China Water Nexus

One of the themes we try to cover in this blog is how Chinese water companies can become globally competitive.

In the past five years, international technology transfer has been the key “internationalization” tool used by Chinese companies.  Chinese companies improve their technology and know-how, while at the same time, give foreign companies access to local markets.  Examples include Beijing Enterprises Water Group with Aqualyn, Suez Water and NWS Holdings, Elster Metering and Jiangxi Sanchuan and Sino-French Water (also Suez) and Chongqing Water.

We can also look at the internationalization aspect of Chinese water companies by geographic presence.  Although many of the listed Chinese water companies are technically “international” if they are listed on an overseas exchange, their management teams and board of directors are  Chinese or Hong Kong based. The exceptions would be those companies with headquarters in Singapore, such as Sound Global. Coincidently, Sound Global was recently awarded its first international contract in Saudia Arabia.  Tri-tech Holdings just announced a contract in India.  Many water parts manufacturing companies on the seacoast are international in the sense that they depend on the export market and must understand international buyers and the water markets they are supplying to.

Revenue size is another way to determine where Chinese water companies fit in the global water market, even if their sales are all domestic. Deane Dray of CITI recently published a report on the global water industry, including a list of the top 25 Global Water companies by water revenue (not the most easy data to compile).  Veolia ranks in #1 with more than $17 billion in revenues, while Aqua America makes #25 with $726 million.  The below chart shows the makeup of where the companies are from.

Although the US dominates in terms of amount of companies in the top 25, it should be noted that France’s Veolia and Suez command more in terms of revenues than all US companies combined (37% versus 34%).  Another interesting point of this chart, is how Companhia de Saneamento Basico (Sabesp), a Brazilian company, ranks as the 3rd largest in the world by revenues. Absent from the list are Chinese companies.  If we take 6 publicly listed Chinese companies by water revenues, we get the below chart.

A quick look at this list shows that only one company would technically make the top 25: Beijing Enterprises Water Group (BEWG). This company is essentially an engineering/construction services company that got 72% of their 2010 revenues from Build and Transfer (BT) projects (87% if we include BOT).  The company remarkably quadrupled its revenues from 2009 to 2010, likely powered from its newly raised capital (debt increased by triple the amount of last year).  Should BEWG be able to continue its growth and expansion into different areas in the water sector, the company should be in next year’s top 25 list, thus making it the first Chinese global water company (by revenues).  If it solely depends on BT projects in the future, however, it may be difficult to scale this business consistently over the long run.

We do one more step and look at total employees (in their water divisions) for these Chinese companies compared to some global peers (we leave Veolia and Suez out, both with massive employee counts).

According to the above chart, most of the international water companies in the Top 25 have employee counts (for their water divisions) of around 6000 and above.  Chinese companies such as Chongqing Water and Beijing Capital are approaching this “6000″ level.  Whether this is significant would require additional study as many SOE companies in China are often known for not having the same efficiency as multinationals.

Companhia de Saneamento Básico (Sabesp): Why number 3?

If a Chinese company is not yet in the Top 25, why then is a Brazilian company able to rank as the third largest global company? China not only has second largest economy in the world, but has a population of more than six times Brazil.

Sabesp, a Brazilian company based in Sao Paulo,  is one of the largest water and sewage service providers in the world based on number of customers (more than 20 million people).  It also sells wholesale treated water to 7 municipalities with a population of 3.6 million people. Internationally, it is doing some work in Costa Rica, Panama, Honduras, as well as other areas.  The company has more than 15000 employees.

Sabesp is able to rank so high on the Top 25 due to its strong monopoly in both waste treatment and water supply in Sao Paulo, one of the richest cities in the world.  In 2010, Sao Paulo’s GDP was close to $600 billion, an economy similar to the size of Poland. Shanghai’s 2010 GDP  was $250 billion, making it similar to the economy of Finland.  Sabesp meanwhile supplies close to 3 billion m³ of raw water and treats 80%+ of Sao Paulo’s sewage.  This amount is much higher than the Chinese water supply and treatment companies.  In 2010, Shanghai Chengtou (a large SOE that gets one third of its 2010 revenues from water) supplied about 1.2 billion m³ of raw water and 564 million m³of treated water in 2010. Shanghai Chengtou also shares the local market through joint ventures with foreign players such as Veolia where Sabesp does not. Guangdong Investment supplied 2 billion m³ of raw water to both Hong Kong and southern China (and is not involved in water treatment).  With respect to the price of water, average prices of water in China’s cities (which are below $0.5 USD)  are still well below Sao Paulo (around $0.8 USD).

Conclusion: Large Chinese water companies will use the local market to enter the Top 25

As China’s cities continue to prosper and develop,  we will see Chinese water supply and waste treatment companies follow the same growth pattern as Sabesp.  This rate of growth will depend on a number of factors such as the city’s GDP, water prices and competitiveness within the jurisdiction area.  Geography will also play an important role on how these Chinese water companies scale in China.  Many Chinese water companies are only focused in their home province (or even home city), and likely depend on local government contacts to secure contracts and orders.  Guangdong Investment is interesting in that its only water business is supplying Hong Kong and areas in Guangdong with water (a cash cow valued highly among fund managers). Its large cash reserves make one speculate on how it will expand in the water space.

For Chinese companies who get most of their revenues from engineering, construction, and fees on BOT projects, diversifying to other regions involves patience.  Some Chinese companies are making giant strides with regard to revenue growth.  BEWG is technically in the top 25 (by revenues) with more than $800 million in revenues.  Chongqing Water, Beijing Capital, and Sound Global may make the list in a few years due to large investment in water infrastructure by the Chinese government and private sector.

Will we see a Chinese company in the Top 25 that focuses on advanced water products and services like filtration, chemicals, membranes, desalination, and smart water systems? As China’s water pollution problems intensify and water pollution worsens, more resources will be spent in this sector.  A mid-sized Chinese water company that focuses on effective and well priced solutions focused for the Chinese market will likely be able to capitalize on this opportunity.  In a previous post, we highlighted Hainan Litree, a filtration products manufacturer that often beats out Siemens, GE Water, and others due to their lower pricing and reliability (the company has been around since 1992).  At $100 to $150 million in revenues, can the company quadruple this number? Of course – look at Haier, Lenovo,  Goldwind, and a dozen solar panel companies.

Alternatively, a Chinese water supply/treatment company may accumulate  enough cash on hand to go out and purchase an international company to help expand into these services.

Both are trends to watch closely in the coming years.

In China, the hot topic in most economic newspapers right now is the “跑路 (pao lu), where the owner of a small to mid-sized factory, due to an inability to pay back creditors or guarantee companies, must close the factory and sell the equipment.  In order to do this without having to deal with labor disputes, the management will send their employees on a “vacation” or field trip so they can remove the equipment and avoid conflict. This is especially occurring in Wenzhou (Zhejiang province), but close watch is now on areas in Guangdong, Henan, and other manufacturing areas in China. 

A recent article (among many) noted that one of the  ”Pao Lu” factories  was 永嘉啊斯泰阀门, a company producing valves related to the water industry.  China Water Nexus has previously looked at the large concentration of water parts manufacturing in China, where competition is especially fierce in water purification,  valves, pipes, and water heaters.  For example, in a water conference in Shanghai, it is normal for 150 companies to attend with headquarters in Shanghai, Hangzhou, Ningbo, Wuxi, Wenhzou and Nanjing.  68% of of these companies entered the market in 2000 and later (41% entered in 2004 or later).

Although it is impossible to tell if water parts manufacturing companies and service companies are seriously in trouble without financial statements, we believe this issue does deserve more study.  In our recent analysis of Pan Asia Environmental Protection, a small cap water stock listed in Hong Kong, we noted that the Jiangsu based manufacturing company has been diversifying out of water and into construction materials.  One must wonder if they are doing this because of the oversaturation in the water parts industry.

In this post, we  do a brief analysis of the capital metrics of all 31 listed China water companies, looking at the changes in the past year.  In particular, we look at cash, debt, interest coverage, working capital and CAPEX by breaking the 31 companies into four groups: 1) Foreign listed small; 2) Foreign listed large; 3) Domestic listed small; 4) Domestic listed large.  We define small as under 200 million RMB in 2010 EBIT for foreign listed Chinese companies and under 100 million 2010 EBIT for domestic listed companies.  This is by no means comprehensive but more meant to look at a general snapshot of how larger and smaller companies operating in the water sector in China compare.   For a more comprehensive analysis on Chinese water stocks, the H20 Research center is good for domestic listed stocks. CLSA (headed by Simon Powell, their Head of Sustainable Research), has been very strong in covering foreign listed water stocks (see Thirsty Asia for an 2007 stock coverage, and Thirsty Asia 2, Thirsty China, Falling up! for sector coverage). Nomura also issues a Water & Environment report on China.

To download the excel for below charts, please click here. 

Cash Position: In all groups, except for Domestic listed big, cash has increased in the first six months of the year for China listed water companies.  This likely reflects the sentiment of managers to be cautious during the European debt crisis.  Larger companies raised more equity capital than foreign listed Chinese companies in 2011, including Beijing Water (mainly a construction services (BT model) company) with a 3 billion HKD float.    A few small Chinese companies have fragile cash positions (Gansu Dayu, Memstar, and Tri-tech), a trend which should be monitored over the next few quarters.

• Large Foreign Listed (all H.K. listed): An increase in cash for this group is mainly due to Beijing Water, which increase its cash through an equity issuance.  Beijing Water’s main strategy is to “aquire large-scale water and sewage projects and other small and middle scaled water investment companies,” a trend which we covered with its JV with Aqualyn (full list of equity partnerships is listed on their website).  Guangdong Investment (60-70%% of its revenues come from water distribution – the rest from property development), which had strong earnings, added to its cash poisition to help it navigate a “non- optmistic” environment.
• Large Domestic Listed:  Blue Star Cleaning, a subsidiary of  ChemChina (a large SOE) with a 20% stake by Blackstone,  and Jiangsu Jiangnan Water both added to their cash positions, while the remaining group was stable.  Shanghai Chengtou had the largest drop in cash.
• Smaller Foreign Listed:  Most companies tried to keep the same level of cash as six months ago. Exceptions include Tri-Tech (listed in US), Memstar (Singapore), and Asia Environment (Singapore).  Tri-tech has been heavy (for its size) on the aquisition front, explaining for its reduction of cash. Also notable is that Pan Asia Environmental Protection’s sizable cash position is slowly dropping as it invests into construction materials.
• Smaller Domestic Listed: Most companies tried to maintain similar cash levels.  Exceptions include Gansu Dayu Water Saving Group (listed on the Chinex), which has been losing cash for the past year due to an inability to make its cash flow from operations positive.  Heilongjiang Interchina Water Treatment had success raising 776 million RMB earlier this year on the market and appears to have spent a good amount on CAPEX, to boost revenues and earnings.  The firm’s strategy in the past year has been focused on the BOT and TOT models and equity participation in water projects.

Debt Position: For smaller sized listed companies in China, raising debt in the first part of the year was very difficult, except for two companies (United Envirotech and Heilongjiang Interchina).

• Large Foreign Listed (all H.K. listed): Beijing Water Doubled its debt from 3 billion to over 6 billion RMB.
• Large Domestic Listed:  Blue Star Cleaning and Zhongshan Public Utilities Group both doubled their debt.
• Smaller Foreign Listed:  Very little change, except for a tripling in debt from United Envirotech (Singapore), which was a convertible bond deal with PE giant, KKR .  Its important to note that Tri-tech, Pan-Asia Environment  and Memstar are debt free.
• Smaller Domestic Listed: Heilongjiang Interchina Water Treatment was the only company in this group add to its debt position.

Interest Coverage: This chart probably best shows the increasing stress smaller companies are facing the global economic crisis.  Although interest coverage ratios of 7 and 8 times are not dangerous, it is something to pay stronger attention to in the coming quarters. 

• Large Foreign Listed (all H.K. listed): Sound Global’s interest coverage decreased due to higher interest payments.
• Large Domestic Listed:  No major changes (except Blue Star Cleaning’s higher EBIT). It must be noted that a few companies have low interest coverage rates (2x to 3x)such as Jiangxi Hongcheng, Zhongshan Public Utilities, and Sichuan Guangan. Because these are SOE companies working with State Owned Banks, this will not raise major alarms.  At the same time, if banks in China do face a liquidity crisis in the future, these coverages will likely be more closely watched.
• Smaller Foreign Listed:  A decrease mainly due to United Envirotech’s debt increase. Careful attention should be put on Asia Environment and Asia Water Technology, which have very low interest coverage ratios.  This may impact their future expansion plans.
• Smaller Domestic Listed: Some of these companies appear in serious trouble, such as Wuhan Sanzhen, Gansu Dayu and Qian Jiang Water Resources.

Cash Flow Operations: We study this chart to see who is in trouble with regard to working capital (normally due to accounts receivables and bills receivables).  We can see special attention should be paid to small domestic listed companies, including Fujian Zhangzhou and Gansu Dayu.    

• Large Foreign Listed (all H.K. listed): Beijing Water has historically had low operating cash flows for the past couple of years, and thus has needed to resort to financing to maintain positive cash and continue CAPEX.  China Everbright International, which has a portion of its revenues focused on water,  also has issues on accounts receivables.
• Large Domestic Listed:  Surprising no major problems with companies from this group. It should be noted however, that many domestic companies receive other cash income from non-related business activities to help their operating cash income (Chongqing Water is a key example).
• Smaller Foreign Listed:  Tri-tech is the number one concern in this group with negative cash flows.  Let’s hope the receivables are real…
• Smaller Domestic Listed: Dayu Gansu is the major concern in this group.

Cash Flow Operations: CAPEX is a great measure to see which companies are really planning for the future  China.

• Large Foreign Listed (all H.K. listed): Tianjin Capital Environmental Protection leads the group while Sound Global has minimal CAPEX.  With relatively strong cash reserves, we look to see what Sound Global plans to do in the future related to CAPEX.
• Large Domestic Listed:  Jiangxi Hongcheng invested 1,884 million RMB in 2010, a sizeable number.
• Smaller Foreign Listed:  If we exclude Hyflux (which has minimal CAPEX in China), the majority of CAPEX for 2010 was under 54 million RMB, and was the same level as 2009.
• Smaller Domestic Listed: Heilongjiang Interchina was the largest CAPEX spender.

Conclusion: Each company listed in this post could easily have its own analysis. At the same time, there are a number of takeaways we can get from analysis.

• Interest in the water sector is high from investors.  We see many listed companies in the past six months being able to place additional equity sales to raise capital (KKR and United Envirotech is one example).  This goes in line with a recent FT article mentioning the strong increase of PE capital entering China’s water sector ($400 million in first half of 2011 versus $50 million in 2010).
• Getting paid by customers in the water industry is difficult.  This means different things for small and large companies.

1. Smaller Companies with limited cash have to buckle down and take control of their working capital and collections.  Tri-tech and Gansu Dayu are the key examples, as its receivables are a signficant drag on its ability to expand its business. This may also impact smaller companies willingness to accept certain type of customers in the future that are known not to pay on time. 
2. Larger Companies with negative cash flow from operations eventually will have to become cash positive, or risk taking a write-off.  So far, the strategy has been to continue financing their operations through debt issues and equity placements.  This is not sustainable either.