities and Futures Commission in Hong Kong. This document is for distribution in Hong Kong only to persons who are “Professional Investors” as defined in Part 1 of Schedule 1 of Securities and Futures Ordinance (Cap 571) of Hong Kong and any rules made thereunder. This document is not intended for distribution to or use by, any person or entity who is a citizen or resident of any jurisdiction where such distribution or use would be contrary to applicable law or regulation within such jurisdiction. This document does not constitute an offer or a solicitation of an offer to buy or sell any securities. This document is circulated to addresses solely and may not be reproduced or redistributed to any other person or published, in whole or in part, for any purpose. The research is based on information obtained from sources believed to be reliable, but Quam Securities does not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without prior notice. Any recommendation does not have regard to specific investment objectives, financial situation and particular needs of any specific addressee. Quam Securities accepts no liability whatsoever for any direct or consequential loss arising from any use of this document. Quam Securities and its affiliates as well as persons associated with any of them from time to time may or may not have interests in the securities mentioned in this document. The prices of securities may move up or down, and past performance is not an indication of future performance. Investors shall consider seeking separate legal or financial advice before making investment decisions.

HOLD We expect the stock to have a total return of < 15% and >-15% over the next 12 months

SELL We expect the stock to have a total return of < -15% over the next 12 months

Disclosures Analyst Certification: The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Li Yiming (CE No. BIE646), the authors of this document and their associates declare that as of the date of the publication of this report, they do not hold any financial interest in the company.

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