China Water Affairs Group Ltd. Assigned #BB+# And #cnBBB+# Outlook Stable

Stocks and Financial Services Press Releases Friday January 20, 2017 16:57
HONG KONG--20 Jan--S&P Global Ratings

HONG KONG (S&P Global Ratings) Jan. 20, 2017--S&P Global Ratings today assigned its 'BB+' long-term corporate credit rating to China Water Affairs Group Ltd. (CWA). The outlook is stable. We also assigned our 'cnBBB+' long-term Greater China regional scale rating to the company.

CWA is China's largest water supply company in terms of revenue. The company is publicly listed in Hong Kong.

The rating on CWA reflects the company's monopolistic water supply position in its operating cities, exposure to evolving regulatory risk in China, lower volume risk versus other public utility services, satisfactory profit margin, and improving cash flow leverage ratio in the coming years.

"CWA is exposed to the evolving regulatory framework for water supply industry in China and we expect to remain so," said S&P Global Ratings credit analyst Vincent Chow. "In our view, the regulatory regime for Chinese water operators is less transparent and has lower return visibility than for regulated utilities companies in developed markets."

The regulatory framework in China, which includes a document issued by central government back in 1998 on allowing 8%-12% project return on equity on water supply project, supports CWA's growth plans. According to the document, water operators could apply for tariff hike if the expected return is below the allowed return. However, the execution by different local governments varies and the decision making of tariff adjustment may factor in public affordability and other considerations.

"In our view, water tariffs are on an upward trend in China because of the water resource scarcity and the roll-out of tiered tariffs on the basis of water usage. That said, we do not expect a material change in the regulatory framework over the next two to three years," Mr. Chow said.

In our view, CWA has satisfactory operating efficiency. CWA has a good track record of improving the efficiency after acquiring a project. This is evident from CWA successfully reducing the percentage of non-revenue water (i.e., water produced but lost before reaching customers)--the leakage rate. CWA's average non-revenue water as a percentage of total water supply was about 19% in the first half of fiscal 2017, which is in line with industry average in China. Compared to other utilities such as power and gas, water usage volume is relatively inelastic to economic growth, but China's continued urbanization and improving household income drive the organic growth of water supply higher than that in the developed market.

CWA's management has extensive experience in the water industry. Founder and chairman of CWA, Mr. Duan Chuan Liang, has 30 years of experience in the water industry and has worked for China's Ministry of Water Resources for more than 10 years. CWA's success hinges on Mr. Duan, its key decision maker.

We also expect CWA to be more focused on the water business as the company exits some of its non-core business lines, e.g., property and cement, and reinvests proceeds into its core segments, such as water supply and sewage.

The stable outlook on the ratings on CWA reflects our expectation that the company will continue its focus and expansion on its water business in China, with stable profitability. We expect the tariff regime will remain generally stable and allow CWA's water supply projects to earn steady return.

We may lower our ratings if regulatory changes in China or poor execution on the 8%-12% allowed return profile undermines the company's profitability and cash flows. This could happen if the government does not allow a tariff hike despite the project return being consistently below target. We may also lower the rating if CWA aggressively expands with higher-than-expected debt burden, such that its FFO to debt is consistently below 18%. We may also lower our ratings on negative developments in the company's management and corporate governance.

We may raise our rating on CWA if the company's financial strength further improves such that its ratio of FFO to debt approaches 30%, while it demonstrates a track record of disciplined financial management and acquisition. Potential improvement in the regulatory environment could also lead us to reevaluate our assessment of the business risk. This could happen if the government sets a more transparent tariff framework, which enhances

CWA's cash flow visibility.

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