Dongjiang Environmental:New SOE leader benefiting from Shenzhen Connect;initiating with Buy

New SOE leader in hazardous waste treatment

    We initiate coverage of Dongjiang (895 HK) with Buy and an HKD15.5 targetprice. We like Dongjiang on the strong capacity growth outlook for China’shazardous waste treatment market, its leading market position and potential toconsolidate the fragmented market, and the company’s transformation into anSOE with an employee share incentive scheme. We expect the Shenzhen-HongKong Stock Connect to be a share price catalyst. We also initiate on Dongjiang-A (002672 CH) with an RMB14.8 target price and Sell, on valuation.

    Leader to benefit from market growth, consolidation, and its new SOE identity

    China’s hazardous waste treatment capacity should post a 17% CAGR, driven bythe Soil Pollution Control Plan. Dongjiang is well-positioned to capture thegrowth, as a leader in capacity, geographic presence, treatment qualificationsand its track record. The company should also benefit as the market, with~1,500 players, consolidates. Dongjiang’s announced share issue to a companyunder Guangdong SASAC will turn it into an SOE and we expect it to benefitfrom its new SOE status in new project wins, project ramp-ups and finance cost.

    Strong earnings growth; employee share incentive scheme should help

    We expect Dongjiang to deliver a recurring earnings CAGR of 26% in 2016-18e, driven by capacity growth and a rise in the utilization rate in industrialhazardous waste treatment. We believe the recently-issued employee shareincentive scheme should help drive Dongjiang’s earnings growth, as it requiresthe company to deliver a recurring earnings CAGR similar to our forecast.

    DCF-based target price of HKD15.5/RMB14.8; key downside risks

    Our DCF valuation is based on a 7.3% WACC, explicit cash flow to 2026E and2% terminal growth. Major risks: fluctuations in China’s industrial activities,slower/faster-than-expected capacity ramp-ups, lower/higher-than-expectedmetal prices, lower/higher-than-expected margins, and changes in China’spolicies.