Equity Research | Environmental

Mar 16, 2015

Sound Global (967 HK) Underperform (downgraded)

No longer a re-rating play; downgrade to Underperform

Target price: HK$4.75 Postponement of results announcement a negative surprise When all investors were supposed to have read how its 2014 earnings maintained high growth YoY following the short seller attack, Sound Global (SG) surprised by postponing the announcement “as the audit of the Group’s annual results for the year ended 31 December 2014 has not been completed”. Trading in the company’s shares has been suspended as management expects the company not to be able to announce 2014 result by Apr 30.

Wallace Cheng SFC CE No. AKX251 [email protected] +852 3719 1049

GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Management’s stake increase and share buyback unlikely to help Chairman Wei Yibo mentioned the possibility of increasing his stake, and proposed that SG starts a share buyback, after the blackout period during a teleconference held last month. However, we do not expect these measures to have the desired effect as the results delay has already caused further trust issues for investors. No longer a re-rating play; rating slashed to Underperform SG’s execution ability has disappointed us as we had expected the company to handle such a critical event with extra care. As such, we see no further room for re-rating given the big hit to investor confidence. We leave our earnings forecasts unchanged, but slash our valuation benchmark from 19x to 8.2x 2015E P/E (1 SD below its average historical forward P/E) to factor in the trust issues. We cut our target price from HK$11.20 to HK$4.75 and downgrade SG from Buy to Underperform. We suggest investors switch to BEWG (371 HK; Buy).

Stock performance 10.0 HK$ 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Sep-10

Major de-rating event We see this as a major de-rating event for SG. First, we believe it has just ruined all its efforts to rebuild investor confidence following the short seller report. Although there had not been any disagreements between SG and the HKEX and Deloitte in previous years regarding its EPC contracts and financial reports, this delay simply triggers further panic. Second, it was a fatal mistake to rush towards the results announcement without considering that Deloitte would take a more rigorous approach to the 2014 results, meaning more time was required. We do not understand why SG was so eager to take the risk of announcing its results as early as mid-March instead of taking the more conservative approach of announcing towards the end of March. We believe management did not recognize that sentiment towards the company is still fragile even though the share price has rebounded by more than 50% from its Feb lows.

Upside risks: 1) Better-than-expected 2014/15 results; 2) Substantial M&A which would lead to significant value accretion for the company; 3) Bigger-than-expected share repurchasing scheme. Sep-11

Sep-12

Sep-13

Sep-14

Source: Bloomberg

Key data

Stock valuation

Ma r 13 cl os e (HK$)

7.00

Sha res i n i s s ue (m)

1,780

Ma jor s ha rehol der

Sound Env. (31%)

Ma rket ca p (HK$ bn)

12.5

3M a vg. vol . (m)

3.7

52W hi gh/l ow (HK$)

9.47 / 5.66

Source: Bloomberg

Turnover Net profit (Rmb m) (Rmb m) 2012 2013 2014E 2015E 2016E

2,652 3,140 4,025 5,183 6,370

428 423 597 831 1,079

Sources: Company data, GF Securities (HK) Note: Calculated based on diluted shares.

EPS (Rmb)

EPS YoY (%)

P/E

BPS (Rmb)

P/B

ROE (%)

0.331 0.328 0.398 0.467 0.606

3.3 -1.0 21.2 17.3 29.9

17.0 17.2 14.2 12.1 9.3

2.05 2.38 2.45 3.53 4.14

4.2 3.6 3.5 2.5 2.1

16.2 13.8 16.3 13.2 14.6

Mar 16, 2015

Company report

Figure 1: New projects announced YTD Date

Project

Capacity Concession Standard Contract amount (kt/day) (Years) (Rmb m)

12-Mar-15 25-Feb-15 24-Feb-15 16-Feb-15 11-Feb-15 2-Feb-15 15-Jan-15 14-Jan-15 13-Jan-15 8-Jan-15 7-Jan-15

Taian Economic Development Zone WWT Feitian Mine Phase I & II water purification station Wuyi County Number 2 WWT Xinshao County water diversion engineering bundled PPP WWT project in rural area of Fu'an Fogang Zhanyang Domestic WWT Xingping Hualu Sewage Treatment Hongze Project Phase II Qingcaohe Water Plant in Jing County 33 township sewage treatment plants in Enyang District 14 urban rural sewage treatment projects in Tongchuan

WWT

BOT (bid) EPC WWT BOT (bid) Water Supply BOT (bid) WWT PPP (bid) WWT BOT (acq) WWT BOT (acq) WWT BOT (expansion) Water Supply BOT (bid) WWT BOT (invest) WWT PPP (bid) Subtotal EPC WWT Water Supply

25

30

1A

15 50 16 30 50 20 20 6 8

25 30 30 20 25

1A

NA 170 70

30

1B 1A 106 1B 1B

110 23 80 180 60 61 98 100 64 60 72

23 640 244

Sources: Company data, GF Securities (HK)

Figure 2: Forward P/E band

Figure 3: Forward P/B band 3.0

20.0

+2 SD

+2 SD

2.4 +1 SD

15.0

+1 SD

1.8 Mean

Mean

10.0

1.2

-2 SD

09/10 11/10 01/11 03/11 05/11 07/11 09/11 11/11 01/12 03/12 05/12 07/12 09/12 11/12 01/13 03/13 05/13 07/13 09/13 11/13 01/14 03/14 05/14 07/14 09/14 11/14 01/15

5.0

-1 SD

-2 SD 0.6

09/10 11/10 01/11 03/11 05/11 07/11 09/11 11/11 01/12 03/12 05/12 07/12 09/12 11/12 01/13 03/13 05/13 07/13 09/13 11/13 01/14 03/14 05/14 07/14 09/14 11/14 01/15

-1 SD

Sources: Bloomberg, GF Securities (HK)

Page 2

Mar 16, 2015

Company report

Figure 4: Financial statements Income Statement 2012 2013 2014E 2015E 2016E

Year end Dec (Rmb m)

Turnkey projects and services Equipment fabrications O&M Turnover YoY (%) COGS Gross profit YoY (%)

2,446 112 94 2,652 15.9

2,883 64 193 3,140 18.4

3,661 57 306 4,025 28.2

4,467 60 655 5,183 28.8

5,450 63 857 6,370 22.9

Cash and cash equivalents Trade and other receivables Amounts due from customers Other current assets Total current assets

2,912 1,433 584 79 5,008

3,534 1,569 1,097 139 6,338

2,379 1,971 1,665 146 6,161

3,073 2,538 2,406 157 8,174

1,707 3,120 3,329 167 8,324

(1,852) (2,181) (2,796) (3,599) (4,415) 800 958 1,230 1,584 1,955 10.8 19.7 28.3 28.8 23.4

Property, plant & equipment Land use right Service concession Other non-current assets Total non-current assets

48 43 1,643 97 1,831

50 78 2,237 95 2,460

51 76 3,397 93 3,617

52 75 4,908 91 5,127

54 74 6,792 89 7,008

Short-term borrowings Trade and other payables Other current liabilities Total current liabilities

465 1,171 127 1,763

764 1,654 151 2,569

1,031 2,120 242 3,393

1,124 2,729 368 4,220

1,225 3,348 527 5,100

Long-term borrowings Senior notes Other non-current liabilities Total non-current liabilities

889 923 610 2,421

1,518 899 738 3,154

1,639 908 165 2,712

1,705 908 165 2,778

1,773 908 165 2,846

Share capital Reserves Equity attributable to Non-controlling interests . Total equity

833 1,811 2,644 11 2,655

833 2,237 3,070 4 3,074

833 2,834 3,667 7 3,674

833 5,458 6,292 11 6,303

833 6,537 7,371 16 7,387

Other operating income Other expenses Distribution expenses Research and development Administrative expenses EBIT YoY (%)

54 2 (38) (24) (118) 677 14.9

95 (11) (38) (20) (132) 851 25.8

134 (16) (56) (28) (177) 1,086 27.5

196 (26) (78) (41) (228) 1,407 29.6

277 (38) (102) (57) (287) 1,747 24.2

Finance costs Profit before income tax

(174) 503

(285) 566

(288) 798

(296) 1,111

(305) 1,443

After tax profit

(76) 428

(141) 425

(198) 600

(276) 835

(359) 1084

Minority interest Net profit YoY (%)

0 428 3.3

(2) 423 (1.0)

(3) 597 41.0

(4) 831 39.2

(5) 1,079 29.9

Income tax expense

Year end Dec (Rmb m)

Cash Flow Statement 2012 2013 2014E 2015E 2016E

Pre-tax profit Tax paid Dep'n and amortization Change in working capital Others Cash from operations Capital expenditure Others Cash from investing Proceed from share issuance Change in borrowings Dividend paid Others Cash from financing FX change Net change in cash

Balance Sheet 2012 2013 2014E 2015E 2016E

Year end Dec (Rmb m)

503 (57) 16 (694) 126 (106)

566 798 1,111 1,443 (66) (119) (166) (215) 17 8 8 8 (621) (1,661) (2,205) (2,764) 221 277 285 294 117 (697) (967) (1,235)

(5) (14) (19)

(6) (143) (150)

(6) 11 5

(6) 11 5

(6) 11 5

0 1,138 (65) (110) 963

0 924 0 (264) 660

0 (175) 0 (288) (463)

1,794 158 0 (296) 1,657

0 169 0 (305) (135)

(0) 838

(6) 0 622 (1,155)

Financial Ratio 2012 2013 2014E 2015E 2016E Gross margin (%) EBIT margin (%) Net margin (%) ROA (%) ROE (%) Net gearing (%) Interest coverage (x) Current ratio

30.2 25.5 16.1 6.3 16.2 NC 3.9 2.8

30.5 27.1 13.5 4.8 13.8 4% 3.0 2.5

30.5 27.0 14.8 6.1 16.3 30% 3.8 1.8

30.6 27.1 16.0 6.2 13.2 9% 4.8 1.9

30.7 27.4 16.9 7.0 14.6 28% 5.7 1.6

0 0 694 (1,365)

Sources: Company data, GF Securities (HK)

Page 3

Mar 16, 2015

Company report

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy

Stock expected to outperform benchmark by more than 15%

Accumulate

Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold

Expected stock relative performance ranges between -5% and 5%

Underperform

Stock expected to underperform benchmark by more than 5%

Sector ratings Positive

Sector expected to outperform benchmark by more than 10%

Neutral

Expected sector relative performance ranges between -10% and 10%

Cautious

Sector expected to underperform benchmark by more than 10%

Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.

Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies did not have any investment banking relationships with the companies mentioned in this research report in the past 12 months. (3) All of the views expressed in this research report accurately reflect the independent views of the analyst(s). Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the companies mentioned in this report, or has any financial interests in or holds any shares of the securities mentioned in this report.

Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or a recommendation for investing in, any securities. This research report is intended solely for use by the clients of GF Securities (Hong Kong). The securities mentioned in this research report may not be allowed to be sold in certain jurisdictions. No action has been taken to permit the distribution of this research report to any persons in any jurisdictions that the circulation or distribution of such research report is unlawful. The information contained in this research report has been compiled or arrived at from publically available sources believed to be reliable in good faith, and no representation or warranty, either express or implied, is made by GF Securities (Hong Kong) as to their accuracy and completeness. GF Securities (Hong Kong) accepts no liability for any losses arising from the use of the materials presented in this research report, unless otherwise required by applicable laws or regulations. Please be aware of the fact that investments involve risks and that the prices of securities may fluctuate and therefore returns may vary. Past results do not guarantee future performance. Any recommendations contained in this research report do not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. This report is not to be taken in substitution for the exercise of judgment by the respective recipients of this report. Where necessary, the recipients should obtain professional advice before making investment decisions. GF Securities (Hong Kong) may have issued, and may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented in this research report. The points of view, opinions and analytical methods adopted in this research report are solely expressed by the analyst(s) but not GF Securities (Hong Kong) or its subsidiaries. The information, opinions and forecasts presented in this research report are the current opinions of the analyst(s) as of the date appearing on this material and are subject to changes at any time without notice. The salespersons, dealers or other professionals of GF Securities (Hong Kong) may deliver opposite points of view to their clients and the proprietary trading division with respect to market commentaries and dealing strategies either in writing or verbally. The proprietary trading division of GF Securities (Hong Kong) may have investment decisions which are contrary to the opinions expressed in this research report. GF Securities (Hong Kong) or its affiliates or respective directors, officers, analysts and employees may have rights and interests in the securities mentioned in this research report. The recipients should be aware of relevant disclosures of interests (if any) when reading this report. Copyright © GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. © GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk

Page 4

Sound Global (967 HK)

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