Equity Research | Environmental Jul 20, 2017

Guangdong Investment (270 HK)

Accumulate (initiation) Cash is king; initiate with Accumulate and TP of HK$12.0

Target price: HK$12.00

Juilice Zhou Defensive water business Around 62% of GDI’s total revenue and approximately 63% SFC CE No. BGR107 of its operating profit are generated from its water business. The Dongshen water supply [email protected] project, which supplies raw Dongjiang water to Hong Kong, and , +852 3719 1111 contributed approximately 87% of GDI’s water segment revenue as well as 54% and 57% of company’s total revenue and pretax profit in 2016. We expect Dongshen project’s business model with three-year predetermined revenues to continue, with project revenue GF Securities (Hong Kong) Brokerage Limited to grow 3% per annum during 2018-2020 as the company has the pricing power to achieve 29-30/F, Li Po Chun Chambers a material tariff hike. In addition, we expect the project’s pretax margin to increase further 189 Des Voeux Road Central by 2pp to 60% in 2020, boosted by improved operating efficiency and better cost control, Hong Kong to contribute ~57% of company’s total pretax profit.

We think GDI is well positioned to capture opportunities arising from the accelerating introduction of PPP projects in China, given its: 1) strong net cash position and FCF, 2) track record of integrated experience in water, tap water and sewage treatment, as well as road construction and operation, and 3) favorable SOE background. So far, the company has secured PPP projects worth a total of HK$6.4bn, mainly involving the construction and operation of A-grade highways and sewage treatment facilities in Hainan and province. Among them, we like the Dongguan PPP project most, which is expected to start partial operation on its phase I in mid-2017 and generate stable cash inflow for GDI. According to management, the IRR for all of these PPP projects could eventually reach 10%, which would be 2pp higher than the current level and thus gradually drive GDI’s EPS to a peak when all of the HK$6.4bn is invested by the end of 2020. In the long run, we expect PPP projects along with M&A to fuel the company’s capacity expansion and boost its bottom line.

As our favorite dividend yield play, We expect GDI’s DPS to grow at a CAGR of 6% during 2016-2020, suggesting a further improvement in its dividend payout ratio of 7pp annually, supported by steady growth in recurring FCF. We expect the company’s FCF per share to remain greater than its EPS by growing 3% per annum during 2016-2020, as substantial non-cash items such as depreciation and amortization need to be subtracted when calculating EPS. The current stock price implies an 8.8%-9.4% FCF yield and a 4.1%-4.8% dividend yield, which are very attractive to us. Stock performance

(HK$) 270 HK HSI Initiate with Accumulate and TP of HK$12.0, implying 16x/15x 2018/19E P/E. The stock 13 28,000 is currently trading at 14.6x/14.3x 2018/19E P/E, higher than the industry average. We believe GDI deserves a premium given its defensive business nature, which is firmly 12 26,000 backed by: 1) a highest dividend yield of 4.1%-4.8% among peers; 2) its strong balance 11 sheet with a net cash position of HK$1.17bn; 3) a healthy debt servicing position with an 24,000 10 EBITDA interest coverage of 54.47x at end-2016; 4) robust cash flow with an 8.8%-9.4% 22,000 FCF yield; and 5) low vulnerability to exchange rate fluctuations. 9 8 20,000

Source: Bloomberg

Stock valuation

Key data 11.12 Turnover Net profit EPS EPS YoY P/E BPS P/B ROE Dvd yield (HK$ m) (HK$ m) (HK$) (%) (x) (HK$) (x) (%) (%) Jul 20 close (HK$) 11.12 Shares in issue (m) 6,540 2015 9,172 3,905 0.62 -11% 17.8 1.81 6.1 12.4% 3.2% Major shareholder GDH (45.4%) 2016 10,464 4,212 0.67 8% 16.5 1.85 6.0 13.1% 4.1% Market cap (HK$ bn) 72.7 2017E 11,322 4,745 0.73 8% 15.3 2.19 5.1 13.7% 4.1% 3M avg. vol. (m) 5.4 2018E 11,845 4,964 0.76 5% 14.6 2.57 4.3 13.6% 4.4% 52W high/low (HK$) 9.41/13.00 2019E 12,226 5,091 0.78 3% 14.3 3.02 3.7 13.2% 4.8% Source: Bloomberg Sources: Company data, GF Securities (Hong Kong)

Company report Jul 20, 2017

Defensive water business

Main profit contributor As parent company GDH’s only water-related business platform, around 62% of GDI’s total revenue and approximately 63% of its operating profit are generated from its water business. The Dongshen water supply project, which supplies raw Dongjiang water to Hong Kong, Shenzhen and Dongguan, contributed approximately 87% of GDI’s water segment revenue as well as 54% and 57% of company’s total revenue and pretax profit in 2016.

Figure 1: GDI revenue breakdown Figure 2: GDI operating profit breakdown

Water resources Property inv & dev Water resources Property inv & dev Department stores Electric power generation Department stores Electric power generation Toll roads & bridges Hotel opt & mgm Toll roads & bridges Hotel opt & mgm 100% 7% 9% 8% 8% 7% 6% 100% 5% 6% 5% 5% 4% 6% 7% 7% 6% 6% 5% 8% 6% 3% 80% 9% 10% 9% 9% 9% 7% 80% 34% 37% 36% 40% 24% 25% 13% 13% 14% 14% 13% 11% 60% 60%

40% 40% 63% 62% 62% 63% 64% 62% 63% 63% 60% 57% 57% 55% 20% 20%

0% 0% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 3: Revenue of Dongshen water supply project Figure 4: Pretax profit of Dongshen water supply project

Project revenue As % of total revenue Project pretax profit As % of total pretax profit (HK$ m) 3,500 (HK$ m) 3,266 62% 6,000 5,489 5,656 3,157 3,129 5,164 64% 2,915 60% 4,775 4,934 3,000 5,000 4,493 2,576 62% 2,424 58% 2,500 4,000 60% 56% 2,000 58% 3,000 54% 1,500 56% 52% 2,000 1,000 54% 50% 1,000 52% 500 48% 0 50% 0 46% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Dongshen water supply project: Starting from 2000, GDI has received lump-sum payments from the Hong Kong government under a 30-year concession agreement regardless of the actual volume of water supplied. The contract is renewed by the Hong Kong government and Guangdong provincial government every three years, taking into account the Rmb/HK$ exchange rate, inflation rates in both cities, changes in operating cost and expected water consumption volume. The current term of the agreement (2015-2017) will end this year. According to past experience, the two governments will start discussions on the new water supply contract in the second half of this year and come to an agreement around Oct 2017. Afterwards, the Hong Kong Legislative Council (LegCo) will review the agreement as part of the government’s annual fiscal budget in Nov before a final contract is signed in Dec.

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Figure 5: Expected timeline for contract renewal

1 Jan 2018 Nov 2017 Implementation of Review by LegCo new tariff

Oct 2017 Dec 2017 Completion of negotiation Signing of the new agreement Announcement made

Sources: Company data, GF Securities (Hong Kong)

Figure 6: Factors for consideration in contract renewal negotiation

Rmb/HK$ Inflation in Changes in Expected water exchange HK & operating consumption Water tariff rate Guangdong cost volume

Sources: Company data, GF Securities (Hong Kong)

Figure 7: Total water supply of Dongshen project Figure 8: Geographical breakdown of water supply under Dongshen project

Total water supply YoY (%) Utilization rate (%) HK Dongguan & SZ 3 (m m ) 100% 2,163 2,200 100% 90%

2,100 2,067 80% 80% 70% 1,991 62% 65% 62% 65% 67% 63% 2,000 1,939 60% 60% 50% 1,900 40% 1,817 1,826 40% 1,800 20% 30% 20% 1,700 0% 37.8% 35.0% 37.9% 35.2% 32.7% 36.6% 10% 1,600 -20% 0% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

We expect this business model with three-year predetermined revenues to continue, but believe that revenue will grow at a slower pace of 3% per annum during 2018-2020 vs. 6.7%/6.4%/6.4% YoY agreed for 2015/16/17. The slowdown is mainly due to: 1) a dim outlook for Rmb appreciation; 2) the persistence of low inflation in Hong Kong; and 3) declining operating cost thanks to improved utilization and higher efficiency. However, management believes revenue is unlikely to remain flat in 2018-2020 as revenue from Dongshen water supply to Hong Kong has never declined in the past.

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Company report Jul 20, 2017

Figure 9: Dongshen project revenue estimates Figure 10: Implied water tariff

HK Dongguan & SZ HK Dongguan & SZ 3 (HK$ m) HK YoY (%) Dongguan & SZ (%) (HK$/m ) 7,000 10% 10 8% 9 9.3 6,000 1,482 1,373 6% 8 8.3 1,199 1,271 7.8 5,000 1,164 7 7.2 4% 6.7 6.2 2% 6 5.8 4,000 5.4 0% 5 5.1 3,000 -2% 4 4.1 4,778 4,922 5,069 5,221 2,000 4,492 -4% 3 -6% 2 0.9 1.0 1.1 1.0 0.9 1.0 1.0 1.0 1.0 1.0 1,000 -8% 1 0 -10% 0 2016 2017E 2018E 2019E 2020E 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 11: Inflation rates in HK & Guangdong Figure 12: Rmb/HK$ exchange rate

Hong Kong Guangdong (CPI) 1.4

120 1.2

110 1.0

100 0.8

90 0.6

80 0.4

70 0.2

60 0.0

Sources: Wind, GF Securities (Hong Kong) Sources: Wind, GF Securities (Hong Kong)

GDI has the pricing power to achieve a material tariff hike for the following reasons. First, water tariff growth in Hong Kong is much slower than that in peer cities, especially first-tier cities in China such as Beijing, Shanghai and Shenzhen which have already experienced several rounds of tariff hikes in recent years. For instance, water tariffs in Beijing grew at a CAGR of 24.9% during 2009-2014 to Rmb9/m3. Considering the higher living standards and wage levels in Hong Kong, we think the city’s government will accept a higher water purchase cost and pass the tariff increase on to end users in the city.

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Company report Jul 20, 2017

Figure 13: Comparison of average water tariff among different countries

Average water tariff (US$/m3)

Denmark 7.23 Australia 6.81 Luxembourg 6.36 Netherlands 5.79 Germany 4.94 Canada 4.88 Seitzerland 4.62 France 4.58 UK 4.3 US 3.38 Spain 3.29 Israel 2.66 Brazil 2.21 Colombia 2.16 Singapore 1.7 Greece 1.65 Italy 0.96 Hong Kong 0.94 Shanghai 0.56 Vietnam 0.29 Thailand 0.26 India 0.23 Saudi Arabia 0.03 0 1 2 3 4 5 6 7 8

Sources: E20, GF Securities (Hong Kong)

Figure 14: 2009-2014 water tariff CAGR in China’s major cities Figure 15: Rising trends of water supply tariff in major China cities since 2007

25% Shanghai Shenzhen Dongguan Beijing (RHS) (Rmb/m3) 20% 2.5 10 9.0 9 15% 2.0 8 7 24.9% 1.5 1.6 1.6 1.6 1.6 1.6 6 10% 5 1.0 1.1 1.1 1.1 4 3.0 3.0 3.0 3.0 3.0 3 5% 9.6% 2.8 2.9 8.4% 0.5 2 3.9% 3.1% 1 0% 0.0 0 Beijing Shanghai Guangzhou Shenzhen Dongguan 2007 2008 2009 2010 2011 2012 2013 2014

Sources: E20, GF Securities (Hong Kong) Sources: E20, GF Securities (Hong Kong)

Second, Hong Kong’s demand for Dongjiang water is believed to be resilient, as nearly 75% of the city’s water supply relies on it, and there are no cost-effective alternative sources of raw water supply. According to the Hong Kong government’s long-term estimates, the city’s annual fresh water consumption should increase ~40% from 959m m3 in 2014 to 1,315m m3 by 2030. Therefore, an upward revision to the annual supply volume cap from the current 820m m3 to 1,100m m3 is possible in our view, though we have not included this into our forecast model.

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Company report Jul 20, 2017

Figure 16: Breakdown of HK’s water supply Figure 17: High utilization of water purchased

Dongshen Local reservoirs Purchased but unused vol. Usage (%) (m m3) (m m3)

1,200 250 100% 203 208 90% 1,000 200 80% 298 252 253 111 103 226 167 332 220 228 70% 800 320 187 228 217 336 150 139 60% 600 105 111 50% 95 96 100 76 40% 400 808 818 744 761 771 715 725 709 724 766 59 54 30% 617 653 681 612 49 200 50 20% 12 2 10% 0 0 0%

Sources: Water Supplies Department, Company Data, GF Securities (Hong Kong)

Figure 18: Historical precipitation in Hong Kong Figure 19: Hong Kong water demand forecast

HK Precipitation YoY (%) (m m3) 1,315 (m m3) 1,200 3,500 3215 100% 3066 1,023 959 983 2847 80% 1,000 945 940 936 932 3,000 2628 2638 2490 2372 60% 2,500 2182 800 1942 1925 1875 40% 2,000 1739 1707 1477 20% 600 1,500 0% 1,000 400 -20% 500 -40% 200 0 -60% 0

2010 2011 2012 2013 2014 2015 2020E 2030E

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2002 Sources: Water Supplies Department, GF Securities (Hong Kong) Sources: Water Supplies Department, GF Securities (Hong Kong)

Third, the competition for Dongjiang water is increasingly fierce among cities near the river due to accelerating economic development and recovering industrial activities. Currently, Dongjiang accounts for more than 50% and 80% of water supply to Shenzhen and eight other riverside cities. According to the Water Resources Department of Guangdong province, the annual average water flow of Donjiang over the past three years was 25.4bn m3, 23% lower than the historical average of 33.1bn m3 during 1956-2005. In comparison, the annual consumption of raw water from Dongjiang by residents in Hong Kong and eight key cities in Guangdong amounts to over 10bn m3, suggesting an increasing possibility of water shortage in the near future.

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Company report Jul 20, 2017

Figure 20: Supply and demand of raw water from Dongjiang (2015) Figure 21: Forecasts of Dongjiang water consumption (2020E)

Max supply vol. Annual water consumption 2015 2020E Supply sufficiency* (m m3) Supply sufficiency* 3 (m m ) 3,000 2,677 2,724 140% 2,350 2,500 180% 2,370 120% 170%2,200 2,200 2,500 119% 160% 1,832 101% 1,974 100% 2,000 2,268 140% 2,350 2,095 2,000 2,200 2,200 89% 120% 85% 80% 1,500 113% 1,763 77% 1,832 103% 100% 1,500 1,149 66% 89% 973 1,553 96% 1,085 60% 1,362 80% 1,000 71% 1,000 800 1,100 60% 40% 40% 973 500 500 800 20% 20% 0 0% 0 0%

Sources: Water Supplies Department, GF Securities (Hong Kong) Sources: Water Supplies Department, GF Securities (Hong Kong) Note: *Supply sufficiency = max supply / consumption Note: *Supply sufficiency = max supply / consumption

We expect to see a water supply shortage in the southern Guangdong region in 2020E where raw water supply from Dongjiang will meet just ~85% of the water consumption needs of nearby cities including Hong Kong. Therefore, we expect the Hong Kong government to play safe and buy itself some insurance in case water supply from local reservoirs is lower than expected. However, annual water supply to Hong Kong under the Dongshen project is expected to decline at an average pace of 4.4% YoY during 2016-2020 due to increasingly scarce water resources in Guangdong province. In contrast, water supply to Dongguan & Shenzhen from the project will jump 27% during the same period.

Figure 22: Consumption of raw water from Dongjiang to increase at Figure 23: Forecasts of raw water supply from Dongjiang in 2020E ~3% CAGR in 2015-2020E

Dongjiang water consumption CAGR (2015-2020E) Hong Kong Dongguan & SZ HK YoY (%) Dongguan & SZ YoY (%) 8% (m m3) 15% 7% 2,000 6% 10% 5% 1,500 5% 1,295 1,257 1,391 1,474 4% 1,128 1,157 1,192 0% 7.5% 1,000 3% -5%

2% 4.0% -10% 500 696 689 682 676 669 662 3.0% 559 1% 2.2% -15% 1.5% 1.5% 0% 0 -20% Zengcheng Dongguan Hong Kong Shenzhen 2012 2013 2014 2015 2016 2017E 2020E

Sources: Water Supplies Department, GF Securities (Hong Kong) Sources: Water Supplies Department, GF Securities (Hong Kong)

Thanks to the advantages of supplying water to Hong Kong, the pretax margin of the Dongshen project has remained above 55% over the years. We expect the pretax margin of the project to further increase 2pp from 2016 to 60% in 2020, driven by improved operating efficiency and better cost control, contributing ~57% of the company’s total pretax profit.

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Company report Jul 20, 2017

Figure 24: Improving pretax margin of Dongshen project Figure 25: ~57% pretax profit contribution from Dongshen project

Dongshen project reptax profit Dongshen Water Supply Property YoY (%) Department store Hotel operation Pretax margin (%) Others (HK$ m) 100% 61% 4,000 59% 58% 58% 60% 60% 60% 70% 54% 57% 80% 3,500 60% 15.0% 3,000 50% 14.5% 14.0% 60% 14.9% 13.1% 12.5%11.6%10.8% 9.7% 2,500 40% 12.4% 2,000 3,865 4,022 30% 40% 3,451 3,715 1,500 3,157 3,129 3,266 20% 2,915 59.6%56.8% 55.7% 2,576 54.8%52.3%48.2%51.7% 53.2%54.8%55.2% 1,000 10% 20% 500 0% 0 -10% 0% 2012 2013 2014 2015 2016 2017E2018E2019E2020E 2011 2012 2013 2014 2015 2016 2017E2018E2019E2020E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Beneficiary of PPP projects

We think GDI is well positioned to capture opportunities arising from the accelerating roll- out of PPP projects in China, given its: 1) strong net cash position and free cash flow (FCF), 2) track record of integrated experience in water, tap water and sewage treatment, as well as road construction and operation, and 3) favorable SOE background.

So far, the company has secured PPP projects worth a total of HK$6.4bn, mainly involving the construction and operation of A-grade highways and sewage treatment facilities in Hainan and Guangdong province. According to the company, the targeted ROI of its PPP projects is around 8%. Among them, the flagship Dongguan PPP project is expected to start partial operation on its phase I in mid-2017 and generate stable cash inflow for GDI.

Figure 26: PPP projects secured in 2016-2017

Water Sewage Project Date City Investment Details supply treatment

(HK$ m) ('000 tpd) ('000 tpd) Yinping Innovation Construction of A-grade highways, connecting Dongguan Project Jun-16 Zone, , 5,614 N/A N/A roads and municipal roads, and related ancillary Dongguan services such as drainage, greening and lighting

Binhai District, Construction and operation of water supply & Binhai Water Project Sep-16 500 100 80 Danzhou, Hainan sewage treatment plants and relevant facilities

Investment in and operation of a water supply Suixi County, plant in the city. Investment, consturction and Suixi Sep-16 Zhanjiang City, 140 60 30 operation of supporting water supply plant in Water Project Guangdong Lingbei Industrial Park, and commissioned operation of Lingbei sewage treatment plant

Investment in, construction, operation and Water Gaozhou, Jan-17 492 200 N/A maintenance of the second water plant supplying Project Guangdong water to the urban area and surburbs of Gaozhou

Wuhua County, Wuhua Sewage Water Development of town-level sewage treatment Apr-17 , 188 N/A 10 Project facilities and ancillary pipeline networks Guangdong Total 6,442 160 120 Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

We like this particular project for several reasons. First of all, the ceiling on the project development cost budget avoids the risk of cost overrun by giving GDI the right to stop investing when total project cost goes over Rmb4,754m (~HK$5,614m). Second, it is a multi-year engagement with separate budgets for each phase and the development cost paid in ten annual instalments by the Xiegang government, which minimizes payment collection risk. Third, it is a long- term PPP project delivering steady returns through an accrued interest (8%), management fee (2.5%) and maintenance fee (1.1%). In addition, we expect GDI to reinvest part of the return from the earlier phases in the later stage of the project, which means that total cash outflow for the entire project will be smaller than the planned capex. Lastly, there is no construction risk as the construction work will be completed by contractors.

Figure 27: Three sources of income for Dongguan project

Project retrun

•8% of outstanding amount

Management fee

•2.5% of development cost

Maintenance fee

•1.1% of development cost per annum for the maintenance period of 10 years

Sources: Company data, GF Securities (Hong Kong)

According to management, the IRR for all of these PPP projects could eventually reach 10%, which would be 2pp higher than the current level and thus gradually drive GDI’s EPS to a peak when all of the HK$6.4bn is invested by the end of 2020. In the long run, we expect PPP projects along with M&A to fuel the company’s capacity expansion and boost its bottom line.

According to management, GDI will focus on PPP projects in Guangdong, where the local government has a steady financial base and minimal payment default risk. To avoid potential competition, GDI also carefully reviews government construction plans and potential budget control risks. For example, GDI had evaluated and analyzed the local government’s development plans for the Xingliu Expressway and Dongguan project before signing the contacts.

More M&A to come

Thanks to its strong balance sheet and net cash of HK$1.17bn, GDI’s strategy to focus on PRC water project acquisition is likely to accelerate and boost capacity addition over the next two years. In addition to the Dongshen water supply project, GDI operates 15 water projects with total water supply capacity of 2.44m tpd and sewage treatment capacity of 393k tpd through its wholly-owned subsidiary Water Group HK. 14 of the 15 projects were acquired from a third party or GDI’s parent company, mostly at a discount and fully funded by cash and internal resources.

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Company report Jul 20, 2017

Figure 28: Water projects in operation

Effective Water Sewage Investment Type of (tpd) Location Date Seller stake supply treatment (HK$ m) transaction Wuhua Guangdong 100% N/A 40,000 188 Apr-17 PPP Local gov Jinsheng Guangdong 90% N/A 70,000 89 Feb-14 M&A Third party Daojiao Guangdong 100% N/A 40,000 49 Jun-14 M&A Third party Meizhou Guangdong 70% 210,000 100,000 293 Sep-14 M&A Third party Guangdong 54% N/A 50,000 27 Nov-14 M&A Third party Danzhou Hainan 70% 100,000 N/A 221 Dec-15 M&A Third party Nansha Guangdong 49% 400,000 N/A 150 Feb-12 M&A Third party Zhanjiang Suixi Guangdong 70% 50,000 N/A 140 Jun-16 M&A Third party Baoying Jiangsu 70% 130,000 N/A Gaoyou Jiangsu 60% 145,000 N/A Jianghe Jiangsu 30% 520,000 N/A 2,964 Jun-15 M&A GDH Yizheng Jiangsu 60% 150,000 N/A Wuzhou Guangxi 51% 355,000 90,000 Guangdong 70% 90,000 N/A Qingxi Xingning Guangdong 44% 290,000 3,000 650 Dec-15 M&A Third party Total 2,440,000 393,000 4,771 Sources: Company data, GF Securities (Hong Kong)

The company’s most noteworthy deal so far is the acquisition of a 100% stake in China City Water Supply in 2015, which operates six water supply plants, one sewage treatment plant, and five water work construction related projects in Guangxi, Guangdong and Jiangsu province. The company paid a total of Rmb993m (HK$1,217m) for the acquisition, implying a 2.2% discount according to an independent auditor’s valuation. We like this acquisition not only given its cheap valuation compared to a takeover premium in the industry, but also its strategic significance to the company. First, it has helped the company accelerate its coverage of the complete water resources management industry chain. Second, it has expanded the scale of the company’s core business with potential synergy such as economies of scale, transfer of experience, technology and water quality improvement. Third, the acquisition has diversified the company’s geographic exposure to fast-growing counties with rising populations and urbanization in Jiangsu province, while strengthening its leading position in Guangdong and Guangxi province.

Figure 29: Structure of acquiree China City Water Supply

China City Water Supply Water supply and sewage treatment business 100%

100% Cititrend

30%

China City Water Supply (Hong Kong) Off-shore

PRC Jianghe Gangwu

86.96% 60% 70% 100% 60% 70% Wuzhou Yizheng Baoying Gaoyou Zhaoqing Huanbao Gongshui Shuiwu Hairun Gongshui Shuiwu

100% 100% Guangdong Yuegang Hairun Gongcheng Water work construction business 51% 71% 70% 60% 51% Wuzhou Baoying Zhaoqing Gaoyou Wuzhou Shuiwu Gongcheng Gongcheng Gongcheng Gongcheng

100%

Wuzhou Jianding

Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure 30: Key information about acquisition price China City Water Supply Total Breakdown Type Investment Holding (HK$ m) (Rmb m) (HK$ m) Sale share 380 310 0 Consideration Sale debt 391 304 304 Repayment of Outstanding paybles 446 244 164 outstanding payables Sources: Company data, GF Securities (Hong Kong)

Figure 31: Valuation benchmark

Discount to independent auditor's valuation: 2.2% (Rmb m)

1,200 993 1,000

800 364 1,016

600 319 400

200 310 0 Sale Share Sale Debt Outstanding Valuation by Payables independent auditor

Sources: Company data, GF Securities (Hong Kong)

In addition, GDI has another eight water projects currently under construction with total water supply capacity of 280k tpd and sewage treatment capacity of 90k tpd. According to the company, approximately 210k tpd under-construction capacity will be completed this year. In addition, the company has won the bid for a new water resources project in Wuhua county of Meizhou, Guangdong province to build eleven sewage treatment plants with daily capacity of 1,000 tonnes. Total initial investment is approximately Rmb160m.

Figure 32: Projects under construction as of end-1Q17 Project Sewage treatment Water supply (tpd) (tpd) Hainan Danzhou 20,000 50,000 Zhanjiang Suixi 0 20,000 Wuhua 15,000 0 30,000 0 Gaozhou 0 100,000 Kaiping 25,000 0 Zhaoqing 0 50,000 Fengshun 0 60,000 Total 90,000 280,000 Sources: Company data, GF Securities (Hong Kong)

As such, we expect the company’s water supply capacity to further increase 9% and 3% YoY to 2.65m/2.72m tpd by 2017/18 based on the current construction pipeline, representing a five-year CAGR of 69%. Furthermore, we expect the company’s sewage treatment capacity to rise ~30% from the current level to 511,000 tpd by the end of 2018, boosting Water Group HK’s revenue to ~HK$1.8bn, more than doubling the figure in 2016. In addition, we expect Water Group HK’s pretax profit to reach HK$449m, implying a pretax margin of 25%, up 5pp from 20% in 2016. The increase in pretax margin will mainly be driven by the expanding sewage treatment business, which offers a much higher profit margin than the water supply business.

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Company report Jul 20, 2017

Figure 33: Rapid expansion of Water Group HK driven by M&A

Urban water supply YoY (%) WWT YoY (%) ('000 tpd) ('000 tpd)

3,000 302% 300% 600 45% 39% 40% 2,500 500 250% 35%

2,000 200% 400 30% 170% 26% 25% 1,500 150% 300 2,650 2,720 20% 2,440 494 511 2,170 1,000 100% 200 390 393 15% 280 10% 500 50% 100 5% 540 3% 200 200 12% 0 0% 9% 3% 0% 0 1% 0% 2012 2013 2014 2015 2016 2017E 2018E 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong)

Figure 34: Revenue and pretax profit forecasts for Water Group HK

Revenue Pretax profit Pretax margin (%) (HK$ m) (HK$ m)

2,000 500 27% 1,800 450 25% 1,600 400 25% 24% 1,400 350 23% 1,200 300 1,000 250 21% 1,797 449 800 200 20% 1,422 341 19% 600 150 854 100 400 168 17% 200 406 50 64 16% 0 0 15% 2015 2016 2017E 2018E 2015 2016 2017E 2018E

Sources: Company data, GF Securities (Hong Kong)

Meanwhile, GDI has broadened the scope of its M&A to non-water business so as to cope with the deteriorating IRR of municipal sewage treatment projects in Guangdong and other provinces due to intensifying competition nationwide. For example, it re-entered the road business by acquiring the Xingliu Expressway project from its parent company in 2015 for an aggregate amount of HK$2,588m, which has now become a key project contributing ~6% of company’s total revenue and pretax profit. As part of the G80 Guangzhou-Kunming Expressway connecting Yunnan, Guangxi and Guangdong province, the Xingliu Expressway commenced operation in Aug 2003 with five toll stations located in Guangxi province. The main line is 99.6km long and the three branch lines have an aggregate length of 52.7km. According to the concession contract, the operation right of the Xingliu Expressway will expire in Sept 2032.

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Company report Jul 20, 2017

Figure35: Location of Xingliu Expressway

Sources: Company data, GF Securities (Hong Kong)

We like the Xingliu Expressway project given its: 1) strong fundamentals, 2) long-term stability, and 3) potential for further profit growth. The Xingliu Expressway is integral to one of the safest and most convenient routes from Guangdong/Guangxi to the coastal areas in southeastern China. It goes through the part of Guangxi that is most developed and active in trade which represents more than a third of the province’s GDP. The Xingliu Expressway has a solid track record of generating stable income and maintaining high profitability with a 60%+ pretax margin since it came into operation in Aug 2003. Daily average traffic in 1Q17 was 26,919 vehicle-trips, up substantially by 20% from 2016. The company expects robust traffic growth for the Xingliu Expressway driven by continuously growing private vehicle ownership in Guangxi province. Therefore, we expect the Xingliu Expressway to become another profit and cash driver for the company in the near future.

Figure 36: Steady increase in both revenue and pretax profit Figure 37: Xingliu Expressway contributed 6% of GDI’s total revenue generated by the Xingliu Expressway and pretax profit in 1Q17

Revenue Pretax profit Revenue contribution Pretax profit contribution Revenue QoQ (%) Pretax profit QoQ (%) (HK$ m) 10% 9% 180 21% 25% 9% 160 20% 8% 140 15% 7% 6% 6% 6.9% 6% 13% 6.2% 5% 120 10% 6% 6.1% 5.9% 100 1% 5% 5% 5.0% -2% 2% 80 167 166 170 0% 4% 150 147 -1% 60 -5% 3% 104 105 40 -15%88-10% 87 87 -10% 2% 20 -15% 1% 0 -20% 0% 2012 2013 2014 2015 2016 1Q16 2Q16 3Q16 4Q16 1Q17

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure 38: 60%+ pretax margin from Xingliu Expressway favorable for Figure 39: Xingliu Expressway to see further rise in daily average GDI’s long-term profitability improvement traffic thanks to favorable location 26,919 (Pretax margin %) Xingliu Expressway GDI 27,000 (Daily avg. vehicle-trips)

65% 63% 26,000

63% 62% 59% 25,000 60% 58% 59% 59% 55% 24,000 55% 52% 23,000 22,429 50% 22,000 21,579

45% 21,000 41% 20,373 20,250 40% 20,000 1Q16 2Q16 3Q16 4Q16 1Q17 1Q16 2Q16 3Q16 4Q16 1Q17

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

In addition, GDI expanded its property investment and development business by acquiring a 73.82% stake in Guangdong Land Holdings Limited (GDL; 124 HK, NR) from its parent company for a total consideration of Rmb3.358bn (equivalent to HK$3.78bn) this April. GDL’s main assets are the Buxin project and the Ruyingju project. According to the company, the Buxin Project, a property development project in Buxin, Luohu of Shenzhen, has a planned total site area of 66,526sqm with planned GFA of 432,051sqm. Meanwhile, a residential property development project in Panyu of Guangzhou, the Ruyingju Project has 917 residential units and 651 parking spaces; 90.2% of the project’s total saleable area had been sold by the end of Sept 2016.

We particularly like the Buxin project for its superior location within the extended area of the Luohu CBD. The project sits next to the Buxin station on and the Shuibei station on Metro , providing easy access to the public transportation system within walking distance of 200m-300m. Moreover, the project is just 15 minutes away from the Luohu check point by car. The surrounding area is well equipped with educational and medical facilities, as well as public parks such as Weilingshan, Donghu, Honghu and Cuizhu parks. The project is designed as a multi-module commercial complex with a focus on the jewelry industry, matching the government’s design for the Shuibei-Buxin area. According to the company, Phase I of the project is expected to be completed in 2021 with pre-sale to commence in 2018, while Phase II is expected to be completed in 2023.

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Company report Jul 20, 2017

Figure 40: Location of the Buxin project

Sources: Company data, GF Securities (Hong Kong)

Cash cow & dividend yield play

As our favorite dividend yield play, GDI continued to raise its dividend payout ratio over the past six years from 37% in 2011 to 62% in 2016. As a result, dividend per share increased at a CAGR of 16% to HK$0.42 supported by the company’s healthy cash flow, strong balance sheet and defensive business nature.

Figure 41: DPS grew at a CAGR of 16% Figure 42: Continuously rising dividend payout ratio

DPS YoY (%) Dividend payout ratio (HK$) 65% 0.45 25% 24% 62% 0.40 60% 22% 21% 0.35 20% 55% 54% 0.30 15% 15% 0.25 50% 0.42 0.20 11% 45% 0.34 10% 0.15 0.28 0.23 40% 40% 0.10 0.18 0.20 5% 37% 37% 0.05 35% 32% 0.00 0% 30% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

We like GDI’s net cash position since 2012 despite its M&A expenses. Net cash reached HK$1.17bn by the end of 2016, representing 12% YoY growth, in line with the steady growth in

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Company report Jul 20, 2017

operating cash flow. In addition, the company has maintained a healthy debt servicing position with an EBITDA interest coverage of 54.47x at the end of 2016 vs. 45.42x at end-2015 thanks to its much lower-than-peers borrowing cost of ~2.5%.

Figure 43: Net cash position since 2012 Figure 44: Steady increase in operating cash flow

(HK$ m Net cash balance Operating cash flow YoY (%) ) (HK$ m)

4,000 3,639 6,500 14% 6,099 3,500 12% 6,000 10% 3,000 8% 2,252 5,429 2,500 5,500 6% 5,185 2,000 4% 1,371 1,500 5,000 4,794 2% 1,041 1,166 4,716 4,550 0% 1,000 4,500 -2% 500 -4% 0 4,000 -6% 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 45: Healthy debt servicing position Figure 46: Lowest borrowing cost among peers

(x) EBITDA/finance cost Borrowing cost 120 7% 114.3 6.2% 6% 100 5% 4.7% 87.5 4.4% 80 4% 3.4%

60 3% 2.5% 54.5 45.4 2% 40 36.4 33.5 1%

20 0% GDI BEW Beijing China Water Tianjin Capital 0 (270 HK) (371 HK) Capital Affairs (600874 CH, 2011 2012 2013 2014 2015 2016 (600008 CH) (855 HK) 1065 HK) Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

We expect GDI’s DPS to grow at a CAGR of 6% during 2016-2020, suggesting a further improvement in its dividend payout ratio of 7pp (cumulative over the period), supported by steady growth in recurring FCF. We expect the company’s FCF per share to remain greater than its EPS by growing 3% per annum during 2016-2020, as substantial non-cash items such as depreciation and amortization need to be subtracted when calculating EPS. The current stock price implies an 8.8%-9.4% FCF yield and a 4.1%-4.8% dividend yield, which are very attractive to us.

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Company report Jul 20, 2017

Figure 47: DPS to grow at 6% CAGR during 2016-2020 driven by Figure 48: FCF per share to remain above EPS by growing 3% per continuously improving dividend payout ratio annum on average

DPS Dividend payout ratio (%) EPS FCF (HK$) (HK$ per share)

0.6 0.55 70% 1.2 0.53 1.05 69% 1.00 1.03 0.49 69% 0.94 0.98 0.5 0.46 68% 68% 1.0 0.42 0.80 67% 0.76 0.78 0.4 0.8 0.73 66% 0.67 65% 0.3 64% 0.6 64% 63% 63% 0.2 62% 0.4 62% 0.1 61% 0.2 60% 0.0 59% 0.0 2016 2017E 2018E 2019E 2020E 2016 2017E 2018E 2019E 2020E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 49: Attractive FCF yield and dividend yield

Dividend yield FCF yield

10% 9% 9.3% 9.5% 8% 9.0% 8.5% 8.8% 7% 6% 5% 4% 4.8% 5.0% 4.2% 4.4% 3% 3.8% 2% 1% 0% 2016 2017E 2018E 2019E 2020E Sources: Company data, GF Securities (Hong Kong)

GDI is a cash cow with its 1) property investment and development, 2) department store, 3) hotel operation and management, 4) electric power generation, and 5) road and bridge businesses. The five segments combined contributed 37.8% and 36.9% of company’s 2016 revenue and profit, in the amounts of HK$3.9bn and HK$1.76bn respectively.

Foreseeable upside to property investment & development in mid/long-term GDI currently has four property projects in both mainland China and Hong Kong, namely Teem Plaza in Guangdong province, Teem Shopping Mall in Tianjin, Guangdong Investment Tower in Hong Kong, and the Panyu Wanbo CBD project in Guangzhou city. Revenue from the property investment & management segment has remained above HK$1.1bn in recent years with a pretax margin of more than 70% thanks to occupancy rates of approximately 100% at older projects and greatly improved occupancy rates at relatively newer ones.

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Company report Jul 20, 2017

Figure 50: Revenue breakdown by segment Figure 51: Net profit breakdown by segment

2016 2016 6.1% 7.3% 1.4% 6.0% Water resources Water resources 7.3% 5.8% 2.1% 1.6% 4.4% 5.1% Property inv & dev 5.7% Property inv & dev 8.1% 3.3% 3.1% 8.9% Department store Department store 6.9% 2015 2015 Electric power 22.1% Electric power 19.2% 12.8% generation generation 62.6% 64.3%62.2% 10.8% Road and bridge 63.0% Road and bridge

Hotel opt & mgm Hotel opt & mgm

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 52: Steady property business revenue… Figure 53: …thanks to ~100% occupancy rates

Property investment & management revenue Teem Plaza Teem Shopping Mall Guangdong Investment Tower Pretax margin (%) (HK$ m) (Occupancy rate) 1,160 1,171 1,130 100% 100% 100% 1,200 1,093 72% 100% 1,040 100% 99% 99% 99% 1,000 940 71% 71% 99% 98% 71% 98% 98% 98% 70% 99% 800 97% 69% 96% 96% 600 69% 69% 68% 95% 100% 68% 99% 99% 99% 99% 99% 400 67% 94% 67% 93% 200 66% 92% 91% 0 65% 90% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Teem Plaza, in which the company has an effective interest of 76.13%, is the largest revenue and profit contributor, accounting for 78%/76% of segment revenue/profit in 2016. While the revenue from Teem Plaza, which consists of rental income from the shopping mall, office building and department stores, declined 2.8% YoY to HK$1.15bn in 2016 due to the negative impact of exchange rate changes, adjusted revenue after excluding the impact of currency translation actually rose 3.4% YoY. The pretax margin of the project also improved by more than 3pp to 69.7% last year after adjusting for changes in fair value of investment properties and net interest income. As such, we expect Teem Plaza to continue to bring considerable rental income to the company on the back of a ~100% occupancy rate and a small increase in the average lease rate. The project is located in the prime area of Guangzhou with lettable area of 103,000 sqm out of 160,000 sqm of floor area.

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Company report Jul 20, 2017

Figure 54: Teem Plaza largest segment revenue and pretax profit contributor

(HK$ m) Teem Plaza Revenue As % of segment revenue (HK$ m) Teem Plaza EBT As % of segment EBT 1,180 1,186 Pretax margin 1,200 1,115 1,152 78% 900 1,056 796 789 803 79% 78% 748 966 78% 800 735 1,000 77% 78% 700 651 77% 76% 76% 76% 76% 76% 78% 600 75% 800 78% 78% 78% 500 73% 600 77% 77% 77% 400 77% 71% 400 77% 300 69.6% 69.7% 77% 69% 77% 200 200 67.4% 67.1% 67.5% 67% 77% 100 66.5% 0 76% 0 65% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016

Sources: Company data, GF Securities (Hong Kong)

Teem Shopping Mall and the Panyu Wanbo CBD project are currently under development, which are expected to enhance segment profit substantially in the mid/long term. The Tianjin project is to develop a large-scale modern shopping mall with a total gross floor area of ~137,100 sqm/56,000 sqm above ground/underground. The company has invested ~HK$2.3bn in the project so far. The other project is to develop a large-scale integrated commercial project in the Panyu Wanbo CBD, which covers a gross floor area of ~260,000 sqm. Around HK$2.1bn had been invested as at the end of 1Q17 based on a cooperation agreement for the project.

Figure 55: Business structure of company’s property investment & development segment

Property Investment & Development

100% 76.02% 100% 76.13% Global Head Tianjin Teem Guangdong Guangdong Teem Developments Shopping Center Properties Holdings (Holdings) Limited Limited Co., Ltd. Limited Teem Plaza 100% 100% 100% 60% Guangdong Tianjin Teem Guangdong Group Guangzhou Tianhecheng Investment Tower Shopping Mall Building properties Investment Co., Ltd. properties Project 68% Guangzhou City Wanye Inestment Management Company Limited

100%

Panyu Wanbo CBD Project

Sources: Company data, GF Securities (Hong Kong)

Potential synergy with property investment & development to provide buffer for department store operation. As of the end of 1Q17, GDI was operating eight department stores with a total leased area of ~169,000sqm, among which Teemall Store accounted for 69.3% of segment revenue. Although operating income from Teemall Store declined 13.1% YoY in full-year 2016 due to an increasingly competitive industry environment, which dragged segment revenue down by 11.7% YoY, it rebounded 11.7% YoY in 1Q17. Therefore, department store operation recorded total revenue of HK$209.5m in 1Q17, up 2.2% YoY, partially offset by the closure of Baiyun New Town Store last July. Thanks to its synergy with the property investment & development business, the segment’s pretax profit rose 10.9% YoY to HK$92.6m in 1Q17, representing a pretax margin of 44%, improving significantly by 10pp compared to 2016. Teemall Store sits within the Teem Plaza, thus benefiting from a lower rental, better location with higher visitor flows, and lower operating cost by sharing the majority of staff with the shopping mall.

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Company report Jul 20, 2017

Figure 56: Department store operation segment revenue Figure 57: Pretax margin improved significantly in 1Q17

Revenue Leased area ('000 m2) Profit before tax Pretax margin (%) (HK$ m) (HK$ m)

900 200 400 50% 43.0% 44.0% 184 41.4% 800 180 350 39.6% 39.8% 45% 169 700 160 34.2% 40% 300 32.1% 147 140 35% 600 130 134 127 120 250 30% 500 100 200 25% 400 772 784 813 337 711 717 80 150 306 312 20% 300 649 280 60 245 15% 100 228 200 40 10% 100 20 50 93 5% 0 0 0 0% 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 1Q17

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Steady income from hotel operation and management As of the end of 1Q17, GDI was managing 32 hotels in mainland China, Hong Kong and Macau, among which six are owned or lease-owned by the company. Five of the six are star rated hotels with the other a budget hotel. Total revenue from the segment amounted to HK$148m in 1Q17, up slightly by 2.1% YoY, mainly due to an improved occupancy rate at the four star-rated hotels managed by the company to 77.6% (1Q16: 71.3%). Nonetheless, quarterly segment pretax profit rebounded significantly from HK$17m to HK$34m as the pretax margin doubled to ~23%. A better occupancy rate of 88.1% (1Q16: 87.3%) was also seen at the five-star Sheraton Guangzhou Hotel, which is managed by Sheraton Overseas Management Corporation rather than company’s own hotel management team. However, the average room rate at Sheraton Guangzhou Hotel dropped 5.6% YoY to HK$1,117, in line with the YoY decline at the company’s other four star-rated hotels. While the average room rate is likely to continue to decline going forward, we expect the downward pressure on earnings to be partially offset by the rising occupancy rate at Sheraton Guangzhou Hotel and overall operating efficiency.

Figure 58: Quarterly revenue and pretax profit of hotel operation Figure 59: Average room rate likely to continue to decline and management

(HK$ m) Revenue Pretax profit Sheraton Guangzhou Hotel Four star-rated hotels Pretax margin (%) Budget hotel 180 25% (HK$) 160 23.0% 1,400 1,318 300 21.3% 1,279 1,302 20.5% 20% 1,248 280 140 18.8% 1,300 1,218 1,198 260 120 1,200 244 247 246 1,117 15% 240 100 1,100 226 220 213 218 80 161 160 11.7% 1,000 200 150 145 148 10% 60 900 180 32 33 30 34 160 40 5% 800 17 141140 20 700 780 751 763 767 120 0 0% 600 693 668 679 100 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 2016 1Q17

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure 60: Occupancy rates and revenue at specific hotels

Sources: Company data, GF Securities (Hong Kong)

Power business profit to bottom out in 2H17 GDI currently has a 100% stake in Thermal Power Plant and 25% stakes in each of Yudean Jinghai Power and Meixian Power. As the two power plants that contribute to the company’s consolidated income statement, Zhongshan Thermal Power Plant and Yudean Jinghai Power together have six generating units with a total installed capacity of 3,800MW. In 1Q17, the two power plants’ revenue grew 53.6%/52.5% YoY to HK$234m/959m, driven by 65.8%/17.2% YoY increase in electricity sales. However, pretax profit was hurt badly due to the jump in coal prices: Zhongshan Thermal Power Plant suffered a 41.4% YoY decline in pretax profit while Yudean Jinghai Power saw a pretax loss of HK$82.7m, which resulted in a pro rata loss of HK$20.2m on GDI’s consolidated income statement. As the coal price has stabilized and coal-fired power companies will receive an on-grid tariff hike starting from 2H17, we expect the earnings of the company’s power business to bottom out given strong power demand and better-than-national-average utilization hours in Guangdong province where the two power plants are located.

Figure 61: Quarterly operating metrics of Zhongshan Power Plant Figure 62: Quarterly operating metrics of Yudean Jinghai Power

Revenue Pretax profit Pretax margin (%) Revenue Pretax profit Pretax margin (%)

250 (HK$ m) 50% 2,500 (HK$ m) 25% 44.7% 45% 20.3% 19.3% 20% 200 40% 2,000 35% 15% 33.0% 32.0% 1,500 12.5% 150 30% 10.4% 10% 26.5% 25% 234 1,000 1,945 5% 100 20% 68 17.1% 1,487 1,509 152 15% 394 0% 500 291 911 959 117 40 155 50 31 109 36 10% 114 -5% 75 24 5% 0 -8.7% -10% 0 0% 1Q13 1Q14 1Q15 1Q16 1Q17-83 1Q13 1Q14 1Q15 1Q16 1Q17 -500 -15%

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure 63: Annual operating metrics of company’s power business

Sources: Company data, GF Securities (Hong Kong)

We expect company revenue to grow 8%/5%/3% YoY to HK$11.3bn/11.8bn/12.2bn in 2017/18/19, driven by 10.3%/58.9%/5.4% YoY growth in its water resources segment, which accounts for 63% of total revenue. The growth slowdown in the water resources segment is mainly due to a smaller tariff hike under the new term of the Dongshen water supply project, which alone contributes approximately 87% of water resources revenue. We estimate that revenue from property investment and development will stabilize at ~HK$1.1bn in 2017/18/19 given the relatively stable performance of Teem Plaza. In the mid/long term, we see significant upside brought by the company’s newly secured large-scale shopping mall project in Tianjin and the integrated commercial project in the Panyu Wanbo CBD. We believe the company’s department store business will also benefit from potential synergy with its shopping malls, with segment revenue to rise 2.9%/5%/6% YoY to HK$738m/775m/882m in 2017/18/19, accounting for 7% of total revenue. The electric power generation business is likely to record revenue of HK$1.1bn/1.2bn/1.2bn in 2017/18/19 as an on-grid tariff hike will be effective in 2H17 despite continued pressure on utilization hours and the expanding scale of market-driven power sales. We are optimistic that the declining trend in the company’s hotel operation and management segment will cease in 2018 with a rebound to take off in 2019; as such, we estimate 2017/18/19 revenue of HK$619m/625m/655m, representing -2.3%/0.9%/4.7% YoY growth. We expect the company’s road and bridge business to generate HK$661m/681m/695m of revenue in 2017/18/19 to account for 5% of total revenue. GDI re-entered the toll road and bridge business in 2015 by acquiring the Xingliu Expressway project from its parent company. We estimate a gross margin of 67.4% in 2017/18/19 backed by the defensive nature of most of the company’s businesses. Excluding the changes in fair value of investment properties, EBIT is likely to increase 9%/5%/3% YoY to HK$6.4bn/6.7bn/7.0bn in 2017/18/19, representing an EBIT margin of 57%. As a result, the company’s recurring profit is likely to reach HK$4.7bn/5.0bn/5.1bn in 2017/18/19, equivalent to an EPS of HK$0.73/0.76/0.78.

Figure 64: Total revenue forecasts Figure 65: Total revenue breakdown

(HK$ m) Total revenue YoY (%) Water resources Property inv & dev Department stores Electric power generation Toll roads and bridges Hotel opt & mgm 100% 14,000 16% 5% 5% 5% 14% 12,226 7% 9% 8% 8% 7% 6% 11,845 90% 11,322 14% 7% 7% 6% 6% 5% 12,000 8% 10% 10% 10% 10,464 80% 9% 9% 10% 9% 9% 12% 7% 7% 7% 7% 10,000 9,172 13% 8,426 70% 13% 13% 14% 14% 11% 10% 9% 9% 7,736 7,990 9% 10% 8,000 7,161 8% 60% 8% 50% 6,000 8% 5% 5% 6% 40% 4,000 3% 3% 30% 63% 62% 62% 63% 64% 62% 63% 63% 63% 4% 20% 2,000 2% 10% 0 0% 0% 2011 2012 2013 2014 2015 2016 2017E2018E2019E 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure 66: Water resources revenue forecasts Figure 67: Dongshen water supply forecasts

Water resources revenue YoY (%) As % of total Water supply volume Tariff (HK$/m3)

9,000 (HK$ m) 70% 2,200 (m m3) 9 7,757 8.3 8,000 7,469 8 7,087 60% 2,100 7.8 7,000 6,505 7.2 7 5,896 6.7 50% 6.2 6,000 5,302 2,000 5.8 6 4,775 4,934 5.4 5,000 4,493 40% 5.1 5 1,900 2,163 4,000 30% 4.1 4 2,067 3,000 1,800 1,991 3 20% 1,973 11.2% 1,939 2,000 10.3% 8.9% 1,898 2 6.3% 7.5% 1,817 1,826 1,854 5.4% 3.9% 10% 1,700 1,000 3.3% 1 0 0% 1,600 0 2011 2012 2013 2014 2015 2016 2017E2018E2019E 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure 68: Gross profit and margin forecasts Figure 69: Recurring profit forecasts

Total gross profit Gross margin (%) Recurring profit YoY (%)

9,000 (HK$ m) 67.4% 67.4% 67.4% 68% 6,000 (HK$ m) 30% 8,000 67% 67% 68% 26% 67% 5,000 25% 7,000 67% 67% 6,000 66% 66% 4,000 20% 66% 5,000 17% 66% 3,000 15% 15% 8,240 4,000 65% 7,631 7,984 5,091 6,880 65% 4,745 4,964 3,000 5,648 6,144 2,000 3,806 4,128 10% 5,087 5,324 65% 3,543 3,728 8% 4,628 2,818 2,000 64% 2,412 1,000 5% 5% 5% 1,000 64% 2% 3% 0 63% 0 0% 2011 2012 2013 2014 2015 2016 2017E2018E2019E 2011 2012 2013 2014 2015 2016 2017E2018E2019E

Sources: Company data, GF Securities (Hong Kong) Sources: Company data, GF Securities (Hong Kong)

Figure70: GF estimates vs. consensus (HK$ m) GF estimates Consensus Difference (%) 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E Revenue 11,322 11,845 12,226 11,378 12,023 12,783 -1% -1% -1% COGS 3,691 3,862 3,986 3,408 3,638 3,551 8% 6% 8% Gross profit 7,631 7,984 8,240 7,970 8,384 9,231 -4% -5% -4% EBIT 6,437 6,735 6,952 6,080 6,349 6,676 6% 6% 6% Pretax Income 6,486 6,785 7,006 6,527 6,741 7,105 -1% 1% -1% Net profit 4,745 4,964 5,091 4,798 4,939 5,122 -1% 0% -1% EPS(HK$) 0.73 0.76 0.78 0.75 0.78 0.82 -4% -3% -4% Sources: Bloomberg, Company data, GF Securities (Hong Kong)

Valuation and recommendation

We initiate coverage of the company with an Accumulate rating and target price of HK$12.0, implying 16x/15x 2018/19E P/E. The stock is currently trading at 14.6x/14.3x 2018/19E P/E, higher than the industry average. We believe GDI deserves a premium given its defensive business nature, which is firmly backed by: 1) a highest dividend yield of 4.1%-4.8% among peers; 2) its strong balance sheet with a net cash position of HK$1.17bn; 3) a healthy debt servicing position with an EBITDA interest coverage of 54.47x at end-2016; 4) robust cash flow with an 8.8%-9.4% FCF yield; and 5) low vulnerability to exchange rate fluctuations.

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Company report Jul 20, 2017

Figure 71: Valuations of comparable companies Company Ticker Price Market cap P/E P/B ROE Net margin (HK$) (HK$ bn) 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E Guangdong Investment 270 HK 11.1 72.7 15.3 14.6 14.3 2.1 2.0 1.9 13.7% 13.6% 13.2% 41.9% 41.9% 41.6% China Everbright International 257HK 10.1 45.2 13.3 11.2 9.9 2.3 2.0 1.8 17.4% 18.3% 18.1% 20.9% 22.3% 22.6% Canvest 1381 HK 4.22 10.4 18.7 15.0 12.5 7.8 5.7 4.2 41.8% 37.7% 33.4% 23.6% 27.0% 27.0% Beijing Enterprise Water Group 371 HK 6.5 56.9 12.0 11.5 11.2 2.6 2.3 2.0 21.4% 19.7% 17.7% 19.8% 17.4% 16.8% Dynagreen 1330 HK 4.01 4.2 3.1 2.6 2.3 0.5 0.4 0.4 14.6% 15.2% 15.6% 17.4% 18.1% 19.4% Yunnan Water Group 6839 HK 3.59 4.3 2.2 1.9 1.8 N/A 11.8% 12.4% 12.9% CTE 1363 HK 1.42 9.0 11.4 9.3 7.9 2.1 1.8 1.5 18.2% 18.9% 18.9% 33.4% 34.4% 35.3% China Everbright Greentech 1257HK 5.59 11.5 13.3 10.5 9.2 11.0 10.0 9.0 83.1% 95.2% 97.6% 18.8% 18.2% 16.2% Dongjiang Environment 895 HK 12.9 16.2 19.0 15.3 12.9 2.7 2.3 2.0 14.0% 15.3% 15.7% 15.9% 16.1% 16.5% Industry Average 6.04 19.7 11.6 9.7 8.5 4.1 3.5 3.0 30.1% 31.5% 31.0% 20.2% 20.7% 20.8% Sources: Bloomberg consensus, company data, GF Securities (Hong Kong) Note: Calcuated based on closing prices on 20 Jul 2017.

Figure 72: Historical P/E band Figure 73: Historical P/B band

(P/E) Price 6x 9x 12x 15x 18x (P/B) Price 0.9x 1.3x 1.7x 2.1x 18x

16.00 16.00

14.00 14.00

12.00 12.00

10.00 10.00

8.00 8.00

6.00 6.00

4.00 4.00

2.00 2.00

0.00 0.00

11-01 12-01 12-09 13-01 13-05 13-09 14-01 14-05 14-09 15-01 15-05 15-09 16-05 17-05 11-05 11-09 12-05 16-01 16-09 17-01

11-05 11-09 12-01 12-09 13-05 13-09 14-01 15-09 16-05 17-01 12-05 13-01 14-05 14-09 15-01 15-05 16-01 16-09 17-05 11-01 Sources: Bloomberg, Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Figure74: Financial statements

Income statement Cash flow statement (HK$ m) FY15 FY16 FY17E FY18E FY19E (HK$ m) FY15 FY16 FY17E FY18E FY19E Revenue 9,172 10,464 11,322 11,845 12,226 Net income 3,905 4,212 4,745 4,964 5,091 Cost of sales -3,028 -3,584 -3,691 -3,862 -3,986 D&A 1,116 1,348 1,361 1,375 1,388 Gross profit 6,144 6,880 7,631 7,984 8,240 Change in w orking capital -252 -345 -215 -120 -167 Other income 813 552 597 625 645 Other operating cash flow 660 884 476 498 515 Administrative expenses -1,345 -1,398 -1,528 -1,599 -1,651 Operating cashflow 5,429 6,099 6,368 6,717 6,826 Other operating expenses -217 -242 -283 -296 -306 Capex -1,457 -560 -371 -375 -378 Operating profit 5,549 5,923 6,437 6,735 6,952 Change in investment -29 2,205 -42 23 64 Finance costs -136 -130 -91 -92 -93 Other investing cashflow -3,116 -504 20 20 21 Other non-recurring items -166 -42 140 142 147 Investing cashflow -4,543 -3,267 -308 -377 -422 Pretax income 5,246 5,752 6,486 6,785 7,006 Change in bank borrow ings 2,809 -2,020 -1,834 36 36 Income tax -957 -1,100 -1,265 -1,323 -1,401 Dividend paid -1,877 -2,255 -2,633 -3,008 -3,197 Net profit 4,289 4,652 5,221 5,462 5,605 Other financing cashflow 22 157 -350 -381 -278 Minority interests 384 440 476 498 515 Financing cashflow 955 -4,118 -4,816 -3,354 -3,438 Net profit attributable to shareholders 3,905 4,212 4,745 4,964 5,091 Net changes in cashflow 1,399 -1,684 1,243 2,986 2,967 Balance sheet Key assumptions & indicators Current assets Revenue breakdown Cash and cash equivalents 9,295 7,194 8,437 11,423 14,389 Water resources 5,896 6,505 7,087 7,469 7,757 Receivables 746 813 879 918 947 Property investment and development 1,160 1,171 1,130 1,106 1,089 Inventories 143 126 130 136 140 Department stores 784 813 717 738 775 Other current assets 6,307 7,751 8,407 8,818 9,113 Electric pow er generation 479 471 847 1,109 1,206 Total current assets 16,492 15,885 17,852 21,295 24,590 Toll roads and bridges 0 150 630 661 681 Non-current assets Hotel operations and management 701 672 634 619 625 PP&E 7,083 6,692 6,386 6,077 5,766 % of Total Revenue Goodw ill 304 301 301 301 301 Water resources 64% 62% 63% 63% 63% Receivables 438 417 397 377 356 Property investment and development 13% 11% 10% 9% 9% Deferred tax assets 47 62 62 62 62 Department stores 9% 8% 6% 6% 6% Other non-current assets 29,747 28,774 28,047 27,379 26,745 Electric pow er generation 5% 4% 7% 9% 10% Total non-current assets 37,618 36,246 35,193 34,196 33,229 Toll roads and bridges 0% 1% 6% 6% 6% Total assets 54,110 52,130 53,045 55,491 57,819 Hotel operations and management 8% 6% 6% 5% 5% Current liabilities YoY (%) Bank and other borrow ings 556 1,012 670 677 684 Revenue 9% 14% 8% 5% 3% Corporate bonds 0 1 2 3 4 Gross profit 9% 12% 11% 5% 3% Payables 4,854 4,361 4,240 4,186 4,063 Operating profit -5% 7% 9% 5% 3% Other current liabilities 368 199 204 212 218 Pretax income -14% 10% 13% 5% 3% Total current liabilities 5,778 5,573 5,116 5,078 4,968 Net profit attributable to shareholders -11% 8% 13% 5% 3% Non-current liabilities Profit margin (%) Bank and other borrow ings 7,016 16,663 25,515 32,855 38,998 Gross margin 67.0% 65.8% 67.4% 67.4% 67.4% Deferred tax liabilities 2,736 2,514 2,514 2,514 2,514 Operating margin 60.5% 56.6% 56.9% 56.9% 56.9% Notes payable 0 0 0 0 0 Net magin 42.6% 40.3% 41.9% 41.9% 41.6% Other payables 0 0 0 0 0 ROE 12.4% 13.1% 13.7% 13.6% 13.2% Other non-current liabilities 1,312 -10,857 -21,201 -28,513 -34,626 ROA 7.7% 7.9% 9.0% 9.1% 9.0% Total non-current liabilities 11,064 8,319 6,827 6,856 6,886 Ratio per share Total liabilities 16,843 13,892 11,943 11,935 11,854 EPS (HK$/share) 0.62 0.67 0.73 0.76 0.78 Reserves 25,760 26,432 28,545 30,500 32,394 BVPS (HK$/share) 4.81 4.93 5.29 5.59 5.88 Issued capital 5,712 5,790 6,064 6,064 6,064 DPS (HK$/share) 0.34 0.42 0.46 0.49 0.53 Equity attributable to shareholders 31,472 32,222 34,609 36,564 38,458 Interest coverage 45.4 54.5 85.6 88.3 90.1 Non-controlling interests 5,795 6,017 6,493 6,992 7,506 Dividend payout ratio 54% 62% 63% 64% 68% Total shareholder's equity 37,267 38,239 41,102 43,556 45,965 Current ratio 2.85 2.85 3.49 4.19 4.95 Sources: Company data, GF Securities (Hong Kong)

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Company report Jul 20, 2017

Rating definitions

Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10%

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