Water sector - Top SGX listed picks United Envirotech and SIIC

The consolidation of China’s water sector, which gained pace last year, will continue. This will be driven by the secular trend that has taken hold in the industry because of China’s resolve to address its environmental issues and surging water demand amid rapid urbanization and further industrialization.

More stringent government policies would continue to force out incompetent players, while higher investment returns through tariff hikes and better economies of scale would create bigger winners. Specifically, state-owned enterprises are better positioned to enjoy interest cost savings and spin off existing assets into a listed platform for further development (with fund-raising) and to unlock value.

Our picks: Sound Global (listed on HKSE) is the best bargain at 30% discount to peers, with promising earnings upgrades backed by a record high orderbook. The rising tide may have lifted United Envirotech but its advanced membrane technologies and growing portfolio keep it as an attractive acquisition target. SIIC Environment is a buy on dip for investors who can wait for the firm to evolve into a bigger and more comprehensive environmental play.

Sound Global a Cheaper China Water Industry Play

Company background. Sound Global is one of the leading one-stop integrated water and wastewater treatment solutions providers in the PRC. Its services cover the full value chain of water and wastewater treatment, including the design and construction as well as operation and maintenance of water and wastewater treatment facilities, and the manufacture of water and wastewater treatment equipment.

A first mover in a CNY430b market. Water treatment investments are set to double in the 12th Five Year Plan Period (2011-2015) to CNY430b in an effort to improve China’s wastewater treatment rate to 85% by 2015, from 77% currently. Commercialisation and privatisation of the Chinese water treatment market is also a long-term trend. With over 20 years of experience, Sound Global has become one of the leading one-stop integrated wastewater treatment solution providers in China, with a respectable market share.

Key revenue drivers. In our view, Sound Global’s revenue will be supported by:
1) continuous order wins thanks to a long-term relationship with the government, and
2) more BOT projects entering their collection period.
A hike in water tariffs in China will also have positive effect on revenue.

Margins likely to fall. Although we are positive on Sound Global’s revenue outlook, its high net margin of the past few years would be very hard to maintain, in our view. Recent high-cost borrowing will weigh on the company’s net margin for the next few years, assuming it does not redeem the senior notes before maturity.

Trading at large discount to peers. Sound Global is trading at a