Behind the significant oversubscription of the 1 billion bond issuance, China Water (00855) seizes the opportunity for a shift towards high-quality development.

On January 22, CHINA WATER (00855) announced that it has issued 1 billion yuan of AA-rated guaranteed blue bonds to several institutional investors, with a maturity of 5 years and a coupon rate of 3.45%. The proceeds from the fundraising will be used entirely for refinancing. The bonds received unconditional and irrevocable guarantees from the credit guarantee and investment fund "CGIF". The bond issuance was significantly oversubscribed in the market, with subscriptions from well-known fund investors, with sovereign funds accounting for 40%. CHINA WATER stated that this is the company's first issuance of offshore RMB bonds, breaking through the national sovereign rating restrictions in cross-border financing. This not only helps to lower financing costs and prevent currency mismatches, but also expands the company's financing channels and investor base. Behind the oversubscription of CHINA WATER's bond issuance lies the institutional funds' optimism about CHINA WATER's future development. As a leading cross-regional comprehensive water service operator in China, CHINA WATER has begun transitioning to high-quality development in the first half of the 2025 financial year (ending September 30), with improvements in operational efficiency and profit margins, driving steady growth in the company's intrinsic value. Starting from CHINA WATER's mid-term financial report for 2024/2025 (ending September 30), a more profound understanding of the changes in its business operations and their significance will be gained. Highlights of CHINA WATER's transition to high-quality development Looking at CHINA WATER's mid-term financial report for 2024/2025, although there was a varying degree of decline in revenue and net profit, this was a result of the company's strategic shift, reducing the expansion of construction business that requires large investments, thereby impacting the performance during the reporting period. However, a detailed breakdown of the performance reveals several highlights. Firstly, operational revenue continues to grow rapidly. CHINA WATER's operational revenue includes revenue from operating businesses such as urban tap water, pipeline direct drinking water, sewage treatment, and drainage services, which is the company's "cash cow," providing a continuous and stable cash flow for the company. During the reporting period, CHINA WATER's operational revenue grew by 16.6% year-on-year to 2.24 billion Hong Kong dollars. In the water supply business, the revenue from urban tap water business grew by 6.8% to 1.724 billion yuan, and the revenue from pipeline direct drinking water business increased significantly by 57.1% year-on-year to 196 million Hong Kong dollars. Specifically, during the reporting period, the average water price for urban tap water was 2.39 Hong Kong dollars per ton, relatively stable year-on-year, and the growth in revenue of this business was mainly due to a 6.9% year-on-year increase in water sales volume to 720 million tons. CHINA WATER stated that during the reporting period, three water supply projects have passed public hearings, and over 20 projects have initiated tariff adjustment procedures, which are expected to progress steadily in the future. Zhongtai stated that over 20 projects that have initiated tariff adjustment procedures account for one-third of CHINA WATER's total operational capacity for tap water, and the tariff adjustment process generally takes about a year, hence, there is a possibility of reflecting the results of tariff adjustments in the year 2025. It can be foreseen that water prices in several cities where CHINA WATER operates will be successfully adjusted in the next two years, which will bring growth to the company's water supply operation in terms of revenue, profit, and cash flow at multiple levels. Importantly, this will significantly improve the profit margin of the company's core water supply business. In the pipeline direct drinking water business, thanks to a 35% increase in the number of direct drinking water projects to 9,200, and a 43% increase in population coverage to 11.4 million people, the operating revenue of the direct drinking water business continued to grow rapidly during the reporting period, recording a significant increase of 57.1% to 196 million Hong Kong dollars. During the reporting period, CHINA WATER adopted an optimization strategy in the construction of direct drinking water projects, delving into the potential of existing projects, while also starting new high-return projects and initiating a light-asset franchise model to accelerate the penetration of the direct drinking water business, further solidifying the company's leading position in the direct drinking water market. With the franchise model, CHINA WATER's direct drinking water business is expected to continue to grow rapidly, paving the way for CHINA WATER to become a leader in direct drinking water in the future. Secondly, revenue from environmental protection business is growing, contributing to the rapid growth of operational revenue. During the reporting period, thanks to the completion and operation of the Huizhou Daya Bay Mofu Sewage Treatment Project, the sustainable operating revenue from the environmental protection business increased by 76.8% to 315 million Hong Kong dollars. It is worth noting that this project belongs to industrial wastewater treatment, with the price per ton of wastewater treatment being more than 10 times higher than that of domestic sewage, and the project serves well-established companies such as Mofu, with no issues of difficult repayment, hence is expected to achieve stable net cash inflows, aligning with the company's strategic policy of high-quality development in the sewage business. Thirdly, an optimization of profit structure leading to margin improvement. During the reporting period, CHINA WATER's gross profit margin was 38.4%, up by 1.5 percentage points year-on-year, and the operating profit margin was 33.9%, up by 2.8 percentage points year-on-year. Achieving a margin improvement amidst a decline in revenue is not easy, mainly due to two factors: an increase in the proportion of operational revenue boosting profitability levels, and a simultaneous downturn in capital expenditure across all sectors, thereby releasing profits. The profit margin of the water supply business division increased by 1.9 percentage points to 30.2% during the reporting period, with the direct drinking water division's profit margin at 45.1%, up by 12.6 percentage points year-on-year. It is worth noting that the net profit margin during the reporting period was 12.7%, up by only 0.64 percentage points year-on-year, significantly lower than the 2.8 percentage points increase in operating profit margin, mainly due to the high interest rates on US dollar loans during the reporting period, without yet benefitting from the three rate cuts in the US dollar and subsequent rate cuts domestically. And the 1 billion yuan offshore RMB bonds issued by CHINA WATER on January 22 will be used for refinancing, to repay some high-interest external debts, reducing the interest rate on interest-bearing liabilities to minimize the impact on net profit.In the future, with the start of external interest rate cuts, CHINA WATER will strive to use low-interest debt to replace high-interest debt, and the improvement space of net profit will become more apparent.Now may be a good time for a long-term layout of CHINA WATER. In commercial history, excellent companies often have a good sense of balance, able to keenly capture changes in the market environment and adjust their development strategies accordingly, which is crucial for the long-term steady development of the enterprise. The shift in CHINA WATER's business strategy stems from changes in the operating environment. It is well known that various construction projects of water companies require large capital expenditures. Although construction operations can drive income growth in the profit and loss statement, this can put a significant financial burden on the company. Additionally, due to the tight finances of local governments, this can extend project payment terms to a certain extent, further exacerbating the company's financial pressure. In light of the current market situation, CHINA WATER, known for its emphasis on high-quality development, has not blindly pursued rapid expansion. It prioritizes project returns in resource allocation, choosing projects that can bring the best returns, thus slowing down the expansion of some construction projects. Through strategic adjustments, CHINA WATER's profitability is expected to gradually increase with the continued growth of operating income from urban tap water, direct drinking water, and sewage treatment and drainage services. After reducing capital expenditures, CHINA WATER is expected to achieve a positive free cash flow goal next year, highlighting its characteristics as a stable and sustainable utility company. This not only increases the possibility of CHINA WATER raising its dividend payout ratio, providing the market with greater imagination space, but also further reduces financial leverage, improves the company's asset structure and quality, laying a foundation for the next round of high expansion. The stable development of the water industry under policy support also provides opportunities for this. On December 5, 2024, the General Office of the Central Committee of the Communist Party of China and the General Office of the State Council issued the "Opinions on Promoting the Construction of New Urban Infrastructure to Build Resilient Cities" (referred to as the "Opinions"). The "Opinions" is a policy document formulated by the Chinese government to deepen urban safety resilience enhancement action, promote the construction of digital, networked, and intelligent new urban infrastructure. The "Opinions" require significant progress in the construction of new urban infrastructure by 2027 and remarkable achievements by 2030, promoting the construction of a number of high-level resilient cities. Key tasks in the "Opinions" include digital transformation and intelligent management of smart municipal infrastructure construction, including urban water supply. In terms of project planning and implementation key suggestions, it recommends overall layout for special planning of water supply, drainage, and continues to promote industry development. The continued steady growth of the industry will give CHINA WATER, known for its sense of balance, greater development initiative when the future market environment improves. At that time, CHINA WATER may have the opportunity to demonstrate greater performance elasticity. However, for investors, now may already be a good time to lay out CHINA WATER for the long term, after all, CHINA WATER's current PB valuation is only 0.56 times, the market value is far below the company's net assets, and the median PB valuation of CHINA WATER in the past five years is about 1 time, indicating that the deviation between the market value and intrinsic value of CHINA WATER has reached a relatively high level, which is already a good "buy-in period". Several securities firms have also released research reports expressing optimism about the future development of CHINA WATER. Soochow maintains a "buy" rating for CHINA WATER, Zhongtai stated that CHINA WATER's mid-term performance exceeded expectations, maintaining a "buy" rating with a target price of HK$6.23, still indicating over 35% upside potential from the current price.