3Q21 results in line with our forecast

Originwater Technology announced its 3Q21 results: Revenue stood at Rmb1.43bn, down 8.3% compared with adjusted revenue in 3Q20; net profit attributable to shareholders stood at Rmb47mn, up 27.8% compared with adjusted attributable net profit in 3Q20. In 1-3Q21, revenue rose 30.3% YoY compared with adjusted revenue in 1-3Q20 to Rmb6.28bn, and attributable net profit increased 56.0% YoY compared with adjusted attributable net profit in 1-3Q20 to Rmb159mn. The results are in line with our forecast.

Profitability slightly declined; notable improvement in financial expenses. In 1-3Q21, the firm’s gross profit margin declined 3.71ppt YoY to 27.9%, which we attribute to equipment purchasing and increased costs amid higher raw material prices. The expense ratio dropped 6.62ppt YoY to 18.5%, with a notable improvement in the financial expense ratio, which declined 6.65ppt YoY to 7.9%.

Operating cash flow under pressure. In 1-3Q21, the firm’s net operating cash flow turned negative to -Rmb2.15bn, mainly due to: 1) a slowdown in collections from upstream companies affected by the macro economy; 2) payment to downstream manufacturers to ensure project settlement; and 3) the impact from new accounting standards that incorporate cash flow from PPP projects (investment costs) into operating costs.

Trends to watch

Private placement approved; coordinated development with China Communications Construction Company (CCCC) to boost earnings. On September 3, Originwater announced its application for a private placement to its controlling shareholder, China Urban and Rural Construction and Development (CURCD), had won official approval. After the deal, CURCD became a controlling shareholder of Originwater, and CCCC (CURCD’s parent company) an indirect controlling shareholder. We expect Originwater to regain strong earnings growth thanks to: 1) synergy between CURCD’s ecological and environmental business and Originwater’s businesses; and 2) CURCD’s ample funds, which should help improve Originwater’s financial capacity and cash flow.

Originwater a leading enterprise in membrane water treatment sector; technology breakthroughs should bolster long-term earnings growth. The firm’s R&D investment continues to be well above that of its peers, which supports its technology iterations. On October 11, the company released a self-developed vibration membrane bioreactor technology that provides excellent denitrification, features a strong pollution-resistant membrane, and consumes low energy. We believe the wastewater recycling market is a good opportunity for Originwater. In addition, we are confident the firm will achieve a strategic transformation and enjoy high-quality development, backed by an expanded presence in the industry with leading technology and a premium brand.

Financials and valuation

Considering Originwater is undergoing a strategic transformation, and CCCC becoming a shareholder should be positive for its development, we maintain our 2021 and 2022 net profit forecasts of Rmb1.50bn and Rmb1.59bn. The stock is trading at 15x 2021e and 14x 2022e P/E. We maintain OUTPERFORM and our target price of Rmb10, implying 21x 2021e and 20x 2022e P/E, offering 39.3% upside.

Risks

Promotion of membrane technology and/or project progress disappoints; market competition intensifies; financing issues.