2021 results in line with our expectations

Chongqing Water announced its 2021 results: Revenue grew 14.22% YoY to Rmb7.25bn; attributable net profit rose 17.13% YoY to Rmb2.08bn, implying EPS of Rmb0.43, in line with our expectations.

Rising sales volume and lower value-added tax (VAT) drove up　revenue. 1) Wastewater treatment volume grew 14.22% YoY to 1.49bn cubic meters, and VAT rate for wastewater treatment service revenue declined from 13% to 6%. As a result, revenue of wastewater treatment service business rose 18.84% YoY to Rmb4.18bn. 2) Water sales volume of the water supply business increased 9% YoY to 621mn cubic meters, driving up revenue of the business 9.54% YoY to Rmb1.70bn.

Profitability pressured; overall expense ratio up; ample cash flow. In　2021, the firm’s blended gross margin (GM) fell 2.27ppt YoY to 41.37%, mainly due to an increasing number of employees at newly established and acquired operations. In addition, GM of wastewater treatment segment dropped 3.71ppt YoY to 47.39% because the firm could no longer benefit from the favorable social security policies as it did during the same period of 2020. Overall expense ratio grew 1.23ppt to 18.05%. Specifically, selling expense ratio edged up 0.33ppt YoY to 2.16%, mainly due to rising expenses from regular water meter replacement of water supply firms.G&A expense ratio rose 0.92ppt YoY to 15.29%, mainly due to the base effect associated with the favorable social security policies in 2020 and delayed payments for maintenance during the COVID-19 pandemic. In 2021, the firm’s net operating cash flow rose 18.83% YoY to Rmb2.74bn.

Trends to watch

Steady development of water business to drive earnings growth. In　2021, the firm put Phase II Beibei Honggong water factory into operation, and completed acquisition of several water factories such as Niutouyan, with its wastewater treatment projects covering all districts and counties in Chongqing. In addition, the firm further penetrated into the rural water supply markets in Yubei and Jiangbei districts, expanded into new businesses such as dual water supply and pipeline operations and maintenance, and accelerated its expansion outside Chongqing. We expect the firm’s main business to remain robust on the back of its steady expansion into local and national markets.

Accelerated digital transformation to boost operational efficiency.The firm continues to advance its digital transformation by accelerating the development of its intelligent water business. It has built a cloud big data platform and integrated over 20 affiliated firms into the platform, offering cloud services to municipal water supply and conservation platforms. In addition, the firm has been advancing the construction of intelligent water and wastewater treatment factories in an orderly manner. We expect the firm’s management and operational efficiency to further improve, facilitating effective expense control and profitability improvement.

Financials and valuation

We maintain our 2022 net profit forecast of Rmb2.26bn, and introduce our 2023 net profit forecast of Rmb2.48bn. The stock is trading at 13.6x 2022e and 12.4x 2023e P/E. Considering the firm’s digital transformation will likely drive its high-quality growth, we raise our TP 23% to Rmb8, implying 17.0x 2022e and 15.4x 2023e P/E with 25% upside. Maintain OUTPERFORM.

Risks

Falling wastewater treatment fees; project progress disappointing; volatile foreign exchange rates.