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Hot Pick: Sound Global, Still As Hot?
Hot Picks, Tradeable | 26 March 2013
By: Simeon Ang
Articles (125) Profile

As our government and civil service officials are oft to ask, “do we take things for granted?”. In a way, I suppose we do, some more so than others. But perhaps, one of the main things we take for granted is the sewage and water treatment facilities we have here in Singapore. This however, cannot be said for all our Asian counterparts living in the second largest economy in the world, China.

China – Investing To Preserve Its Water Environment
With the advancement of industralisation in China, sewage discharge also witnessed a rising trend. To combat this, China made environmental protection among the largest investments in its 12th Five-Year Plan (2011-2015). Prior to this, investments in the wastewater treatment sector had already tripled to a total of about US$54 billion (World Bank estimates). According to the Global Water Intelligence, China intends to spend Rmb380 billion (US$61.2 billion) on urban wastewater treatment facilities from 2011-2015.

This huge investment, according to market watchers, will be used to support the water industry in meeting various standards set out in the 12th Five-Year Plan by developing more treatment infrastructure and acquiring assets and technology.

Sound Global, A Chinese Water Treatment Proxy
Enter, Sound Global. A manufacturer and operator of wastewater treatment and water recycling plants. The company was founded by Wen Yibo, a former Tsinghua University (one of the top two universities in China) professor. Wen currently owns about 54 percent of Sound Global and sits at the chair of the board of directors.

Sound Global was previously a market darling of sorts as investors flocked to ride on the investments made by the Chinese government on wastewater treatment. Recently however, things seem to have gone awry.

Picture of Sound Global’s waste water treatment facility in China. Source: Sound Global Annual Report 2011

Disappointing Quarter And Management Change
Sound Global announced on 28 February 2013 that its Chief Financial Officer (CFO), Gerald Yu had left the company. This is the second CFO in as many years to have left the company and does not bode well for the company’s internal structure as well as investor relations efforts. In fact, analysts from JP Morgan view this development as a negative impact on the company’s fundamentals.

In terms of earnings, Sound Global has had to also deal with a dismal 4Q12 report card due mainly to higher borrowing costs. The costs were incurred due to heavy investments it doled out for its “Built, Operate and Transfer” (BOT) projects. Overall, net profit for the quarter slid 22.9 percent from Rmb106.9 million to Rmb82.4 million in 4Q12. However, revenue did manage to eke out growth of 14.7 percent during the quarter due mainly to higher recurring Operation and Maintenance income from its BOT projects.

Earnings Visibility With Record Order Book
Despite the disappointing quarter, market analysts at DBS Vickers still believe there is much steam left in Sound Global. They point to the record high order book that Sound Global has managed to accumulate since 2012. That figure, now swollen at Rmb3.5 billion, boasts of key projects including wastewater treatment plants in the rural areas of China as well as about Rmb2 billion worth of BOT projects.

These same analysts predict that with about 60 to 70 percent of these projects completed in 2013, Sound Global’s turnkey engineering, procurement and construction segment could grow 12 percent to Rmb2.7 billion from its current Rmb2.4 billion in FY12.

Management Shake-Up A Wild Card
As with most companies, a management team is an important determining factor for investors when choosing which company to invest in. If the management were to change as often as they do at Chelsea Football Club (no offence to the Blues), investors might shy away from the counter. This is evident when news broke out of Gerald Yu’s departure from Sound Global.

However, in a baptism of fire, true diamonds are found. This could well be applicable for Sound Global as it appointed Zhang Jingzhi as the Chief Executive Officer. Zhang is reported as having extensive experience in the water industry of China. He had previously served as executive general manager of Sound Environmental Resources, the shares of which are listed on the Shenzhen Stock Exchange.

Challenges Ahead
The road ahead for Sound Global could be challenging with key downside risks being mushrooming interest costs from its previous fund raising activities. In particular, JP Morgan points to the conversion of outstanding convertible bonds which could potentially result in a dilution of about “13 percent” to Sound Global’s earnings per share.

Also, lower-than expected utilisation rates of Sound Global’s BOT projects could also hamper growth in its Operation and Maintenance segment. This is because revenue for that segment is calculated based on the volume of wastewater actually treated.

Despite these challenges, the stock is currently trading at around 8.4x* price-to-earnings (PE) ratio (lower means more bang for your buck), at more than 40 percent discount to its peers’ average of 15x PE. Based on this, Sound Global appears to be the cheapest Chinese water proxy in the region. Does this appear to be a cheap deal? Certainly some food-for-thought for bargain hunters!

*Based on 25 March 2013’s closing price of $0.545

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Simeon, an LSE graduate, is currently the editor of Aspire. He specialises on topics surrounding trading psychology, politics and macroeconomics.

Please click here for more information about this author.

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