November 29, 2016 COMPANY UPDATE CANVEST ENVIRONMENTAL PROTECTION GROUP [1381.HK, HK$3.63, NOT RATED] – Strong project growth to continue over the next few years Analyst: Wayne Fung, CFA; Tel: (852) 3698 6319 Rachel Chui; Tel: (852) 3698 6391 Our latest discussion with Canvest suggests that new project additions Canvest Environmental Protection Group are progressing well. The projects secured by the Company are enough to increase its capacity by 141% by 2019E. We also note that the latest government policies remained very supportive to the sector. We believe Canvest is well-prepared to capture opportunities in Guangdong and Guangxi provinces. Canvest is trading at 14x 2017E consensus PER, slightly higher than China Everbright International [0257 HK; not rated] (12.8x), because of Canvest’s higher growth potential. Also, Canvest is included in SZ-HK Stock Connect, which will help attract more potential investors in the future. Capacity additions well on track. As of June 2016, Canvest’s daily processing capacity reached 6,900t. In March 2016, its acquisition of the Xingyi project was completed, which contributes daily capacity of 700t. The results will be consolidated in the 2H16E financial statements. Currently, five projects are underway, with daily processing capacity reaching 7,600t. Another three projects have Market Cap: US$952m; Free Float: 29% been approved by the government and are under construction: Eco- Tech Phase 2, China Scivest Phase 2, and Zhongshan. The HKD 2014 2015 2016E 2017E Zhangshan project is under a management agreement between Revenue (m) 794 1,185 1,552 2,278 Canvest and Zhongshan City Guangye Longcheng Environmental COGS (m) (452) (745) (943) (1,428) Company Limited. Based on our understanding, the latter failed to Gross profit (m) 342 439 610 850 complete the construction because of a lack of capital, so Canvest Gross margin (%) 43 37 39 37 took the opportunity and has been entrusted with the management EBIT (m) 294 377 502 687 of the construction and operation of the project. The expected Capex Net profit (m) 191 272 383 519 of this project is ~RMB200m. Also, Laibin Zhongke Phase 1 is Net margin (%) 24 23 25 23 undergoing a technological upgrade, and Beiliu Phase 1 is under EPS 0.13 0.14 0.19 0.26 planning. The total capacity will add up to 13,040t by end-2017. Processing capacity to jump 141% by 2019. In addition, six more ROE (%) 13 12 15 17 projects are now under planning, including Lufeng, which is Dividend yield (%) 0.0 0.0 0.7 1.0 estimated to start construction at end-2017. The announced daily PER (x) 28.6 26.7 19.0 14.2 capacity will amount to 18,340t in 2019 (including the Zhongshan PBR (x) 3.1 3.1 2.7 2.3 management contract of 1,040t). Capex of RMB2.5bn is expected in Source: Bloomberg the next two to three years. Canvest has maintained a target project IRR of 8-12%. Company background. Founded by KM Lai in 2003, China MSW processing capacity to increase by 159% from 2014 Canvest Environmental Protection Group (Canvest) is a to 2020. According to the draft proposal of the 13th Five-Year Plan private waste-to-energy (WTE) operator based in regarding the planning and construction of municipal solid waste Guangdong. Canvest was listed on the HKEx in Dec 2014 (MSW) processing facilities, the daily national processing capacity and raised HK$1,069m at HK$2.33 per share. In Jan 2016, by incineration is targeted to climb from 200,601 tonnes in 2014 to IFC offered a convertible loan to Canvest of HK$465m 520,408 tonnes in 2020. In Guangdong, Guangxi and Guizhou, (conversion price: HK$3.90). In May 2016, Canvest issued where Canvest does business, the daily capacity is expected to 34.2m new shares at HK$3.40, raising HK$112m. grow remarkably, ranging from 159% to 1,238% (figure 1). Currently, Loretta Lee (Chairwoman), KM Lai and CT Lai, Moreover, across the country, the rate of MSW processing by through a trust, own a 64.5% interest in Canvest. incineration is expected to increase from 28.6% in 2014 to 50.0% in 2020. The figures in Guangdong are similar to the national target, Risk factors. (1) Project delays; (2) change in WTE and rising from 28.2% to 49.5%. As for Guangxi and Guizhou, the coal power tariffs in the future; (3) potentially stricter proliferation of MSW processing by incineration is expected to environmental standards. increase as well – up proportionally to 28.2% and 28.1% from 5.7% and 3.6%, respectively. 1 Continued additional support from the government for incineration On 22 Oct 2016, four ministries (the Ministry of Housing and Urban-Rural Development, the National Development and Reform Commission, the Ministry of Land and Resources and the Ministry of Environmental Protection) issued a document regarding further support for incineration for handling municipal waste. Two weeks later on 5 Nov 2016, the Guangdong Environmental Sanitation Association published a more specific implementation plan. Some of the key points are highlighted as follows. To echo the launch of 13th Five-Year Plan, 50% of municipal waste must be processed by incineration and all of it must achieve the designated standard for environmental impact. More attention must be paid to location selection. WTE plant projects must be incorporated within the Urban Planning Yellow Line. This means these plants will officially become part of the infrastructure projects of cities. The land use of the projects will be secured and smoother construction progress will be expected. The newly constructed WTE plants must fulfill the high-standard requirements based on the principles of safety, reliability, economy and environmental friendliness. Advanced technology is encouraged, and construction quality has to be strictly monitored. Also, reasonable subsidies will be provided. More communication and mutual benefits should be established between WTE projects and adjacent residents. Some green areas associated with these projects may be shared with the surrounding residents. Improving the employment rate through such infrastructure projects is also a positive factor in getting citizens to accept the WTE plants. Figure 1: Capacity of incineration to handle municipal solid waste per day (tonnes) - National, Guangdong, Guangxi and Guizhou Sources: NDRC, CGIS Research 2 Figure 2: Comparison of the percentage of technologies for handling MSW-processing capacity per day between 2014 and 2020 (estimated) on National, Guangdong, Guangxi and Guizhou basis Sources: NDRC, CGIS Research 3 Figure 3: Project Overview Location Daliy MSW processing Installed power Combustion Business model Cocession period Waste treatment fee Status capacity generation capacity technology Eco-Tech WTE Dongguan, 1,800 tonnes (1,200 36MW Moving grate BOO n/a RMB110/tonne Trial Operation Plant (Phase 1) Guangdong Province tonnes before technological upgrade) Eco-Tech WTE Dongguan, 1,500 tonnes 50MW Moving grate BOO n/a RMB110/tonne Undergoing Plant (Phase 2) Guangdong Province preparatory works Kewei WTE Plant Dongguan, 1,800 tonnes 30MW Moving grate BOO n/a RMB110/tonne Commercial operation Guangdong Province China Scivest WTE Dongguan, 1,800 tonnes 42MW Moving grate BOT 24 years (from 10 RMB110/tonne Commercial operation plant (Phase 1) Guangdong Province December 2004 to 30 November 2028) China Scivest WTE Dongguan, 1,200 tonnes Planning Moving grate BOT Under negotiation RMB110/tonne Planning plant (Phase 2) Guangdong Province Qingyuan WTE Qingyuan, Guangdong Phase 1: 1,500 tonnes Planning Moving grate BOT 30 years after passing RMB 50 / tonne Planning plant Province Phase 2: 1,000 tonnes the environmental (Under negotiation) impact assessment) Zhanjiang WTE Zhanjiang, Guangdong 1,500 tonnes 30MW Moving grate BOT 28 years (from 18 April RMB81.8/tonne Under development plant Province 2013 to 17 April 2041) (Expect to commence trial operation in the first half of 2016) Laibin WTE plant Laibin, Guangxi After technological Phase 1: 24MW Moving grate (after BOT Until April 2042 RMB95/tonne In operation (will (Phase 1&2) Zhuang Autonomous upgrade: Phase 2: Planning technological upgrade) undergo technological Region Phase 1: 1,000 tonnes Fluidised bed (before upgrade) Phase 2: 500 tonnes technological upgrade) (500 tonnes before technological upgrade) Lufeng (Southeast) Lufeng, Guangdong 1,600 tonnes Planning n/a BOT Planning RMB91.5/tonne Under construction Province I: 1,200 tonnes II: 400 tonnes Zhongshan Zhongshan, 1,040 tonnes n/a n/a Mgt Contract Planning RMB93/tonne Planning Guangdong Province Beiliu WTE plant Beiliu, Guangxi Zhuang Phase 1: 700 tonnes Planning Moving grate BOT 30 years commencing RMB83 / tonne Planning Autonomous Region Phase 2: 350 tonnes from the date of formal (Calculated on commissioning weighted average basis) Xingyi WTE plant Xingyi, Guizhou Phase 1: 700 tonnes Phase 1: 12MW Moving grate BOT 30 years commencing RMB80/tonne Phase 1: Under Province Phase 2: 350 tonnes Phase 2: 6MW from the date of formal operation commissioning Phase 2: Planning Sources: Company, CGIS Research Figure 4: Canvest’s waste processing capacity expansion plan Tonne Lufeng (Southeast) - BOT, 30 years until 2046) 20,000 Zhongshan (Management Contract) 18,000 Xingyi WTE plant (phase two) - BOT (30 years) Xingyi WTE plant (phase one) - BOT (30 years) 16,000 Beiliu WTE plant (phase two) - BOT (30 years) 14,000 Beiliu WTE plant (phase one) - BOT (30 years) 12,000 Laibin Zhongke (phase two) - BOT (2016-2042) Laibin Zhongke (phase one) - BOT (2016-2042) 10,000 Qingyuan (phase two) - BOT (30 years) 8,000 Qingyuan (phase one) - BOT (30 years) 6,000 Zhanjiang