SINGAPORE (Jan 5): RHB is maintaining its “overweight” call for China's water sector.

That’s because the stocks under its coverage -- Everbright Water, CITIC Envirotech and SIIC Environment -- have strong book-to-bill ratios and solid balance sheets to bid for new projects.

In addition, with China facing slowing growth and high debt levels, the research house believes the Central Government will continue to push for more infrastructure spending to support the economy.

“As such, we expect to see faster adoption and quicker approval of public-private partnership (PPP) projects in the water sector in 2017,” says analyst Juliana Cai who expects to see continued strong construction revenues from both companies in 2017 and has SIIC as its top pick.

Despite slower project acquisitions witnessed in 2016, Cai says outlook for the sector stays promising. Last year, China aggressively advocated the adoption of the PPL model – especially for mature environment-related industries such as wastewater treatment. This helped to ease the financial burden of industry players, allowing them to bid for larger projects.

Moreover, Beijing has also mapped out a pipeline of 4,800 projects with a total investment value of RMB430 billion ($89.3 billion) to improve water quality.

“In 2017, we also expect to see a system in place that would incentivise local governments to complete water remediation projects on schedule,” says Cai.

The analyst expects the government to increasingly bundle low-return projects (such as water reclamation and pipe works) with better-yielding wastewater treatment projects in the PPP model.

This means the future growth of companies may be benchmarked against project investment scale rather than growth in treatment capacity.

“We believe this move would further consolidate the industry, as only the big state-owned enterprises (SOEs) with strong ability to control their cost structure would be able to take on these huge projects,” adds Cai.

While this could also lead large state-owned enterprises to lower their bids, Cai does not expect to see more than 1ppt of IRR erosion for the stocks under RHB’s coverage.

Meantime, more Singapore-listed water stocks are expected to pay out dividends, or at least planning to doing so in the near term, despite the capital-intensive nature of the sector.

While the amount may not be substantial, Cai views this positively as it demonstrates the cash flow-generating ability of the companies’ operations.

So far, for FY15, Everbright Water has declared a 35 cent DPS (12% payout ratio) while CITIC Envirotech declared a 36 cent DPS (11% payout ratio).

“We believe SIIC would also start to pay out dividends after its dual-listing in Hong Kong is completed,” says Cai.

Potential catalysts include faster-than-expected project wins. In this respect, both companies have net gearing levels of about 0.5x, which holds them in good position to gear up for more project acquisitions.

As at 12.02pm, shares of SIIC Environment, CITIC Envirotech and China Everbright are trading at 56 cents, $1.37 and 49.5 cents respectively.