21 October 2010
Update Report
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Increase Exposure
China Environment Ltd
 Intrinsic Value
 Prev Close
Big Plans Ahead

We visited China Environment Ltd’s (CENV) headquarters at
Longyan City, Fujian Province. We saw firsthand the
complexity of building waste gas treatment systems, which
involves design, steel fabrication, electronic and electrical
engineering, construction and testing. Maintain Increase
Exposure view on an intrinsic value of S$0.370 (+45.1%
value-price gap).
Key Observations:



The Longyan facility seems to be running at full
capacity, with parts laid out up to the yard. There were
at least nine systems being constructed when we
visited the plant.
A typical gas treatment solution consists of both
mechanical and electronic/electrical sub-modules. As
CENV produces both parts itself, it enjoys a cost
advantage over peers that have to make up for
technical capabilities they do not posses by
outsourcing to contractors.
S$0.370
S$0.255
Main Activities
China Environment Ltd is a provider of waste gas
treatment systems in the PRC, with headquarters in
Longyan City, Fujian Province. Its key products
include electrostatic precipitators and other types of
dust collectors.
Financial Highlights
(Y/E Dec) RMB m
m
Revenue
FY08
FY09
FY10F
464.0
499.6
580.6
Gross Profit
134.3
145.0
161.5
Earnings
82.9
53.8
89.0
EPS (RMB cts)
14.5
9.0
13.9
Source: Company, SIAS Research
Key ratios (FY10F)
PER
9.2
P/BV
1.9
Return on Common Equity
21.8%
Return on Assets
17.9%
Gross Debt to Common Equity
22.8%
Current ratio
4.4
Source: SIAS Research
Indexed Price Chart
Green (FSSTI)
White (CENV)
2
CENV has also been allocated a 200,000m plot of
land that it has yet to purchase. This allotment gives
CENV the option to expand and take on more projects
in the future.
Value Catalysts:
CENV is currently in talks with a partner to build a system
that comprises of dust, NOx and sulphur removal modules.
To finance such large-scale projects, CENV is considering
various funding options, which may include dual listing plans.
Source: Bloomberg
We see the realization of these events as value catalysts for
CENV. In the long run, CENV intends to expand its
capabilities to include technologies for water and noise
pollution. Given China’s growing market for environmental
protection equipment, we maintain our bullish outlook on
CENV.
Analyst:
Liu Jinshu, Investment Analyst
[email protected]
Tel: 6227 2107
Page 1 of 10
52wks High-Low
Number of Shares
Market Capitalization
S$0.670 /S$0.175
639.5m
S$163.1m
21 October 2010
Update Report
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Back to Fujian Province
CENV’s headquarters and main production facility is in Longyan City, which is
located about 140km northwest of Xiamen, in Fujian Province, China. Currently,
CENV also has another facility in Handan County, Hebei Province. From time to
time, the company will rent additional space to fabricate its products nearer to
clusters of customers.
Longyan City, where a major competitor in the industry, Fujian Long King
Environmental Protection Limited (福建龙净环保股份有限公司), is also located,
can be considered to one of the hubs for waste gas treatment systems in China.
Hence, CENV enjoys economies of scale, such as availability of skilled labour
and raw materials, at Longyan City.
CENV’s products are mainly waste gas treatment systems such as electrostatic
precipitators (ESPs), including electrostatic lentoid precipitators (ESLPs), and
baghouses. We also visited one of CENV’s customers, a cement maker at
Lantian Village, 40km away from Longyan to sight completed and installed ESP
and ESLP systems.
Figure 1: Illustrative Locality Map
Longyan City
Lantian Village
Xiamen
Source: Google Maps, SIAS Research
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In The Longyan Facility
CENV’s Longyan facility is located at the local Economic Development Zone, at
the foot of a mountain range. We saw an office block, two fabrication plants and
2
several smaller workshops for testing and storage purposes on the 46,573m
compound. The land and building are leased assets. CENV does not own the
land use rights to them.
Figure 2: Office Block (Front of Compound)
Figure 3: Left Hand View of the Compound
Fujian Dongyuan Environmental Protection Co., Ltd is
the wholly owned PRC operating company of CENV,
the listed entity.
CENV sits on the edge of the Economic Development
Zone. The right hand side of the compound consists of
mainly factories of other companies.
Source: SIAS Research
Source: SIAS Research
At the fabrication plant itself, multiple activities were being carried out with
workers busy welding metal pieces, shifting parts between work stations and
painting completed items. CENV’s products are typically large-sized industrial
equipment, whose parts are usually fabricated at the company and assembled
3
onsite. An ESP system may take up about 504.5m of space, equivalent to
approximately 2 single storey 5-room flats. Our conversations with the floor
supervisor suggested that there are at least nine systems whose parts were
being fabricated in Longyan during our visit.
In an adjacent shed, we sighted control systems being assembled into
approximately 2m tall grey-colored metal boxes. Within each box are panels of
control switches and circuit boards. Some of them had screens in front which
displayed an in-house developed graphical user interface/ monitoring software.
Electronic and electrical components used were a mixture of foreign imports and
domestic produce, depending on customers’ specifications. Hence, the level of
customization offered extends beyond the layout of the system to the choice of
parts used. CENV’s engineering expertise is a competitive edge. According to
the staff, some of the smaller companies have to outsource this part of the
manufacturing process, which in turn gives CENV a cost advantage.
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Completed control systems are tested using a mini-ESP unit before delivery.
The assembled system is tested, commissioned and handed over onsite. The
entire waste gas treatment system typically has a one year warranty.
Figure 4: Workers at Fabrication Plant I
Figure 5: Workers at Fabrication Plant II
Source: SIAS Research
Source: SIAS Research
Figure 7: Inside a Control Unit
Figure 6: Control Units Being Tested
ESP unit
Control Units
Source: SIAS Research
Source: SIAS Research
Figure 8: Each system may require multiple units.
Source: SIAS Research
Page 4 of 10
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CENV’s customer at Lantian Village is a cement maker, whose waste gas
contains cement dust that needs to be removed before being emitted. The entire
structure is five floors high and can be easily identified by the pyramidal dust
hoppers. The hoppers collect the dust particles removed and are connected to a
dust conveyor system which removes the dust.
From our understanding, these systems require regular maintenance. In the
case of baghouses, their filter bags need to be replaced from time to time.
Figure 9: At The Foot of The Chimney
Figure 10: Five Storey High ESLP System
The ESLP is on the other side of the
chimney, hidden from view.
Hopper
Source: SIAS Research
Source: SIAS Research
Figure 11: Schematic of a Gas Treatment System
Source: Company, SIAS Research
Page 5 of 10
21 October 2010
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Ambitious Plans
To facilitate expansion, CENV was also allocated an adjacent plot of land of
2
approximately 200,000m by the government in August 2007. As of 30 June
2010, CENV has yet to purchase the land use rights for this property, estimated
to cost about RMB25m back in mid 2009.
Currently, CENV is pursuing talks with a Chinese partner to build a
comprehensive waste gas treatment system, comprising of de-NOx,
desulphurization and de-dusting modules, in a developing country. CENV’s
ambitions are not unfounded.
Chinese power plant construction companies have been gaining success
overseas as developing countries want to boost power output, but abhor the
high prices that US and European suppliers charge. In India, Chinese
companies supply about 25% of new capacity added to its grid each year. As
early as 2005, Chinese companies have also been building power plants in
Indonesia, with some contracts worth as much as RMB15bn. Hence, it makes
sense for CENV to extend its relationships with customers in the power plant
construction industry to include larger overseas projects. Already, some of
CENV’s products are being shipped to Indonesia, where its customers are
building power plants.
Since 2008, CENV has been working with an environmental technologies
provider to research and develop desulphurization systems. The company
claims that it has the technology to build such systems now. However, we noted
a lack of available space on the Longyan facility for more concurrent projects at
the moment. The Longyan plant seems to be working at full capacity, with parts
piled up even in its yard, which has a basketball court.
Figure 12 Needs More Space I
Figure 13: Needs More Space II
Source: SIAS Research
Source: SIAS Research
Page 6 of 10
21 October 2010
Update Report
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In addition, Chairman and CEO Mr. Huang Min’s long term vision for CENV
seems to be that of a complete environmental protection company, extending to
the provision of water and noise pollution solutions. Hence, the allocated piece
of land is not necessarily too big for CENV.
For now, CENV’s plan to offer a comprehensive set of de-dusting, de-NOx and
desulphurization products, if executed, will require substantial working capital.
As such, the company is considering multiple financing options such as bank
loans, share placements or dual listings.
We believe that the award of more extensive projects to CENV will be a catalyst
for value discovery. Should the company decide to list its shares on another
exchange, its share price might receive another boost.
We maintain our forecasts and valuation on CENV, preferring to make further
adjustments when the company announces its 3Q FY10 results. CENV’s share
price has risen of late, closing at S$0.255 as of 20 October 2010 – up 8.5%
since our last update in August and 34.2% since our initiation of coverage in
May. Nonetheless, CENV’s current price still reflects a 45.1% value-price gap
from our intrinsic value of S$0.370. Maintain Increase Exposure view.
Page 7 of 10
21 October 2010
Update Report
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Figure 14: Economic Profit Valuation Model
RMB m
Revenue
EBIT
Tax on EBIT
NOPLAT
Invested Capital
% of Debt
% of Equity
WACC (%)
Capital Charge
Economic Profit
Terminal Value
Discount Rate (%)
Present Value
Book Value
Explicit Value
Terminal Value
Value of Firm
Number of Shares (m)
Value per share (RMB)
Value per share (S$)
FY10F
580.6
122.6
-20.8
101.8
397.3
25.2%
75%
11.88%
47.2
54.6
FY11F
650.3
140.8
-23.9
116.8
539.6
18.5%
81%
12.18%
65.7
51.1
FY12F
747.9
164.0
-27.9
136.1
610.8
16.4%
84%
12.28%
75.0
61.1
0.95
51.6
377.3
253.7
557.2
1188.2
639.5
1.858
0.370
0.84
43.0
0.75
45.8
Source: SIAS Research
Page 8 of 10
FY13F
897.4
199.7
-33.9
165.7
694.0
14.4%
86%
12.37%
85.8
79.9
0.66
53.1
Risk Free
Beta
Market RP
Cost of Equity
Cost of Debt
LT Growth
RMBSGD
FY14F
1076.9
242.5
-41.2
201.3
796.7
12.6%
87%
12.45%
99.2
102.1
944.8
0.59
60.2
1.99%
1.2
9.19%
13.02%
8.50%
2.00%
0.1996
21 October 2010
Update Report
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Figure 15: Financial Forecasts and Estimates
RMB m
Revenue
Gross Profit
Operating Profit
Net Profit
Attributable to Shareholders
FY07
240.3
64.6
55.3
50.3
FY08
464.0
134.3
115.1
82.9
FY09
499.6
145.0
116.0
53.8
FY10F
580.6
161.5
123.6
89.0
FY11F
650.3
181.0
140.8
101.7
FY12F
747.9
208.2
164.0
118.8
FY13F
897.4
249.8
199.7
146.8
FY14F
1076.9
299.8
242.5
178.2
Total Current Assets
Total Non-Current Assets
Total Current Liabilities
Total Non-Current Liabilities
Total Equity
176.3
0.0
130.1
0.0
46.2
249.9
3.4
121.2
1.1
131.0
421.8
4.3
46.5
2.3
377.3
566.1
4.8
128.3
3.0
439.6
639.3
5.6
131.1
3.0
510.8
725.5
6.4
134.9
3.0
593.9
833.2
7.4
140.9
3.0
696.7
964.0
8.5
148.0
3.0
821.4
Cash from Operating Activities
Cash from Investing Activities
Cash from Financing Activities
Net change in cash
3.9
-89.3
118.9
33.5
37.9
-1.7
-22.1
14.1
-65.0
26.3
60.6
21.8
-48.4
-1.2
50.7
1.1
116.8
-1.4
-30.5
84.9
-6.5
-1.6
-35.6
-43.7
95.4
-1.8
-44.0
49.6
-4.5
-2.1
-53.5
-60.1
21
73
32
16
73
10
31
116
6
40
150
6
40
150
7
40
150
7
40
150
7
40
150
7
66.8%
29.0%
242.5%
1.4
93.6%
38.6%
67.4%
2.1
21.2%
15.8%
6.0%
9.1
21.8%
17.9%
22.8%
4.4
21.4%
16.7%
19.6%
4.9
21.5%
17.3%
16.8%
5.4
22.7%
18.7%
14.4%
5.9
23.5%
19.7%
12.2%
6.5
1.75
1.4
14.6
17.7
2.88
4.6
8.8
5.6
1.80
11.8
14.2
2.2
2.78
13.7
9.2
1.9
3.17
15.9
8.0
1.6
3.71
18.5
6.9
1.4
4.58
21.7
5.6
1.2
5.56
25.6
4.6
1.0
Inventory Days
Receivable Days
Payable Days
ROE
ROA
Gross Debt/Common Equity
Current Ratio
EPS (S cents)
BV/Share (S cents)
PER
P/BV
Source: Company, SIAS Research
Page 9 of 10
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Rating Definition:
Increase Exposure – The current price of the stock is significantly lower than the underlying fundamental value. Readers can
consider increasing their exposure in their portfolio to a higher level.
Invest – The current price of the stock is sufficiently lower than the underlying fundamental value of the firm. Readers can
consider adding this stock to their portfolio.
Fairly Valued – The current price of the stock is reflective of the underlying fundamental value of the firm. Readers may not
need to take actions at current price.
Take Profit – The current price of the stock is sufficiently higher than the underlying fundamental value of the firm. Readers
can consider rebalancing their portfolio to take advantage of the profits.
Reduce Exposure - The current price of the stock is significantly higher than the underlying fundamental value of the firm.
Readers can consider reducing their holdings in their portfolio.
IMPORTANT DISCLOSURE
As of the date of this report, the analyst and his immediate family may own or have positions in any securities mentioned
herein or any securities related thereto and may from time to time add or dispose of or may be materially interested in any
such securities. Portfolio structure should be the responsibility of the investor and they should take into consideration their
financial position and risk profile when structuring their portfolio. Investors should seek the assistance of a qualified and
licensed financial advisor to help them structure their portfolio. This research report is based on information, which we believe
to be reliable. Any opinions expressed reflect our judgment at report date and are subject to change without notice. This
research material is for information only. It does not have regards to the specific investment objectives, financial situation and
the particular needs of any specific person who may receive or access this research material. It is not to be construed as an
offer, or solicitation of an offer to sell or buy securities referred herein. The use of this material does not absolve you of your
responsibility for your own investment decisions. We accept no liability for any direct or indirect loss arising from the use of this
research material. We, our associates, directors and/or employees may have an interest in the securities and/or companies
mentioned herein. This research material may not be reproduced, distributed or published for any purpose by anyone without
our specific prior consent.
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