China is one of the most water-deficient countries in the world as recognised by the United Nation, with 400 out of 660 cities suffering from water shortage. Pressures from the rapid rate of urbanisation and the weak state of the local government’s balance sheets have presented an opportunity for private companies to add value through Private-Public-Partnerships (PPP) in the water sector.
China Water Affairs Group (CWAG), whose founder and Chairman, Mr Duan Chuan Liang, pioneered bringing PPP in the industry, has been among the first movers.
CWAG is currently engaged in projects across 50 cities in China. A typical project is jointly owned by CWAG and the local government to provide water tap supply to the growing number of inhabitants coming to the city. CWAG collects the money directly from the customer (residential and commercial) and then redistributes the share to the local government.
At present, only 15% of China’s water tap supply is privatised with the majority of the state-operated water supply either running at break-even or unprofitable. Many services are unmetered and poorly collected.
Another problem is the amount of water that gets lost between source and tap. Nationally this wastage is around 50%. CWAG’s upgrade program typically cuts this to around 16%. With an expected shortage of 199bn cubic meters, or 25% of demand by 2030, private operators, in this case, are seen as a key solution to address the intensifying water shortage challenge.
CWAG gets paid per connection, including the installation of meters, and on a volume basis. As part of the drive to encourage responsible usage, it charges higher rates for heavy users.
Water tap supply is a regulated industry with ROE’s set between 8-12%. It is a very important social resource and local governments are therefore reluctant to sell off local utilities to just anyone. Other private operators in China such as Guangdong Investments or Yunnan Water are typically affiliated with a local government, and so incapable of gaining the national footprint that CWAG has achieved.
CWAG has one of Japan’s leading non-bank financiers, ORIX, as an 18% shareholder, with board representation, a presence that gives us comfort on governance issues. It also has debt funding backing from a blue-chip selection of lenders, including the World Bank’s private sector offshoot, the International Finance Corporation.
Focussed on small cities, we see CWAG as operating in a sweet spot otherwise overlooked by large enterprises but necessary for cash-strapped local governments who have economic growth KPIs that need to be delivered to Beijing. Water is a key focus area for the Central Government at the moment with a slew of favourable policies including “Water Ten”, “Progressive Tariff”, “Rural Revitalisation Strategy” and “Beautiful China”, all strong tailwinds supporting CWAG’s growth prospects.
Included in the FTSE Environmental Opportunities Asia Pacific Index in 2009, we view CWAG as one of the players in improving the social and environmental landscape in China.
We believe that even allowing for uncertainties about the future regulatory environment CWAG is too good a business for it to be trading at just 10x expected March 2019 earnings.
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