Since a change at the helm of Hankore Environment Tech Group in 2011, the firm has posted two consecutive years of profit and clinched numerous awards, including recognition as one of the Top Ten Fastest Growing Water Companies in China. Will the management be able to ride on their success wave to new heights?

Back in 2000, before China commercialised its water treatment industry, the nation possessed 360 plants. Fast forward to present day and we are faced with over 4,000 water stations serving the country while 2,000 more are being constructed as well as 5,000 additional plants targeted in five to 10 years? time.

With an array of wastewater treatment businesses within the industry to venture into, it is easy to lose focus and attempt to expand into other areas which may seem profitable. However, Hankore has decided to stick with what it knows best ? sludge handling, residential and industrial water treatment.

Earnings Visibility
In our recent interview with Hankore?s chief financial officer, Felix Yau, it was highlighted that the high gross profit margin enjoyed from wastewater treatment is the reason for the decision to drive growth in the segment. ?Hankore is able to secure higher water tariff rate and daily contracted treatment capacity as it progresses along each phase for each project,? added Yau. In the case of the recently upgraded plant in Nanjing Liuhe, its capacity was doubled to 200,000 tons per day and the tariff rate increased from Rmb0.92 per ton to Rmb1.45 per ton.

As each water plant only serves one client, the firm is able to sign agreements with their customers guaranteeing the minimum tariff rate and daily capacity. ?Hankore has a strict policy of only dealing with clients that we trust and possess sufficient funds to facilitate the capital expenditure required for the development of the water plants,? shared Yau.

This translates to a high water charges collection rate experienced by the firm. In turn, this provides investors? with a clear picture of the potential income Hankore is able to derive from their wastewater operations during the concession period, which usually lasts for 25 to 30 years.

Sustainable Improved Margins
As evident in their latest financial performance, the construction segment?s turnover improved to Rmb167.5 million from Rmb72.8 million in FY12, contributing 45.4 percent of the full year?s result compared to 29.7 percent in the preceding year, while its gross profit margin rose 6.3 percentage points to 15.1 percent. Although the management expects to maintain the improved construction business margin moving forward, it recognises the fact that construction income tends to occur only once for each project.

This foresight has led them to focus on expanding and upgrading their water plants instead, as they chase higher water tariffs and contracted capacity which offers a recurring effect absent from the construction business. In FY13, the wastewater treatment unit pulled its own weight as revenue increased Rmb29.3 million to Rmb201.5 million year-on-year while its gross profit margin gained 4.5 percentage points to 69.8 percent.

Wave Of Expansions And Upgrades
Presently, Hankore has identified six out of its existing 11 water plants prime for expansion and upgrading works, estimated to cost Rmb750 million. Out of the total cost, approximately 65 percent, or Rmb487.5 million, will be financed through bank loans, while the balance fulfilled by issuance of placement shares and its multicurrency medium-term note programme. Recently, the firm made a private placement to Wang Yu Huei, a notable investor in the Singapore scene with stakes in Dukang Distillers Holdings and Sarin Technologies, and will be looking to make more placement shares available in the next annual general meeting.

Yau acknowledged the need for external funds, ?The management has a debt to capitalisation threshold of 50 percent which currently sits at 27.3 percent, in line with other industry players. This presents the firm with plenty of headroom to take on more debt to support our expansion and upgrading plans.? Yau stressed that the funds obtained will be used solely for expansion and upgrading purposes and intends to release future tranches of its note programme only on a need-be basis.

Business Outlook
Although expansion promises higher income, David Chen, chairman of Hankore, emphasised that the management will not sacrifice the quality of its profitability and collection rate. However, with 0.9 million tons worth of existing water treatment capacity not utilised, the firm will focus on completing the internal upgrading plan to maximise its current portfolio.

Not only does the recent acquisition of Jiangsu Tongyong Environment provides the firm with necessary licenses and an experienced team in the engineering, procurement and construction segment in a far shorter duration compared to the time it would have taken the management to develop their own capabilities and apply for the licenses, it would direct previously outflowing earnings to subcontractors into the pockets of Hankore in the future.

?A large portion of our projects are aimed at residential wastewater treatment, which has simple and stable end-users compared to the industrial segment, where different industries would impose various criteria on the treated water,? noted Chen. Based on data furnished by the firm, residential water and sewage treatment demand in China is expected to reach 120 billion cubic meters by 2030, up from 78 billion cubic meters in 2010.

Making reference to a recent analyst report from Maybank Kim Eng, Hankore is presently trading at 8.2 times its 12-month trailing price-earnings ratio compared with a 22.6 times average for its SGX-listed peers. At such an attractive valuation, would you want to get your feet wet in the water treatment industry?