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研究报告:中国水务行业报告:更具盈利性和透明性的过渡-060725

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Product July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 1 July 25,2006 China: Utilities: Water Quenching investment thirst Industry context China is facing acute water shortage problems, and the quality of the already scarce water resources is also deteriorating. The Chinese government is recognizing the need to reduce water wastage and pollution levels, and is encouraging investment in the sector. We think the sector is poised for transition from being inefficient and bureaucratic to more profitable and transparent. Source of opportunity We expect the government to encourage further investment in the water and water treatment sectors. To this end, we also expect the price of water, which has historically been treated as an “almost free” public good, to increase significantly. We think that this should also increase funding available for improving water metering systems, water leakage and pilferage reduction programs and higher levels of sewage treatment rates. Catalyst We believe that, like the city gas distribution sector in recent years, more cities will open their water and sewage sectors to external investment, implying new investment opportunities for listed water companies. Higher tariffs and a reduction in the levels of non- revenue water should also improve returns. Risks We believe grass root resistance could slow down the pace of water sector and tariff reforms. Also, the current regulatory environment for water is opaque and may evolve more slowly than expected or may be inconsistent across sub-sectors or geographically. Best buy idea We think the tap water segment has the most potential for improving returns through higher tariffs and improved efficiency—Shanghai Municipal Raw Water (600649.SS, Neutral) has the best exposure to this segment. Near-term, however, Guangdong Investment (0270.HK, Neutral) is our preferred water stock on attractive valuations. Sinomem Technology (SINO.SI, Buy) is the preferred equipment company within Goldman Sachs coverage due to its undervalued profit potential. SUSTAINABLEINVESTING: Environmental Focus BESTBUYIDEAS Shanghai Municipal Raw Water (600649.SS, Neutral) on asset injection potential Guangdong Investment (0270.HK, Neutral) for attractive valuations Sinomem (SINO.SI, Buy) for undervalued profit potential UPCOMINGEVENTS Goldman Sachs/Gao Hua Alternative Energy/Water Corporate Days, July 27-28,2006 RELATEDRESEARCH Gao Hua Securities Shanghai Municipal Raw Water: Asset injections provide further upside catalyst, July 2006 Beijing Capital Initiation: Rising with the sector, May 2006 Guangdong Investment initiation: Steady growth and strong cash flow, April 2006 Goldman Sachs Hyflux initiation: Modest upside, June 2006 Sinomem Technology Initiation: Undiscovered gem, May 2006 Franklin Chow, CFA +86(10)6535-3012 | franklin.chow@ghsl.cn Beijing Gao Hua Securities Company Limited Qi Zhou +86(10)6535-3054 | qi.zhou@ghsl.cn Beijing Gao Hua Securities Company Limited Beijing Gao Hua Securities Company Limited and its affiliates do and seek to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For analyst certification, see the text preceding the disclosures. For other important disclosures, contact your investment representative. Beijing Gao Hua Securities Company Limited Investment Research July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 2 Table of contents Overview: Positive macro outlook from water reform 3 Water shortage to lead to regulatory support for the sector 6 Rectifying tap water problems presents an investment opportunity 8 More sewage treatment needs to be encouraged 12 Equipment providers to grow with the operators 13 Risks: Lack of transparency in tariff-setting and bidding schemes 14 Valuation: Higher reform potential deserves a premium 15 Shanghai Municipal Raw Water (600649.SS, Rmb5.17, Neutral): Asset injections create new catalysts 20 Guangdong Investment (0270.HK, HK$3.00, Neutral): Steady and strong cash flow 22 Tianjin Capital (1065.HK, HK$1.82, Neutral): Turning over a new leaf 24 Beijing Capital (600008.SS, Rmb4.74, Neutral): To double capacity by 201026 Sinomem (SINO.SI, S$0.78, Buy): Misunderstood and undervalued 28 Hyflux (HYFL.SI, S$2.12, Neutral): Modest upside to risk-adjusted return 30 EXPECTEDNEWSFLOW/EVENTS DATEEVENTCOMMENT Aug./Sept.2006 4Q06 4Q06 Announcements of interim results by Chinese companies under our coverage We expect Shanghai Raw Water’s City South asset swap to close and Shanghai tap water tarrifs to increase in 4Q2006 Possible resolution to franchise application by Tianjin Capital We expect further increase in tariffs and ROE should improve investor sentiment. More clarity on disclosure on new projects regarding operations; improved profitability should also boost investor confidence Source: Company data, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates Notes: The following analysts cover the respective companies as mentioned in the report: Franklin Chow of Gao Hua Securities covers Beijing Capital, Guangdong Investment, Shanghai Municipal Raw Water, and Tianjin Capital. Christina Hee of Goldman Sachs covers Hyflux and Sinomem Technology. Jenny Ping of Goldman Sachs covers AWG, Kelda, Northumbrian Water, Pennon, Severn Trent, United Utilities, and Veolia Environnement. Deane Dray of Goldman Sachs covers Pentair. Robert Koort of Goldman Sachs covers Nalco Holding. The prices in the body of this report are based on the market close of July 21,2006. Gao Hua Securities acknowledges the role of Christopher Wong of Goldman Sachs and Ming Che of Gao Hua Securities in the preparation of this product. Goldman Sachs’ environmental, social and governance (ESG) research works to integrate ESG issues with industrial analysis and valuation on a sector-by-sector basis, and to identify investment opportunities related to carbon finance, alternative energy, and other emerging ESG issues. This area covers a wide range of topics from resource use and alternative energy to human resource management and business ethics to corporate governance and shareholder rights. We believe the terms sustainable investing, SRI (socially responsible investing), extra-financial issues, CSR (corporate social responsibility) and many other related concepts fall under the umbrella of ESG. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 3 Overview: Positive macro outlook from water reform Government is encouraging private sector investment We believe the current water shortage and pollution problems in China could create significant investment opportunities over the next few years. The problems include: Relatively short supply of water on a per capita basis. The amount of water consumed per unit of GDP is very high. The quality of water resources is deteriorating, in part because of pollution. Government is more focused on environmental issues. The Central Government has recognized the urgency and severity of this and is promoting greener GDP for the country. Foreign investment is being allowed in the water sector and the government seems willing to let tariff levels rise. We think this should improve sector returns and attract more investment. Additional funding can then be used to reduce wastage, improve metering systems and increase water and sewage treatment levels. China cannot afford to delay addressing the water problems. Years of neglect towards infrastructure maintenance and environmental protection has finally pushed the water shortage and pollution problem to dangerous levels. We, therefore, see good opportunities for operators and equipment providers while the system is being rehabilitated. Private investment in water has been increasing as the investment conditions are gradually improving. Tap water: Our preferred segment We think the tap water segment stands to benefit most from a greater level of commercialization of the sector. By increasing end user prices and the number and quality of water meters, the industry could help encourage consumers to use water more efficiently. In addition, if tap water companies have more money and earn higher returns, this will enable them to invest in reducing losses through non-revenue water (NRW). NRW represents water supplied by utilities for which they do not receive income because of issues including pipeline leakage, absence of billing, and theft. Additionally, we believe that demand for city water in the near- term should rise in line with rising wealth levels, growing urbanization and population density. Sewage treatment: Slow but steady growth We think rising sewage capacity and utilization rate will boost revenue for sewage treatment plants. Government support in the form of construction of pipes which collect and route sewage is needed to increase the utilization rates for sewage plants. However, although the Central Government has stipulated the importance of environmental protection, we see difficulties in implementation at the local level. Environmental protection often takes a back seat and is often at odds with the goal of faster economic growth. Indirect revenue collection adds to complications. Sewage companies do not usually charge the customer directly for sewage processed because the charges are often included in the consolidated water bill. Therefore, collection of receivables through government channels can sometimes be slow. Raw (untreated) water: Lacking major catalysts Mostly a transportation business from the water source to treatment plants. Vital as it may be as a public service, the raw water (untreated water from the source) business is a much lower value-added segment along the value chain for investors. Unlike tap water and sewage treatment segments, we see relatively little scope of improvement from demand-side management, tariff increases, and leakage reduction. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 4 Equipment: Leveraging the growth of utilities and industrials Deriving growth from the need for more and better water supply and treatment. We think equipment providers are key contributors for the improvement in China’s water infrastructure. We see rising demand for products such as treatment technology, pipeline construction materials, and meters. While international suppliers often seem to be preferred in China due to their higher quality, we see domestic providers catching up in time. Gao Hua/Goldman Sachs best buy ideas We believe: Shanghai Water (600649.SS, Neutral), with 16% potential upside to the 12-month DCF-based target price of Rmb6.0, should benefit from continued injection of tap water/sewage treatment assets from parent company. Guangdong Investment (0270.HK, Neutral), with 17% potential upside to the 12-month DCF-based target price of HK$3.5 has a defensive profile and steady cash flow. Sinomem (SINO.SI, Buy), with 40% potential upside to the 12-month SOTP-based target price of S$1.09, is misunderstood and undervalued. Valuation We think Chinese water utilities deserve a higher premium than US or European ones. We think there is more scope for regulatory changes and potential upside for pricing and volume in China than the more mature markets. We, however, recognize the inherent uncertainties of a developing market. Within the China segment, we think tap water could justify higher valuations compared with other water segments. We believe there are more potential upside surprises from tariff increases and NRW reduction in the tap water segment. Better valuations than independent power producers (IPPs) can also be justified. We believe in the near term there are more positive industry developments and a lower risk profile for the water sector. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 5 Exhibit 1: Plenty of profit opportunities for the utilities and equipment providers From water shortage to company profits Alleviating water shortage Water Conservation Environmental Protection Reduction in wastage Reduction in transmission losses Reduction in pollutant discharge Increase in sewage treatment Higher tariff Improved pipeline network Higher tariff Improved pipeline network Better meters Better meters Higher standards Higher capacity and utilization Civic education Deter pilferage Stricter enforcement Improved efficiency Benefits to water utilities / equipment providers Macro environment Solutions Higher revenue realization and profit margin Source: Gao Hua Securities Research, Goldman Sachs Research. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 6 Water shortage to lead to regulatory support for the sector China is very short of water on a per capita basis Disproportionately scarce water resources. With about 2,800bn cubic meters of water, China has one of the world’s largest water reserves. However, this amounts to only about 2,100 cubic meters per capita, about a quarter of world average (see Exhibit 2). Acute water shortage plagues China. During the 2006 Strategic Forum on Urban Water Sector in Beijing, it was reported that 400 cities out of about 660 lack sufficient water supply with 110 of them suffering serious shortages. Further, the situation in Northern China is worse than Southern China. For example, water resource per person in Northern China (including Beijing) stands at only about 700 cubic meters, well below the “danger” threshold of 1,000 cubic meters set by the United Nations. Exhibit 2: China is significantly short of water resources on a per capita basis 2006E per capita renewable water resources of selected countries 89,111 80,482 43,588 31,622 24,158 10,135 3,355 3,290 3,354 2,456 1,862 1,694 137 2,137 4,221 8,462 010,00020,00030,00040,00050,00060,00070,00080,00090,000 Canada New Zealand Brazil Russian Federation Australia United States World Mexico France Italy Japan United Kingdom China Germany India Singapore Per capita cubic meters of water China is only 1/4 of world average Source: World Resources Institute, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. Water that is available is increasingly polluted The government is getting increasingly concerned about water pollution levels. With a steadfast focus on economic growth in recent years, infrastructure needs (e.g. water and sewage distribution network and sewage treatment) have taken a back seat. However, as the society becomes more affluent and aware of the long-term consequences of pollution, the society has begun to focus more on this essential issue. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 7 We think sewage treatment companies can benefit from rising sewage and sludge treatment rates, expanding pipeline coverage, and increasing adoption of recycled water. However, we still believe the local government’s commitment to environmental protection may not be as strong as its commitment to economic growth. Nonetheless, reports of high-profile water contamination are raising the priority of environmental protection. According to government statistics,53% of rivers,50% of lakes, and 35% of aquifers are classified as polluted in China. In particular, the widely publicized Songhua River (in Heilongjiang province) water contamination has again rung the bell of urgency. After all, not only are water resources being increasingly polluted, the volume of sewage water also continues to rise. Water conservation is key to sustainable tap water supply In China, water wastage is high despite increasing water shortage. Many agricultural and manufacturing processes are plagued with inefficiencies ranging from leakage, and excessive and indiscriminate use of water which further exacerbates the scarcity problem. On average, it takes China about five times more water than the world average to produce the same amount of GDP (see Exhibit 3). We recognize the GDP components across the world could be quite different but believe the evidence of China’s inefficient use of water is strong. Exhibit 3: China uses more water than other industrialized nations on a per unit of GDP basis Water consumption (cu. m.) of selected countries 3,308 628 238200197171 390 521 0 500 1,000 1,500 2,000 2,500 3,000 3,500 China World average Canada United States Korea France Japan Germany Water consumption (cu. m.) per US$10,000 GDP Note: All data is as of 2005 except for China water consumption data which is as of 2003. Source: International Monetary Fund, UNESCO 2nd World Water Development Report, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 8 Rectifying tap water problems presents an investment opportunity Virtuous cycle: Higher tariffs, higher returns, more investments We think the government’s initiative to preserve China’s scarce water resources will require significant investment by both the public and private sectors. We believe the government’s commitments to increase water tariffs (particularly tap water tariffs) and attract external investments into the sector are constructive moves towards industry development. Higher water prices should improve company returns. Higher returns should also encourage companies to make further infrastructure investments, which should reduce wastage and losses. This should further enhance returns of current industry participants and attract newcomers, creating a virtuous circle, in our view (see Exhibit 4). Exhibit 4: Virtuous cycle of higher industry profits to be kicked off by higher tariffs higher tariffs more funding for eradicating leakage and pilferage higher industry profits more investment capital Source: Gao Hua Securities Research, Goldman Sachs Research. Tap water is our preferred segment in the water value chain. Exhibit 5 shows the key opportunities and challenges faced by different segments of the water value chain in China and the reasons for our preference for the tap water segment. We think a lot of the actions that can be taken to deal with the water shortage problems will likely be most effective when applied in the initial stages of reform to the tap water segment. Tap water segment represents the primary interface with the consumers of water, so issues of revenue collection, demand management and proper water metering can be addressed at this stage. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 9 Exhibit 5: We think tap water offers the most attractive opportunities now Opportunities and challenges facing the operators and equipment providers Raw Water Tap Water Sewage Treatment Equipment providers Comments Opportunities Tariff increase low high medium N/AHigher potential for tap water as it is the most important and primary interface for the public Volume increase medium medium high N/AGenerally rising with the economy; more scope for sewage as there is plenty of untreated sewage Leakage reduction low high N/A high Gradual pipe network upgrade and repair should boost operating margins Billing improvement low high low high More accurate metering and higher vigilance in billing to recoup lost revenue in the tap water business Efficiency increase low high high high Experienced operators to fix inefficient facilities; higher quality requirement drives equipment demand Foreign participation N/A medium medium high JVs with locals to bring in best practices and technological know-how Challenges Competition low medium medium high Bidding for new projects may keep returns in check; individual water projects are a natural monopoly Capital intensiveness high high high medium Pipeline requires significant investment, though mostly funded by the government Regulatory change medium high high low Tariff levels are mostly driven by government policy rather than pure market forces Revenue collection low low medium medium Lack of funding in local governments leads to high receivables for sewage treatment companies Operators Source: Gao Hua Securities Research, Goldman Sachs Research. Water prices have already started rising. As recently as this week, the China Business News reported that Guangdong province plans to raise its water resources fee (see Exhibit 6 for the different tariff charges). These fees generally belong to the government rather than the utilities. Earlier this year, the province raised its raw water prices also. As shown in Exhibit 7, tariff increases across China have been rising recently. We expect more to come—for example, we assume a 50% tariff increase in Shanghai starting at the end of this year. We think tariff levels across China should reach more economically-reasonable levels in the next two years. We, then, see much more modest and periodic increases mostly to offset inflation. Exhibit 6: We expect tap water prices to rise in China The four tariff components of a consolidated water bill Component Comments Resources Recognition of resource scarcity Tap water supply Sourcing, sanitization, and transmission of tap water Sewage treatment Sewage treatment and environmental protection Infrastructure Long-distance water transmission Source: Gao Hua Securities Research, Goldman Sachs Research. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 10 Exhibit 7: Significant tariff increases are gaining weight Selected urban tariff increases across China since 2003 0% 10% 20% 30% 40% 50% 60% La nz ho u Q in gd ao Q in hu an gd ao U lu m uq i Zh en gz ho u B ao ji H uh eh ao te B ei jin g Xi an N an jin g D on gg ua n S he nz he n H an gz ho u Ti an jin B ao di ng Y an zh ou Ji na n C he ng du Note: Current prices in these cities range from Rmb1.2/cu. m. in Dongguan to Rmb3.7/cu. m. in Beijing. Source: Shanghai Municipal Raw Water, Gao Hua Securities Research, and Goldman Sachs Research. Higher returns should encourage investments to reduce non-revenue water Non-revenue water represents unpaid services, and consists of two primary parts: leakage and unbilled water (see Exhibit 8). Exhibit 9 illustrates the NRW as a percentage of total water output from a tap water plant. To water companies and the government, NRW represents water for which expenses (purchase and/or treatment costs) have been incurred but no associated revenue is being earned on it. Exhibit 8: Technical and unbilled water losses What Why Technical - physically lost in the distribution - physical leakage from the old and ill-maintained pipe network Unbilled - unmeasured - inaccurate meters or no meters at all - unpaid (pilferage) - illegal connections, meter sabotage, and corruption Source: Gao Hua Securities Research, Goldman Sachs Research. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 11 Exhibit 9: Non-revenue water deprives China of 25% of potential total revenue Comparison of NRW across selected countries (%) 55% 44% 37% 25% 23% 10% 18% 0% 10% 20% 30% 40% 50% 60% India Philippines Malaysia China United Kingdom USAJapan Non-revenue water (%) Source: Best Water Technology, Public Services International Research Unit, UNEP-UNESCOYouth Xchange, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. Investing to improve revenue collection on water supplied The 4 “Ms” of water management. With better returns, water companies and the government should have more money to invest in reducing NRW, which should improve returns further, in our view. We think the best place to start tackling existing problems is in the provision of tap water to homes and businesses. If all homes and businesses have meters that accurately measure how much water is consumed and then pay a reasonable tariff for this water, then the amount of water wasted or not paid for should fall. Wasted and unpaid water represents a cost to the water company. See Exhibit 10 for details on what we call as the 4 “Ms” of water management. Exhibit 10: 4 ”Ms” of water management in tackling non-revenue water problem Measure Monitor Manage Monetize Benefits Accurate and timely data on production and consumption volume and water quality Intelligence on pipe leakage, waste, and pilferage Better water quality and service continuity; more informed investments on infrastructure Fuller billing system and improved revenue realization Means Meter installation and upgrade Implementation of data management system to improve detection and measure progress Data-based management; incentives for billing staff; tariffs that consider true costs Improved billing and collection enforcements; better civic education Source: Gao Hua Securities Research, Goldman Sachs Research. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 12 More sewage treatment needs to be encouraged We expect the sewage processing rate to rise. We estimate that the average sewage treatment ratio in cities now stands at around 40%, while that for counties at around 10%. Although treatment rates for major cities, such as Beijing and Tianjin, have reached around 70%, there are still plenty of less-developed areas with no sewage treatment at all. The government has set a national target of 60% sewage treatment ratio for cities by end-2010 (see Exhibit 11), with major cities reaching 80%, and 20% for rural areas with the most severe tap water shortages. The Ministry of Construction has said it plans to invest up to Rmb300bn in sewage treatment and recycling between 2006 and 2010. We, therefore, think that sewage treatment companies should benefit from rising volume processing levels. Exhibit 11: We expect sewage treatment rate to rise 2004 and 2010E statistics on sewage treatment in China 2010E City County Total Total Number of sewage plant 6611177781,300 Treatment capacity (mn cu. m./day) 49.12.751.9100.0 Treatment rate 46% 11% 44% 60% 2004 Note: 2010E number of sewage plants is based on a capacity assumption of no more than 100,000 cu. m. per plant. Source: Gao Hua Securities Research, Goldman Sachs Research. Expanded pipeline network construction should raise plant utilization rate. Since the construction of pipelines has not caught up with the sewage treatment plants, we estimate average utilization rate for the sewage treatment plants to be only around 60% across China. To fully leverage the rising number of sewage plants, we think the government will construct a new pipeline network to divert currently untreated sewage to these treatment plants. With higher utilization and economies of scale, profitability of these plants should improve. Recycled water could present an emerging solution. According to one study,30%-40% of industrial water is recycled in China, compared with 80% in developed countries. The government is also encouraging production and use of recycled water as a way to maximize scarce water resources. Our understanding is that the government plans to have recycled water volume reach 20% of total sewage treatment volume for water- deficient cities in Northern China by 2010. Much of this recycled water can be used in parks and recreational facilities, cooling systems for industrial processes, and non-drinkable uses in households. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 13 Equipment providers to grow with the operators Strong growth ahead. We expect the water treatment equipment market to grow strongly with rising demand for clean water. As returns for water utilities companies’ improve, we think they will be more willing to invest in more advanced water treatment systems. For example, although membrane bio-reactor (MBR) technology is more expensive than conventional treatment technology, it produces water that is bacteria-free and is more space-efficient. Additionally, we also expect companies supplying meters and pipeline infrastructure equipment and construction to benefit. However, there are not many significant listed names in this area yet in China. Leveraging the growth in both the public and private sectors. As per our Goldman Sachs analyst, companies such as Sinomem and Hyflux are providing water treatment solutions not only to the utilities but also to industrial users. Exhibit 12 compares the characteristics of the markets. Sinomem, though currently not in the water treatment market, is seeking to penetrate the Chinese municipal water market by selling its BIO- CEL membrane bioreactor (MBR). Exhibit 12: Industrial markets offer higher margins Comparison of the industrial and utilities market characteristics Industrial Utilities Net margin earned 15% - 20% 10% - 15% Treatment quality requirement Generally higher and more complex Relatively standardized Technological barrier to entry Higher Lower Source: Gao Hua Securities Research, Goldman Sachs Research. Intense competition in a fragmented market. Equipment providers, unlike the water utilities companies, are generally not subject to government-regulated returns. They, however, face greater competitive pressures. In the build-own-transfer (BOT) market for example, the industry is fragmented and competitive. For large projects, participants tend to be large corporations (e.g., General Electric, Degremont Suez) with the requisite financial capacity and track record. For small projects, the competition is intense, with numerous participants in this segment. Well-connected participants are better-positioned to source for contracts and while many contracts are open for bids; what is more crucial is who wins the better-margined, lower-risk ones. Foreign brands perceived to be of better quality. Even so, foreign companies still need to be relatively price competitive as the criteria for purchasing water treatment equipment is efficiency and cost. We think a medium-term risk for equipment suppliers is the protection of their intellectual property. Eventually, we believe that local competitors will likely close the technological gap with foreign product designs. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 14 Risks: Lack of transparency in tariff-setting and bidding schemes Expected tariff increases could come slower than expected Tariff increases are complicated by politics and misinformation. The government has long hesitated to raise tariffs substantially as social customs perceive water as a public good. Furthermore, the government also worries that higher tariffs could disrupt the stability of the agricultural sector and economic growth. We think that is not a strong argument as we think only around 1%-2% of disposable income is spent on residential water in China. This proportion is in-line with households in Latin America, Eastern Europe, and South Asia, and much lower than the 5% set by the World Bank. For example, China charges on average only a few cents per cubic meter of water for agricultural use; opponents to tariff increases argue that will create inflation. Regulatory regimes remain localized and often inconsistent Opaque tariff-setting and bidding process impairs investment opportunities. The operators are operating under a rough guideline of permitted ROE of 8% to 12%, especially when it comes to tariff negotiation. However, similar to the fuel-cost-pass-through mechanism in the power industry, it is extremely difficult to gauge the prospect of tariff increases based on this type of generic guideline. We believe the current processes of granting operating rights are not homogeneous across China. This has become an impediment to raising funds for projects. However, we think the central government is working on standardization and establishing more regulations for these processes. Execution risks facing the operators Diversification into projects of different types across regions is a demanding task for management. In an effort to develop market share and asset growth, many utilities opt for operating in both the tap water and sewage treatment businesses across China. Inability to turnaround inefficient plants may present as earnings downside risk. Securing appropriate tariff levels, reducing operating costs and NRW are critical to operators. Any miscalculation in the bidding processes for BOT (build-operate-transfer) and TOT (transfer-operate-transfer) bidding terms could be detrimental to long-term profitability. Utilities to lessen their reliance on government subsidies. With the momentum in market reform and tariff increases, many utilities are re-negotiating their water business models (focus on tariffs and volumes) with governments. This may present short-term earnings and cash flow volatility, in our view. Competition for projects has intensified Operators may choose market share over profits in an environment of increasing competitive bidding. Traditionally, water utilities are run by local governments and enjoy regional monopoly. However, to improve market transparency, plant operational efficiency, and minimize financial risks, local governments are increasingly using competitive bidding to grant third parties operating rights for their tap water and sewage treatment plants. However, in an effort to showcase their technical capability and increase market share, some companies seem willing to sacrifice profits and returns in order to secure new projects. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 15 Valuation: Higher reform potential deserves a premium Higher valuation for Chinese water utilities Higher valuation for the China market vs. mature markets reflects higher upside potential from market development. We believe currently, opaque regulations, poor enforcement, and inadequate infrastructure offer more profit opportunities compared with foreign water utilities albeit with higher levels of risks. The “developing” nature of the sector could lead to more potential earnings upside through efficiency gains, pricing changes and higher rates of growth compared to water utilities in developed markets. Limited investable Chinese A-shares could also create a scarcity premium, in our view. Currently, on a return-adjusted analysis, Chinese utilities are trading at a premium to global peers within the coverage of Gao Hua Securities and Goldman Sachs (see Exhibit 13). However, we observe that the P/E of Chinese utilities are falling as earnings improve in the near future (see Exhibit 14). Exhibit 13: A-share Chinese water companies seem to command higher valuation EV/GCI vs. CROCI/WACC for Chinese, European, and US operators and equipment providers Veolia Kelda NorthumbrianPennon Severn Trent Tianjin Capital Shanghai Municipal Beijing Capital Guangdong Investment Sinomem Hyflux Pentair Nalco United Utilities AWG y = 0.83x + 0.01 R2 = 0.63 0 1 2 3 4 5 012345 CROCI/WACC EV/GCI Source: Datastream, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 16 Exhibit 14: 2007EP/E of Chinese water utilities are lower than global peers Financial summary of global water companies Avg. daily Market trading vol. GSPricing Price cap (US$ mn) Ticker rating Currency 21-Jul-06 (US$mn) 3-mos 20052006E 2007E 20052006E 2007E Water utilities Asia-Pacific Asia-Pacific average 20.9 21.9 14.7 China China average 28.329.215.3 Guangdong Investment 270 HKNeutral HKD 3.00 2,324 3.63 0.23 0.23 0.25 13.2 13.3 12.1 Beijing Capital 600008 SSNeutral RMB 4.74 1,306 14.21 0.22 0.20 0.24 21.7 24.0 19.5 Shanghai Municipal Raw Water 600649 SSNeutral RMB 5.17 1,221 8.82 0.20 0.22 0.27 25.8 23.4 19.2 Tianjin Capital Environmental Protection 1065 HKNeutral HKD 1.82 536 0.40 0.13 0.17 0.19 14.7 11.0 9.6 NWSHoldings 659 HKNCHKD 15.15 3,746 1.95 1.62 0.91 1.29 9.4 16.6 11.7 China Water Affairs 855 HKNCHKD 2.05 219 5.08 (0.07) 0.02 0.10 NA 102.5 21.6 Qianjiang Water Resources 600283 SSNCRMB 5.88 210 1.36 0.08 NANA 73.5 NANA Nanhai Development 600323 SSNCRMB 7.55 197 1.93 0.37 0.55 0.57 20.4 13.9 13.3 Wuhan Sanzhen Industry 600168 SSNCRMB 3.47 192 1.72 0.10 NANA 34.7 NANA Eguard Resources Development 000826 SZNCRMB 6.70 152 3.61 0.16 NANA 43.2 NANA Jiangxi Hongcheng 600461 SSNCRMB 5.09 89 1.80 0.20 NANA 26.1 NANA Malaysia Malaysia average 10.4 12.6 15.7 Puncak Niaga Holding BHDPNHMKNCMYR 2.51 317 0.32 0.22 0.26 0.28 11.6 9.6 9.1 Taliworks Corp Bhd CIMKNCMYR 1.73 174 1.16 0.13 0.13 0.11 13.8 13.4 15.2 PBAHoldings BHDPBAHMKNCMYR 1.33 120 0.03 0.11 NANA 11.8 NANA Ranhill Utilities Bhd RANUMKNCMYR 1.21 97 0.04 0.27 NANA 4.5 NANA Intan Utilities BHDINTUMKNCMYR 1.92 50 0.00 0.19 0.13 0.08 10.2 14.9 22.9 Aliran Ihsan Resources Bhd AIRBMKNCMYR 0.59 34 0.00 (0.00) NANANANANA Salcon Bhd SALCMKNCMYR 0.52 30 0.04 (0.14) NANANANANA Philippines Manila Water MWCPMNCPHP 7.60 289 0.55 0.94 1.00 0.74 8.1 7.6 10.3 Thailand Eastern Water Resources EASTWTBNCTHB 5.05 176 0.21 0.39 0.39 0.42 12.9 13.0 11.9 Europe Europe average 19.917.717.3 France France average 19.3 18.8 16.5 Suez SZEFPNCEUR 31.30 50,354 286.25 2.39 1.96 2.21 13.1 16.0 14.2 Veolia Environnement VIEFPNeutral EUR 40.65 21,043 110.95 1.60 1.88 2.17 25.5 21.6 18.7 United Kingdom UK average 20.1 17.3 17.5 United Utilities UU/ LNSell GBP 643.00 10,381 70.29 46.65 41.89 46.24 13.8 15.3 13.9 Severn Trent SVTLNNeutral GBP 1,232.00 7,920 61.51 53.23 79.76 70.98 23.1 15.4 17.4 Kelda KELLNNeutral GBP 850.00 5,886 43.47 49.06 47.73 53.51 17.3 17.8 15.9 AWGAWGLNNeutral GBP 1,280.00 3,359 21.62 47.94 76.51 48.13 26.6 16.7 26.5 Pennon PNNLNNeutral GBP 1,435.00 3,163 20.21 54.14 59.62 80.43 26.5 24.1 17.8 Northumbrian Water NWGLNSell GBP 252.00 2,429 10.22 19.07 17.64 18.47 13.2 14.3 13.6 United States US average 29.624.921.8 Pentair PNRUSNeutral USD 30.30 3,081 19.47 1.80 2.08 2.35 16.8 14.6 12.9 Aqua America WTRUSNCUSD 21.57 2,834 17.49 0.71 0.75 0.85 30.4 28.9 25.5 Nalco Holding NLCUNNeutral USD 16.65 2,379 8.65 0.46 0.70 1.00 36.3 23.8 16.6 California Water Service Grp CWTUSNCUSD 35.12 646 2.68 1.35 1.65 1.77 26.0 21.3 19.9 SJWrp SJWUSNCUSD 25.07 458 1.05 1.12 NANA 22.4 NANA Southwest Water SWWCUSNCUSD 12.23 277 2.20 0.34 0.38 0.45 36.0 32.2 27.0 Middlesex Water MSEXUSNCUSD 17.70 205 0.89 0.71 0.74 0.77 24.9 23.9 23.0 York Water YORWUSNCUSD 26.58 185 0.12 0.84 0.90 0.97 31.6 29.5 27.4 Connecticut Water Svc CTWSUSNCUSD 22.16 182 0.80 0.89 NANA 24.9 NANA Pennichuckrp PNNWUSNCUSD 18.50 78 0.09 0.55 NANA 33.6 NANA BIWLtd BIWUSNCUSD 16.80 28 0.01 0.39 NANA 43.1 NANA (local currency) P/E (X) EPS Note: Outlier values are excluded from the calculation of averages. Estimates for companies not under coverage are based on consensus data from I/B/E/S. Source: Bloomberg, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 17 Exhibit 15 illustrates the valuation comparison among global peers for water utilities and equipment providers, respectively. Exhibit 15: 2005 P/E of Chinese water utilities are in-line with Asia-Pacific peers Financial summary of Asia-pacific water equipment providers Avg. daily Market trading vol. GSPricing Price cap (US$ mn) Ticker rating Currency 21-Jul-06 (US$mn) 3-mos 20052006E 2007E 20052006E 2007E Water equipment providers Asia-Pacific Asia-Pacific average 13.2 14.7 11.2 China China average 13.0 NANA Science City Development 000975 SZNCRMB 3.78 252 2.63 0.12 NANA 31.2 NANA Tianye Water 8280 HKNCHKD 2.00 134 0.67 0.17 NANA 11.8 NANA Asia Environment Holdings AENVSPNCSGD 0.30 53 0.24 0.11 NANA 13.8 NANA Shanghai Young Sun Investment 900935 SSNCRMB 0.36 83 0.36 0.14 NANA 2.6 NANA China Evergreen Environment CEECUSNCUSD 0.23 31 0.01 0.04 NANA 5.8 NANA Malaysia Brite-Tech Bhd BTECMKNCMYR 0.44 18 0.00 0.00 NANANANANA Singapore Singapore average 13.4 14.7 11.2 Hyflux Ltd HYFSPNeutral SGD 2.12 691 2.03 0.09 0.09 0.12 23.0 24.4 17.7 Sinomem Technology SINOSPBuy SGD 0.78 227 0.62 0.06 0.05 0.08 13.6 14.3 9.5 Bio-Treat Technology BIOTSPNCSGD 1.15 638 2.17 0.39 0.42 0.49 14.9 13.7 11.7 United Envirotech UENVSPNCSGD 0.33 57 0.05 0.02 0.05 0.06 17.1 6.5 5.7 Asia Water Technology AWTSPNCSGD 0.73 84 0.11 0.31 NANA 11.9 NANA Darco Water Technologies DWTSPNCSGD 0.29 34 0.09 0.03 NANA 9.4 NANA Dayen Environmental DAYENSPNCSGD 0.40 17 0.06 0.03 NANA 11.8 NANA Pan Asian Water Solutions PAWSSPNCSGD 0.09 7 0.00 0.02 NANA 5.3 NANA Eco Water ECOSPNCSGD 0.06 4 0.01 (0.04) NANANANANA EPS (local currency) P/E (X) Note: Outlier values are excluded from the calculation of averages. Estimates for companies not under coverage are based on consensus data from I/B/E/S. Source: Bloomberg, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. We value tap water the highest and raw water the lowest We think tap water warrants higher valuation than other water segments. We believe there are more potential upside surprises from tariff increases and NRW reduction in tap water. Therefore, it is reasonable for the tap water business to command a premium valuation to the raw water and sewage businesses. The raw water business likely deserves a slightly lower valuation, given its reliable but lower earnings growth opportunities, in our view. We like Shanghai Municipal Raw Water the most among our coverage universe of Chinese water utilities in terms of fundamental development. It is divesting all its raw water assets to its parent in exchange for further tap water assets (and to a lesser extent sewage). Water deserves higher valuation than power in the near term We see many attractive characteristics in the water segment that are absent in the IPPs. Eventually, key characteristics of the water sector may be stable return as stipulated by the government—a staple of utilities. However, in the near-term, we think the sector is poised to transition from being inefficient and bureaucratic to more profitable and transparent. On the other hand, IPPs (independent power producers) are in a cyclical downturn, so we think the water sector deserves a higher multiple. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 18 Exhibit 16: Water sector looks more appealing in the near term than power sector Comparison across operational metrics Water Power Comments Organic growth from demand project-based We expect water utilities to benefit more from regional demand growth due to higher natural monopoly Rising tariffs XGenerally, much larger degree for water utilities; IPPs not likely to see further increases soon Falling raw material costs XWe expect unit coal prices for IPPs to continue to fall Rising utilization rate cyclical IPPs are burdened with concerns on falling utilization rates in the near term Declining losses (leakage/self-use rate) XWe see limited reduction in self-use rate for IPPs Natural monopoly: Existing capacity X Future capacity X IPPs could face competitions from nearby new plants Source: Gao Hua Securities Research, Goldman Sachs Research. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 19 Company snapshots The following section provides snapshots for the four Chinese water utilities (under Gao Hua Securities coverage) and two equipment providers (under Goldman Sachs coverage). Exhibit 16 provides a valuation summary for these six stocks. Our preferred names in the sectors are: Shanghai Water (600649.SS, Neutral), with 16% potential upside to the 12-month DCF-based target price of Rmb6.0, should benefit from continued injection of tap water/sewage treatment assets. Guangdong Investment (0270.HK, Neutral), with 17% potential upside to the 12-month DCF-based target price of HK$3.5 has a defensive profile and steady cash flow. Sinomem (SINO.SI, Buy), with 40% potential upside to the 12-month SOTP-based target price of S$1.09, is misunderstood and undervalued. Exhibit 17: Water utilities are trading at a premium to equipment manufacturers with coverage by GH and GS Valuation summary of utilities and equipment manufacturers in the China water market Market Price 12-month Ticker Stock rating cap (US$bn) Local currency 21-Jul-06 target price 20052006E 2007E 2008E 20052006E 2007E 2008E Utilities Guangdong Investment 0270.HKNeutral 2.32 HKD 3.003.5013.213.312.111.73.03.13.43.5 Beijing Capital 600008.SSNeutral 1.31 CNY 4.745.4021.724.019.517.43.82.93.64.0 Shanghai Raw Water 600649.SSNeutral 1.22 CNY 5.176.0025.823.419.216.31.92.12.63.1 Tianjin Capital 1065.HKNeutral 0.54 HKD 1.822.1014.410.79.48.52.12.83.23.5 Equipment Sinomem SINOSPBuy 0.23 HKD 0.781.0913.614.39.59.01.21.31.42.1 Hyflux HYFSPNeutral 0.69 HKD 2.122.5023.024.417.715.10.40.60.60.8 3.94% 19.73% 62.03% 1 mth 3 mth 12 mth 1 mth 3 mth 12 mth 20052006E 2007E 2008ECROCI (%) ROA (%) ROE (%) P/B (X) Utilities Guangdong Investment 12.1 (12.4) 27.72.9 (4.5) (3.5) 0.230.230.250.2629.74.511.41.5 Beijing Capital (4.0) 10.051.0 (7.9) (6.7) (7.4) 0.220.200.240.2719.04.89.42.2 Shanghai Raw Water 3.618.37.9 (0.3) (1.4) (54.1) 0.200.220.270.329.65.56.71.5 Tianjin Capital 11.7 (6.2) (27.2) 2.11.5 (46.9) 0.130.170.190.2210.34.69.51.0 Equipment Sinomem 1.3 (23.5) 20.0 (0.5) (16.0) 17.00.060.050.080.0930.313.016.12.2 Hyflux (6.6) (22.3) (38.4) (8.3) (14.7) (39.9) 0.090.090.120.1438.28.821.34.7 Reported P/E (X) Dividend yield (%) Absolute Relative EPS 2006E Source: Datastream, Gao Hua Securities Research estimates, and Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 20 Shanghai Municipal Raw Water (600649.SS, Rmb5.17, Neutral): Asset injections create new catalysts Shanghai Municipal Raw Water is becoming the flagship water utilities company in Shanghai. By the end of 2006, we expect the company to no longer engage in the raw water business but focus on the tap water and sewage treatment businesses which should offer more value-added opportunities for shareholders. We also believe the company will begin to invest outside Shanghai. Exhibit 18: Shanghai Municipal Raw Water financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart52-week range (CNY) 4 -6.1 Absolute (%) 1.015.74.4 Yield (%) 2.1 Rel to Index (%) (2.7) (1.7) (57.7) SHANGHAISECOMPOSITE - PRIC 1,655.1 Capitalization Forecasts/valuation 2006E 2007E Market cap CNY (mn) EPS 0.220.27 Latest net debt / (cash) (bn) 83.4 P/E (X) 23.419.2 Free float (%) 29.8 ROE (%) 6.77.9 Derivatives EV/EBITDA (X) 14.410.7 Shares outstanding (mn) 1,884 9,742 0 1 2 3 4 5 6 7 JAONJFMMJ -0.4 -0.35 -0.3 -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1Abs. price performance (left scale)Rel. to Index (right scale) Note: Sudden drop in company share price on April 14 due to non-tradable share reform. Source: Company data, Datastream, and Gao Hua Securities Research estimates. Investment summary We maintain our Neutral rating but are becoming more positive on the stock as it offers the best exposure, within our coverage universe, to asset and earnings growth in the near term. We think further injection of tap water and sewage treatment assets is positive for fundamentals. It recently announced its second asset swap (expected around October) with Shanghai Chengtou (parent company). Although current P/E is not low, we recognize the potential for ROE and profit growth. Earnings drivers Tariff increases should drive earnings near term. With the tap water asset injections in progress, the key earnings driver near term will be a tariff increase, which we assume will be 50% yoy in late 2006. We also assume a very gradual reduction in non-revenue water from the current average of 25% to further boost earnings. Injections of sewage treatment businesses, which we expect may come later in 2007, could also benefit from increases in tariffs and utilization rates. Risks to the investment case Regulatory risks: Lower-than-expected or delayed tariff increases and/or lower-than-expected tap water and sewage treatment volumes. Execution risks: Earnings volatility due to unforeseen costs from current and future asset swaps, and lower- than-expected profitability from expansion projects beyond Shanghai. Valuation The stock is trading at a 16% discount to our DCF-based 12-month target price to Rmb6.00. We think there is upside risk to our valuation should any future asset injections turn out to be more earnings accretive than we expect. The shares are trading at 19X 2007E earnings, which is at the high end within our coverage universe. We think this is attributable to the positive investor sentiment towards the asset injections. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 21 Exhibit 19: Shanghai Municipal Raw Water summary financials In Rmb millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008E Total revenue 1,010.61,011.71,484.31,668.7 Cash & equivalents 921.5936.3720.4982.9 Cost of goods sold (366.1) (359.6) (582.2) (620.3) Accounts receivables 243.1184.5270.6304.2 SG&A (28.3) (69.6) (128.1) (116.8) Inventory 22.7164.0335.0320.7 R&D 0.00.00.00.0 Other current assets 424.4200.0200.0200.0 Other operating profit / (expenses) 2.199.9180.8116.0 Total current assets 1,611.61,484.81,525.91,807.9 EBITDA 618.3682.5954.81,047.6 Total investments 837.2778.4719.6660.7 Depreciation & amortization (233.0) (241.1) (290.7) (318.4) Intangible assets 183.9180.0176.0172.1 EBIT 385.3441.4664.1729.2 Net fixed assets 3,906.16,100.96,130.85,893.1 Interest income 5.911.714.615.0 Other long term assets 0.00.00.00.0 Finance charges (7.9) (14.3) (35.9) (43.0) Total assets 6,538.98,544.18,552.38,533.7 Associate income (14.0) 0.00.00.0 Accounts payables 10.019.731.934.0 Others 78.175.175.175.1 Short-term loans 200.0405.9448.7339.0 Pretax profits 447.4513.9717.8776.3 Other current liabilities 262.31,209.3763.5763.5 Income tax (70.3) (96.8) (210.0) (177.7) Total current liabilities 472.31,635.01,244.11,136.5 Minorities 0.00.00.00.0 Long-term loans 0.0613.8713.6457.7 Other long term liabilities 0.00.00.00.0 Net income pre preferred dividends 377.1417.1507.8598.6 Total long term liabilities 0.0613.8713.6457.7 Preferred dividends 0.00.00.00.0 Total liabilities 472.32,248.81,957.61,594.2 Net profits 377.1417.1507.8598.6 Share capital & share premium 3,963.63,963.63,963.63,963.6 Post tax exceptionals 0.00.00.00.0 Other reserves 2,103.02,331.72,631.12,975.9 Net income 377.1417.1507.8598.6 Total common equity 6,066.66,295.36,594.76,939.5 Minority interests 0.00.00.00.0 EPS (weighted average) 0.200.220.270.32 Total liabilities and equity 6,538.98,544.18,552.38,533.7 EPS (post-exceptionals) 0.200.220.270.32 BVPS 3.223.343.503.68 EPS (fully diluted) 0.200.220.270.32 DPS 0.100.110.130.16 Ratios Dividend payout ratio (%) 50.050.050.050.0 ROE (%) 6.46.77.98.8 Free cash flow yield (%) 2.7 (7.0) (2.3) 8.2 ROA (%) 5.95.55.97.0 ROACE (%) 7.37.27.89.0 Growth and margins Inventory days 21.194.8156.4192.9 Sales growth (%) 4.00.146.712.4 Receivables days 66.577.156.062.9 EBITDA growth (%) (5.4) 10.439.99.7 Payables days 13.215.116.219.4 EBIT growth (%) (4.4) 14.650.49.8 Net debt / equity (%) Net cash 1.36.7 Net cash Net income growth (%) (13.0) 10.621.817.9 Interest cover - EBIT (X) 193.2169.731.226.1 EPS growth (%) (13.0) 10.621.817.9 Gross margin (%) 63.864.560.862.8 VALUATION 20052006E 2007E 2008E EBIT margin (%) 38.143.644.743.7 P/E (analyst) (X) 25.823.419.216.3 EBITDA margin (%) 61.267.564.362.8 P/B (X) 1.61.51.51.4 Net margin (%) 37.341.234.235.9 EV/EBITDA (X) 14.514.410.79.1 Dividend yield (%) 1.92.12.63.1 Cash flow analysis 20052006E 2007E 2008E Additional metrics Net income pre preferred dividends 377.1417.1507.8598.6 Power generation (kWh) -- -- -- -- DD&A add back 233.0241.1290.7318.4 Power attributable capacity (MW) -- -- -- -- Minority interests add back 0.00.00.00.0 Weighted-avg power tariffs (CNY / kWh) -- -- -- -- Net (inc)/dec working capital (44.3) 1,098.4 (690.8) (17.3) Unit fuel costs (CNY / kWh) -- -- -- -- Others (55.9) (21.6) (33.8) (19.5) Utilization rate (%) -- -- -- -- Net cash flow from operations 510.01735.074.0880.1 Reserve margin (%) -- -- -- -- Gas sales volume (gas unit) -- -- -- -- Capital expenditures (249.7) (6,739.6) (282.9) (57.2) Weighted-avg gas tariffs (CNY / gas unit) -- -- -- -- Net (inc)/dec investments 0.00.00.00.0 Unit gas costs (CNY / gas unit) -- -- -- -- Net (inc)/dec other assets 1.64,329.20.00.0 Tap water tariffs (CNY/ ton) -- 1.551.701.87 Others 57.858.858.858.8 Tap water capacity (000 ton) -- 3,3303,4143,497 Net cash flows from investments (190.2) (2351.5) (224.1) 1.7 Tap water sales volume (mn ton) -- 912948986 Sewage processing tariffs (CNY / ton) 0.420.420.460.46 Dividends (188.4) (188.4) (208.4) (253.8) Sewage processing capacity (000 ton) -- -- -- -- Debt drawdown (repayments) 100.0819.8142.5 (365.5) Sewage processing volume (mn ton) 670584584584 Common stock issuance 0.00.00.00.0 Others (6.8) 0.00.00.0 Net cash flows from financing (95.3) 631.3 (65.9) (619.2) Net inc/(dec) in cash 224.514.9 (216.0) 262.6 Note: Last actual year may include reported and estimated data Note: All values in CNY millions, except for per share values Source: Gao Hua Securities Research estimates Source: Company data, Gao Hua Securities Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 22 Guangdong Investment (0270.HK, HK$3.00, Neutral): Steady and strong cash flow Industry cash cow. After the 2000 acquisition of the Dongshen water assets (raw water sales to Hong Kong, Dongguan and Shenzhen) and subsequent divestiture of several non-core businesses (e.g., brewing, tanning, malting, and tours), Guangdong Investment (GDI) has transformed itself into a raw water utilities company. We think non-water assets will not drive earnings growth, given the relatively large scale of the water assets. Exhibit 20: Guangdong Investment financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart52-week range (HKD) 2 -3.7 Absolute (%) 8.9 (10.3) 34.1 Yield (%) 3.1 Rel to Index (%) 1.1 (4.5) (0.7) MSCIChina 35.8 Capitalization Forecasts/valuation 2006E 2007E Market cap HKD (mn) EPS 0.230.25 Latest net debt / (cash) (bn) 9,616.4 P/E (X) 13.312.1 Free float (%) 37.4 ROE (%) 11.411.7 Derivatives EV/EBITDA (X) 8.37.6 Shares outstanding (mn) 6,018 18,053 0 0.5 1 1.5 2 2.5 3 3.5 4 JAONJFMMJ -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25Abs. price performance (left scale)Rel. to Index (right scale) Source: Company data, Datastream, and Gao Hua Securities Research estimates. Investment summary We like the GDI’s attractive valuations and defensive profile. The company’s strong and steady cash flow lends its balance sheet strength, giving it financial flexibility for possible acquisitions in the water sector and, to a lesser extent, in the toll road and property areas. Although we like the growth in Guangdong province water sales, we think steady earnings from other segments still mute its impact. However, Hong Kong water sales are not benefiting from the momentum of rising tariffs in China. Earnings drivers Steady sales to Hong Kong (77% of 2006E water revenue) are a cash cow, but earnings growth for the rest of the decade are likely to come from water supplied to the Shenzhen and Dongguan areas within the existing business through increases in tariffs and volumes. PRC volume growth should eventually drive capacity growth. We assume 8% yoy growth in raw water demand in Shenzhen and Dongguan until 2010, reflecting general growth of the economy. For sales to Hong Kong, we think the need for capacity expansion is unlikely in the foreseeable future. Risks to the investment case Regulatory risks: Lower-than-expected or delayed tariff increases, lower-than-expected Guangdong government subsidies associated with sales to Hong Kong, and/or lower-than-expected tap water volumes in Shenzhen and Dongguan. Execution risks: Higher non-cash earnings volatility due to interest rate swaps, sooner-than-expected expiry of preferential tax rates, and EPS dilution from possible exercise of employee stock options. Valuation Our 12-month DCF-based target price of Rmb3.50 implies 17% potential upside. The shares are trading at 12X 2007E earnings, below the peer average of the four water companies in our coverage. We think GDI shares are best for investors who prefer a defensive profile with participation in long-term water sector growth. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 23 Exhibit 21: Guangdong Investment summary financials In HK$ millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008ETotal revenue 5,249.25,386.65,593.35,717.8 Cash & equivalents 2,114.01,536.52,122.12,308.5 Cost of goods sold (1,868.6) (2,055.9) (2,140.5) (2,229.2) Accounts receivables 288.3236.2245.3250.8 SG& A 0.00.00.00.0 Inventory 49.151.053.155.3 R& D 0.00.00.00.0 Other current assets 230.0230.0230.0230.0 Other operating profit / (expenses) 0.00.00.00.0 Total current assets 2,681.52,053.82,650.52,844.5 EBITDA 3,380.63,330.63,452.73,488.5 Total investments 1,447.71,483.61,519.51,554.8 Depreciation & amortization (1,052.7) (1,055.2) (1,067.9) (1,100.1) Intangible assets 12,287.711,705.411,123.110,540.8 EBIT 2,327.92,275.52,384.92,388.4 Net fixed assets 7,722.87,896.28,036.08,354.3 Interest income 49.918.327.433.2 Other long term assets 6,409.36,265.86,122.35,978.8 Finance charges (754.1) (560.6) (496.6) (436.6) Total assets 30,549.129,404.829,451.429,273.2 Associate income 104.4108.9112.2113.9 Accounts payables 132.1135.5141.1147.0 Others 0.00.00.00.0 Short-term loans 45.7557.6512.5456.5 Pretax profits 1,728.21,842.02,027.92,098.9 Other current liabilities 1,667.01,725.11,753.01,763.7 Income tax (218.2) (276.3) (304.2) (314.8) Total current liabilities 1,844.82,418.32,406.62,367.1 Minorities (206.5) (211.5) (232.9) (240.8) Long-term loans 13,110.810,595.29,736.88,672.8 Other long term liabilities 2,512.52,394.32,276.12,157.9 Net income pre preferred dividends 1,303.51,354.21,490.81,543.3 Total long term liabilities 15,623.312,989.612,012.910,830.8 Preferred dividends 0.00.00.00.0 Total liabilities 17,468.115,407.914,419.513,197.9 Net profits 1,303.51,354.21,490.81,543.3 Share capital & share premium 3,008.83,008.83,008.83,008.8 Post tax exceptionals 0.00.00.00.0 Other reserves 8,469.59,277.210,184.911,104.1 Net income 1,303.51,354.21,490.81,543.3 Total common equity 11,478.312,285.913,193.714,112.9 Minority interests 1,602.71,711.01,838.21,962.5 EPS (weighted average) 0.230.230.250.26 Total liabilities and equity 30,549.129,404.829,451.429,273.2 EPS (post-exceptionals) 0.230.230.250.26 BVPS 1.912.042.192.35 EPS (fully diluted) 0.220.220.240.25 DPS 0.090.090.100.11 Ratios Dividend payout ratio (%) 39.741.241.241.2 ROE (%) 12.111.411.711.3 Free cash flow yield (%) (15.6) 10.811.310.6 ROA (%) 4.34.55.15.3 ROACE (%) 8.78.59.19.2 Growth and margins Inventory days 9.18.98.98.9 Sales growth (%) 2.72.63.82.2 Receivables days 16.017.815.715.8 EBITDA growth (%) 9.4 (1.5) 3.71.0 Payables days 24.123.823.623.6 EBIT growth (%) 16.6 (2.3) 4.80.1 Net debt / equity (%) 84.468.754.142.4 Net income growth (%) 13.43.910.13.5 Interest cover - EBIT (X) 3.34.25.15.9 EPS growth (%) 10.5 (0.8) 10.13.5 Gross margin (%) 64.461.861.761.0 VALUATION 20052006E 2007E 2008E EBIT margin (%) 44.342.242.641.8 P/ E (analyst) (X) 13.213.312.111.7 EBITDA margin (%) 64.461.861.761.0 P/ B (X) 1.61.51.41.3 Net margin (%) 24.825.126.727.0 EV/ EBITDA (X) 7.58.37.67.1 Dividend yield (%) 3.03.13.43.5 Cash flow analysis 20052006E 2007E 2008E Additional metrics Net income pre preferred dividends 1,303.51,354.21,490.81,543.3 Power generation (kWh) DD& A add back 1,052.7997.31,010.01,042.2 Power attributable capacity (MW) Minority interests add back 206.5211.5232.9240.8 Weighted-average power tariffs (HKD / kWh) Net (inc)/ dec working capital 100.1111.722.38.8 Unit fuel costs (HKD / kWh) Others 642.9 (0.0) (0.0) (9.1) Utilization rate (%) Net cash flow from operations 3305.72674.72756.02825.9 Reserve margin (%) Gas sales volume (gas unit) Capital expenditures (260.2) (588.3) (567.4) (769.0) Weighted-average gas tariffs (HKD / gas unit) Net (inc)/ dec investments 0.00.00.00.0 Unit gas costs (HKD / gas unit) Net (inc)/ dec other assets 4.90.00.00.0 HK raw water tariffs (HKD/ ton) 3.093.093.093.09 Others (765.0) 107.7107.6108.2 HK raw water volume (mn tons) 820820820820 Net cash flows from investments ( 1020.3) ( 480.6) ( 459.8) ( 660.8) China raw water tariffs (HKD / ton) 0.540.570.630.63 China raw water volume (mn tons) 1,2251,3231,4291,543 Dividends (432.7) (546.6) (583.0) (624.1) Total capacity (000 tons) 6,6386,6386,6386,638 Debt drawdown (repayments) (1,080.5) (2,121.8) (1,021.8) (1,238.2) Common stock issuance 110.40.00.00.0 Others (844.9) (103.3) (105.8) (116.5) Net cash flows from financing ( 2,247.6) ( 2,771.6) ( 1,710.6) ( 1,978.8) Net inc/ ( dec) in cash 56.0 ( 577.5) 585.6186.4 Note: Last actual year may include reported and estimated data Not e: All values in HKD m illions, excep t f or per share values Source: Gao Hua Secu rit ies Research est im at es Source: Company data, Gao Hua Securities Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 24 Tianjin Capital (1065.HK, HK$1.82, Neutral): Turning over a new leaf Improving fundamentals in 2006. Headquartered and dominant in Tianjin, Tianjin Capital is investing beyond Tianjin for future earnings growth. Building on its roots in sewage treatment, the company’s new projects outside Tianjin now include tap water plants. Though it may present a long-term opportunity, its recycling business is still small and unprofitable and will likely remain so in the near term. Exhibit 22: Tianjin Capital financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart52-week range (HKD) 2 -2.7 Absolute (%) 6.7 (9.3) (29.6) Yield (%) 2.8 Rel to Index (%) (1.1) (3.4) (64.4) MSCIChina 35.8 Capitalization Forecasts/valuation 2006E 2007E Market cap HKD (mn) EPS 0.170.20 Latest net debt / (cash) (bn) 2,015.8 P/E (X) 10.79.4 Free float (%) 40.1 ROE (%) 9.59.8 Derivatives EV/EBITDA (X) 15.612.5 Shares outstanding (mn) 340 4,170 0 0.5 1 1.5 2 2.5 3 JAONJFMMJ -0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1Abs. price performance (left scale)Rel. to Index (right scale) Source: Company data, Datastream, and Gao Hua Securities Research estimates. Investment summary We would be more positive on the shares if the company's long-term earnings growth is more assured. We are becoming more confident of the earnings improvement as many of the new Tianjin plants are collecting revenue now after repeated delays. Also, we think management could boost investor confidence by delineating its long-term expansion strategy. Earnings drivers The sewage water processing interim service agreement finalized in May is a positive. We now assume the interim agreement will enable revenue to be earned by the company's new plants for the whole of 2006 (except for Beicang which could still be starting in 2H2006). This is sooner than our previous assumption of a start from mid-year. We think this additional revenue will more than offset the loss of construction revenue. However, we remain watchful for possible unforeseen cost increases for new plants in their initial operations. Risks to the investment case Regulatory risks: Eventual resolution of the Tianjin franchise application may spell downside risk to Tianjin’s sewage tariffs, with lower-than-expected or delayed tariff increases in projects outside Tianjin, and/or lower- than-expected volumes in tap water and sewage treatment. Execution risks: Earnings volatility due to the significant number of new projects, the low profitability threshold required for new projects outside Tianjin, and/or unexpected (and further) delays to the commissioning of new plants. Valuation Target price of HK$2.10 implies a 15% potential upside. The shares are trading at 9X 2007E earnings; the lowest within our Chinese water utilities coverage. We attribute this to a lack of clarity in strategy and overhang in the franchise application progress (tariff). However, we believe A shareholders do not share this level of concern as the A shares are trading at 19X 2007 EPS. This valuation is, nonetheless, in-line with those of other A-share water companies such as Beijing Capital and Shanghai Raw Water. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 25 Exhibit 23: Tianjin Capital summary financials In Rmb millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008ETotal revenue 611.8809.2998.01,075.2 Cash & equivalents 753.3495.0564.0511.2 Cost of goods sold (115.6) (194.2) (252.0) (281.1) Accounts receivables 67.8110.9136.7147.3 SG& A (56.9) (78.1) (81.7) (84.4) Inventory 11.814.819.221.4 R& D 0.00.00.00.0 Other current assets 25.925.925.925.9 Other operating profit / (expenses) (23.1) (33.2) (42.9) (46.8) Total current assets 858.8646.5745.8705.8 EBITDA 416.2503.8621.5662.8 Total investments 99.497.194.992.6 Depreciation & amortization (70.9) (89.2) (130.8) (163.9) Intangible assets 0.00.00.00.0 EBIT 345.4414.6490.7499.0 Net fixed assets 2,430.73,312.93,628.23,798.8 Interest income 8.89.710.911.1 Other long term assets 1,156.91,141.51,126.01,110.6 Finance charges (94.2) (85.8) (125.1) (133.3) Total assets 4,545.95,198.05,594.95,707.8 Associate income 0.00.00.00.0 Accounts payables 8.414.118.320.5 Others 0.00.00.00.0 Short-term loans 749.31,072.41,158.81,129.0 Pretax profits 260.0338.4376.5376.7 Other current liabilities 266.8285.0297.3269.4 Income tax (84.3) (109.8) (122.1) (94.2) Total current liabilities 1,024.51,371.51,474.51,418.8 Minorities 1.8 (3.3) (6.1) (7.1) Long-term loans 1,185.11,310.71,416.31,379.9 Other long term liabilities 5.75.75.75.7 Net income pre preferred dividends 177.5225.4248.3275.4 Total long term liabilities 1,190.81,316.41,422.01,385.6 Preferred dividends 0.00.00.00.0 Total liabilities 2,215.42,687.92,896.52,804.4 Net profits 177.5225.4248.3275.4 Share capital & share premium 1,405.81,405.81,405.81,405.8 Post tax exceptionals 0.00.00.00.0 Other reserves 875.51,047.71,228.41,429.3 Net income 177.5225.4248.3275.4 Total common equity 2,281.42,453.52,634.22,835.1 Minority interests 49.156.664.268.3 EPS (weighted average) (HKD) 0.130.170.190.22 Total liabilities and equity 4,545.95,198.05,594.95,707.8 EPS (post-exceptionals) 0.130.170.190.21 BVPS ( HKD) 1.651.922.062.22 EPS (fully diluted) 0.130.160.180.20 DPS (HKD) 0.040.050.060.06 Ratios Dividend payout ratio (%) 30.030.030.030.0 ROE (%) 7.99.59.810.1 Free cash flow yield (%) (4.8) (16.4) (3.1) (0.0) ROA (%) 3.94.64.64.9 ROACE (%) 6.87.17.37.8 Growth and margins Inventory days 27.825.024.626.4 Sales growth (%) (19.0) 32.323.37.7 Receivables days 137.740.345.348.2 EBITDA growth (%) (26.8) 25.127.36.6 Payables days 26.621.223.525.2 EBIT growth (%) (32.4) 24.122.11.7 Net debt / equity (%) 50.775.274.568.8 Net income growth (%) (45.1) 27.010.210.9 Interest cover - EBIT (X) 4.05.44.34.1 EPS growth (%) (44.7) 33.714.610.9 Gross margin (%) 81.176.074.873.9 VALUATION 20052006E 2007E 2008E EBIT margin (%) 56.553.052.549.5 P/ E (analyst) (X) 14.410.79.48.5 EBITDA margin (%) 68.062.362.361.6 P/ B (X) 1.11.00.90.9 Net margin (%) 29.027.924.925.6 EV/ EBITDA (X) 20.715.612.511.7 Dividend yield (%) 2.12.83.23.5 Cash flow analysis 20052006E 2007E 2008E Additional metrics Net income pre preferred dividends 177.5225.4248.3275.4 Power generation (kWh) DD& A add back 70.989.2130.8163.9 Power attributable capacity (MW) Minority interests add back (1.8) 3.36.17.1 Weighted-average power tariffs (CNY / kWh) Net (inc)/ dec working capital (227.1) (22.1) (13.7) (38.7) Unit fuel costs (CNY / kWh) Others 77.8 (26.8) (17.4) (14.1) Utilization rate (%) Net cash flow from operations 97.2268.9354.1393.7 Reserve margin (%) Gas sales volume (gas unit) Capital expenditures (322.2) (926.9) (411.0) (302.7) Weighted-average gas tariffs (CNY / gas unit) Net (inc)/ dec investments 0.00.00.00.0 Unit gas costs (CNY / gas unit) Net (inc)/ dec other assets 0.40.00.00.0 Tap water tariffs (CNY/ ton) Others 392.60.00.00.0 Tap water capacity (000 tons) Net cash flows from investments 70.7 ( 926.9) ( 411.0) ( 302.7) Tap water volume (mn tons) Sewage tariffs (CNY / ton) 1.931.931.931.93 Dividends (133.2) (53.2) (67.6) (74.5) Sewage capacity (000 tons) 4221,4401,4901,490 Debt drawdown (repayments) (113.9) 448.6192.1 (66.2) Sewage volume (mn tons) 131321350367 Common stock issuance 0.00.00.00.0 Others (95.4) 4.21.5 (3.1) Net cash flows from financing ( 342.5) 399.6126.0 ( 143.8) Net inc/ ( dec) in cash ( 174.6) ( 258.3) 69.1 ( 52.8) Note: Last actual year may include reported and estimated data Not e: All values in CNY m illions, excep t f or per share values Source: Gao Hua Secu rit ies Research est im at es Source: Company data, Gao Hua Securities Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 26 Beijing Capital (600008.SS, Rmb4.74, Neutral): To double capacity by 2010 Capitalizing on China water market growth. Headquartered in Beijing, Beijing Capital has tap and sewage water capacity spanning seven provinces. It is focused on transforming itself into a leading water company in China. In just five years, the company has managed to build its tap and sewage water business from scratch, starting with the acquisition of Beijing Gaobeidian Sewage Treatment Plant in 2001. It is committed to doubling its daily capacity to 15 mn cu. m. by the end of 2010. Exhibit 24: Beijing Capital financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart52-week range (CNY) 4 -6.5 Absolute (%) (4.8) 1.19.5 Yield (%) 2.9 Rel to Index (%) (8.5) (16.3) (52.6) SHANGHAISECOMPOSITE - PRIC 1,655.1 Capitalization Forecasts/valuation 2006E 2007E Market cap CNY (mn) EPS 0.200.24 Latest net debt / (cash) (bn) 3,340.5 P/E (X) 24.319.7 Free float (%) 35.5 ROE (%) 9.311.2 Derivatives EV/EBITDA (X) 17.112.3 Shares outstanding (mn) 2,200 10,428 0 1 2 3 4 5 6 7 JAONJFMMJ -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3Abs. price performance (left scale)Rel. to Index (right scale) Note: Sudden drop in company share price on April 19 due to non-tradable share reform. Source: Company data, Datastream, and Gao Hua Securities Research estimates. Investment summary Growing with the sector. We think Beijing Capital is well positioned to grow strongly in the medium term, supported by rising tariffs and volumes. Rising tap water and sewage tariffs will likely drive near-term earnings growth. Increasing sewage treatment volumes in Beijing should benefit the company near term. Reduction in NRW should be a key earnings driver from 2008. Steady subsidies provide key support for earnings and cash flow but not profit growth. Earnings drivers Water tariff increase has a compounding effect. A key strategy for the company is to secure greater pricing power for its projects, enabling it to take fuller advantage of any tariff increases approved by the government. We expect a 1% change in the average 2006E tariff to produce a corresponding 1% change in our 2006E EPS estimate and a 2% increase in our net present value per share estimate. Aggressive reduction in non-revenue tap water starting in 2008 should propel earnings growth. Management says it will begin seriously tackling NRW beginning 2008. We assume average NRW to fall by 12 percentage points over 2008-2010, resulting in about 40% earnings growth over the period. We have assumed associated capex for pipeline network upgrades and meter installation. Risks to the investment case Regulatory risks: Lower-than-expected or delayed tariff increases, loss of government subsidies, and/or lower-than-expected volumes in tap water and sewage treatment. Execution risks: Earnings volatility due to a significant number of new projects, higher-than-expected tax rates, and a possible cut in consensus EPS estimates which may depress the share price near term. Valuation Our 12-month DCF-based target price of Rmb5.40 implies 14% potential upside. The shares are trading at 20X 2007E earnings; this is in-line with other A-share peers. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 27 Exhibit 25: Beijing Capital summary financials In Rmb millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008ETotal revenue 470.91,158.41,835.72,481.8 Cash & equivalents 1,439.3762.91,011.7768.1 Cost of goods sold (137.5) (371.5) (586.5) (884.3) Accounts receivables 30.858.692.8125.5 SG& A (158.9) (260.8) (345.7) (450.8) Inventory 30.362.298.1147.9 R& D 0.00.00.00.0 Other current assets 323.1329.9329.9329.9 Other operating profit / (expenses) 429.7280.2274.3268.5 Total current assets 1,823.51,213.61,532.51,371.4 EBITDA 604.2806.31,177.81,415.2 Total investments 4,106.04,114.84,126.64,136.1 Depreciation & amortization (94.4) (261.2) (357.9) (444.4) Intangible assets 103.9100.396.793.1 EBIT 509.8545.1819.9970.8 Net fixed assets 2,340.14,364.55,616.86,735.9 Interest income 13.511.79.49.4 Other long term assets (0.0) (0.0) 0.00.0 Finance charges (140.1) (154.7) (227.5) (300.1) Total assets 8,373.59,793.111,372.612,336.5 Associate income 133.782.254.554.5 Accounts payables 51.591.2144.0217.1 Others 9.4 (3.0) (3.0) (3.0) Short-term loans 1,527.91,718.11,877.4940.6 Pretax profits 526.3481.3653.2731.6 Other current liabilities 380.7204.0258.1265.4 Income tax (40.9) (45.0) (99.1) (106.5) Total current liabilities 1,960.12,013.32,279.41,423.1 Minorities (3.9) (7.1) (24.7) (33.2) Long-term loans 1,617.72,385.33,136.04,434.1 Other long term liabilities 24.724.724.724.7 Net income pre preferred dividends 481.5429.1529.4592.0 Total long term liabilities 1,642.42,410.03,160.84,458.8 Preferred dividends 0.00.00.00.0 Total liabilities 3,602.54,423.45,440.25,881.9 Net profits 481.5429.1529.4592.0 Share capital & share premium 3,805.03,805.03,805.03,805.0 Post tax exceptionals 0.00.00.00.0 Other reserves 792.3825.21,054.21,275.7 Net income 481.5429.1529.4592.0 Total common equity 4,597.34,630.24,859.25,080.6 Minority interests 173.6739.51,073.11,373.9 EPS (weighted average) 0.220.200.240.27 Total liabilities and equity 8,373.59,793.111,372.612,336.5 EPS (post-exceptionals) 0.220.200.240.27 BVPS 2.092.102.212.31 EPS (fully diluted) 0.220.200.240.27 DPS 0.180.140.170.19 Ratios Dividend payout ratio (%) 82.270.070.070.0 ROE (%) 10.99.311.211.9 Free cash flow yield (%) 1.1 (18.1) (7.8) (6.8) ROA (%) 6.24.75.05.0 ROACE (%) 9.97.17.68.0 Growth and margins Inventory days 61.145.449.950.8 Sales growth (%) 50.6146.058.535.2 Receivables days 18.514.115.016.1 EBITDA growth (%) 8.233.446.120.2 Payables days 89.670.173.274.5 EBIT growth (%) 2.26.950.418.4 Net debt / equity (%) 35.862.267.571.4 Net income growth (%) (1.8) (10.9) 23.411.8 Interest cover - EBIT (X) 4.03.83.83.3 EPS growth (%) (1.8) (10.9) 23.411.8 Gross margin (%) 70.867.968.164.4 VALUATION 20052006E 2007E 2008E EBIT margin (%) 108.347.144.739.1 P/ E (analyst) (X) 21.724.319.717.6 EBITDA margin (%) 128.369.664.257.0 P/ B (X) 2.32.32.12.1 Net margin (%) 102.337.028.823.9 EV/ EBITDA (X) 15.717.112.310.6 Dividend yield (%) 3.82.93.64.0 Cash flow analysis 20052006E 2007E 2008E Additional metrics Net income pre preferred dividends 481.5429.1529.4592.0 Power generation (kWh) DD& A add back 94.4261.2357.9444.4 Power attributable capacity (MW) Minority interests add back 3.97.124.733.2 Weighted-average power tariffs (CNY / kWh) Net (inc)/ dec working capital (4.2) (203.5) 36.6 (2.0) Unit fuel costs (CNY / kWh) Others (14.5) (0.8) (0.0) 0.0 Utilization rate (%) Net cash flow from operations 561.1493.1948.61067.5 Reserve margin (%) Gas sales volume (gas unit) Capital expenditures (349.0) (2,701.3) (1,606.6) (1,559.9) Weighted-average gas tariffs (CNY / gas unit) Net (inc)/ dec investments 0.00.00.00.0 Unit gas costs (CNY / gas unit) Net (inc)/ dec other assets 0.4420.00.00.0 Tap water tariffs (CNY/ ton) 1.231.481.631.63 Others 107.7 (8.8) (11.8) (9.5) Tap water capacity (000 tons) 1,7402,3204,3206,320 Net cash flows from investments ( 240.9) ( 2290.1) ( 1618.4) ( 1569.4) Tap water volume (mn tons) 2513946531,111 Sewage tariffs (CNY / ton) 0.721.221.471.47 Dividends (132.0) (396.0) (300.4) (370.6) Sewage capacity (000 tons) 1002,2002,2002,200 Debt drawdown (repayments) 272.5957.9910.0361.3 Sewage volume (mn tons) 26425597627 Common stock issuance 0.00.00.00.0 Others (123.6) 558.7308.9267.6 Net cash flows from financing 16.91,120.6918.6258.4 Net inc/ ( dec) in cash 335.8 ( 676.4) 248.7 ( 243.6) Note: Last actual year may include reported and estimated data Not e: All values in CNY m illions, excep t f or per share values Source: Gao Hua Secu rit ies Research est im at es Source: Company data, Gao Hua Securities Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 28 Sinomem (SINO.SI, S$0.78, Buy): Misunderstood and undervalued Sinomem Technology is a China-based membrane filtration specialist that focuses on the industrial filtration market i.e., in designing and installing membrane-based separation, concentration, and purification solutions for various industries, with a special niche in the pharmaceutical industry. It is an integrated filtration specialist, with a 50% stake in Microdyn-Nadir (M-N). Our Goldman Sachs analyst thinks this is the most valuable part of the supply chain given its high technology content. Exhibit 26: Sinomem financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart 52-week range (SGD) 1.05 -0.65 Absolute (%) 1.3 (23.5) 20.0 Yield (%) 1.3 Rel to Index (%) (0.5) (16.0) 17.0 SINGAPORESTRAITSTIMESINDEX 2,371 Capitalization Forecasts/valuation 2006E 2007E Market cap SGD (mn) EPS 0.050.08 Latest net debt / (cash) (mn) (76.3) P/E (X) 14.39.5 Free float (%) 30.0 ROE (%) 16.120.7 Derivatives EV/EBITDA (X) 9.25.9 Shares outstanding (mn) 461.8 360 0 0.2 0.4 0.6 0.8 1 1.2 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5Abs. price performance (left scale)Rel. to Index (right scale) Source: Company data, Datastream, and Goldman Sachs Research estimates. Investment summary Deserves higher valuation. The market tends to compare Sinomem with the other Singapore water-related companies. However, its superior technology should deserve higher valuation. Misunderstood and not widely followed. This may be due to limited investor relations personnel and publicity. Its small size and limited free float escapes the attention of most fund managers. Sinomem’s changing business model is under-appreciated. In 2005, Sinomem ventured upstream into the attractive membrane manufacturing business and downstream into the nutriceutical business. Earnings drivers Healthy replacement or expansion capex drives demand for membrane systems. We conservatively forecast membrane system sales to grow at 12.5% in 2006E and 10% in 2007E and 2008E (up from 6% in 2004 and about 10% in 2005) on healthy fixed-asset investment growth in China. Volumes and prices drive nutriceutical sales. We assume Sinomem’s new gibberellin (150-200 tonnes) and xanthan gum (8,000-15,000 tonnes) plants to start in stages by the end of 2007. We also assume prices to fall by 15% in 2006E as Sinomem enters the competition. We think average margins will decline as the proportion of nutriceutical sales increase. We expect sales contribution from nutriceutical to rise to 50% in 2007 from 25% in 2006. However, net profit margins in the nutriceutical business (15%-20%) are half those in the filtration business (30%-40%). Risks to the investment case Slower-than-expected operational and financial improvements at M-N and knowledge transfer to M-NChina; smaller-than-expected market share, and higher-than-expected costs. Valuation 12-month SOTP-based target price of S$1.09 implies 40% potential upside. The shares are trading at 10X 2007E earnings, which is more attractively priced than Hyflux. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 29 Exhibit 27: Sinomem summary financials In SGD millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008E Total revenue 81 91 150 192 96 76 52 93 22 18 41 34 Cost of goods sold (49) (56) (94) (121) 6 5 12 10 SG&A (6) (11) (18) (22) 9 10 19 17 R&D (2) (2) (2) (3) 133 109 124 154 Other operating profit / (expenses) — — — — 28 44 54 59 EBITDA 26 28 48 60 — — — — Depreciation & amortization (2) (6) (11) (14) 16 56 93 104 EBIT 24 22 37 46 — — — — Interest income 1 1 1 1 178 209 271 316 Finance charges — — — — Associate income — 5 6 5 8 13 23 23 Others 2 — — — 6 — — — Pretax profits 27 28 43 52 12 20 35 38 Income tax (2) (2) (2) (7) 27 33 58 61 Minorities (2) (1) (4) (5) — — — — Net income pre preferred dividends 24 25 38 40 1 5 5 10 Preferred dividends — — — — 1 5 5 10 Net profits 24 25 38 40 28 38 63 71 Post tax exceptionals — — — — Net income 24 25 38 40 91 91 91 91 55 76 108 141 EPS (weighted average) 0.06 0.05 0.08 0.09 146 166 199 232 EPS (fully diluted) 0.05 0.05 0.08 0.09 4 5 9 14 DPS — 0.01 0.01 0.02 178 209 271 316 Dividend payout ratio (%) 16.8 18.9 13.4 18.8 0.32 0.36 0.43 0.50 Free cash flow yield (%) (11.5) (5.8) (8.6) 13.0 Growth and margins Sales growth (%) 55.9 11.6 65.6 27.4 20.9 16.1 20.7 18.7 EBITDA growth (%) 39.2 7.6 69.2 25.1 16.2 13.0 15.7 13.7 EBIT growth (%) 34.6 (8.9) 64.6 26.1 25.7 13.4 20.4 19.3 Net income growth (%) 11.2 5.7 49.8 6.4 34.7 34.5 32.3 32.7 EPS growth (%) 7.0 (4.9) 49.8 6.4 82.8 81.1 71.3 71.5 Gross margin (%) 39.9 38.6 37.8 37.1 69.9 69.5 70.6 70.1 EBIT margin (%) 30.1 24.6 24.4 24.2 Net cash Net cash Net cash Net cash EBITDA margin (%) 32.5 31.3 32.0 31.5 NMNMNMNM Net margin (%) 29.3 27.7 25.1 21.0 Key earnings assumptions 20052006E 2007E 2008ECash flow analysis 20052006E 2007E 2008E Revenue breakdown: 24 25 38 40 Filtration (%) 50.5 51.0 34.5 30.3 2 6 11 14 Nutriceuticals (%) 25.2 24.2 46.2 52.4 2 1 4 5 Others (%) 24.3 23.3 15.0 12.6 (13) 16 (14) 14 (3) (5) (6) 0 Nutriceutical business 12 43 33 73 Gibberellin Sales volume (tonne) 72.8 90.0 150.0 150.0 (4) (46) (48) (25) ASP (RMB mn/tonne) 1.40 1.20 1.10 1.10 (21) (6) (4) — — — — — Xanthan gum 3 — — — Sales volume ('000 tonne) — — 510 (22) (52) (52) (25) ASP (RMB/tonne) — — 34,00032,000 (4) (5) (5) (8) 6 (6) — — 43 — — — (4) — — — 41 (11) (5) (8) 31 (19) (24) 41 Cash & equivalents Accounts receivables Inventory Other current assets Total current assets Total investments Intangible assets Net fixed assets Other long term assets Total assets Accounts payables Short-term loans Other current liabilities Total current liabilities Long-term loans Other long term liabilities Total long term liabilities Total liabilities Share capital & share premium Other reserves Total common equity Minority interests Total liabilities and equity Book value per share Ratios ROE (%) ROA (%) ROIC (%) Inventory days Receivables days Payables days Net debt / equity (%) Interest cover - EBIT (X) Net income pre preferred dividends DD&A add back Minority interests add back Net (inc)/dec working capital Others Net cash flow from operations Capital expenditures Net (inc)/dec investments Net (inc)/dec other assets Others Net cash flows from investments Dividends Debt drawdown (repayments) Common stock issuance Others Net cash flows from financing Net inc/(dec) in cash Source: Company data, Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 30 Hyflux (HYFL.SI, S$2.12, Neutral): Modest upside to risk-adjusted return Hyflux is involved in the design, fabrication, installation, operation and maintenance of water and wastewater treatment systems (using membrane filtration technology) for municipal authorities. Hyflux is adopting an asset light strategy by securitizing its BOT projects, through selling a partial stake to investors or via the establishment of a business trust. It will, however, take Hyflux a couple of years to build up the requisite portfolio of assets for a business trust. Exhibit 28: Hyflux financial snapshot Stock Data Price performance 1M 3M 12 MPrice perfomance chart 52-week range (SGD) 3.92 -2.05 Absolute (%) (6.6) (22.3) (38.4) Yield (%) 0.6 Rel to Index (%) (8.3) (14.7) (39.9) SINGAPORESTRAITSTIMESINDEX 2,371 Capitalization Forecasts/valuation 2006E 2007E Market cap SGD (mn) EPS 0.090.12 Latest net debt / (cash) (mn) (12.7) P/E (X) 24.417.7 Free float (%) 55.8 ROE (%) 21.323.9 Shares outstanding (mn) 515.9 EV/EBITDA (X) 19.013.0 1,094 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2Abs. price performance (left scale)Rel. to Index (right scale) Source: Company data, Datastream, and Goldman Sachs Research estimates. Investment summary With 18% potential share price upside, the Hyflux stock is inexpensive post the recent market sell-off and should see limited downside, in the view of our Goldman Sachs analyst. However, we think that the upside is modest relative to its risks. While Hyflux is in the right sector (i.e., the water treatment market) at the right time, we caution that the industry is competitive, financing requirements can be substantial, and project risks are high. Earnings drivers Strong long-term demand for water and wastewater treatment. The greatest increase in demand is expected to come from Asia (especially China and India). Growth in orderbook. Order activity can be lumpy. The award of contracts is dependent on pricing, the bidder’s track record, its ability to obtain financing, and its relationship with (potential) customers. Healthy replacement or expansion capex. Industry sources estimate that the US$550 mn Chinese membrane market will grow at about 15% per year for the next three to five years. Volumes and tariffs drive BOT revenues. Most of Hyflux’s BOT projects are structured on a take-or-pay basis—as such, utilization rates are meaningful only above a certain threshold. Risks to the investment case Operational risks: Tariff increases are driven by government decisions rather than market forces; unforeseen and unfavorable project progress (e.g. contract revisions or cancellation, cost overruns); lackluster new order activity. We highlight that a strong earnings quarter can nevertheless receive a tepid investor response if new order activity is lackluster. Valuation 12-month SOTP-based target price of S$2.50 SOTP value implies 18% potential upside. The shares are trading at 18X 2007E earnings. (Note that we have adjusted our EPS estimates for accounting changes for 2006E so as to be comparable against historical EPS.). July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 31 Exhibit 29: Hyflux summary financials In SGD millions, except for per share values Profit model 20052006E 2007E 2008EBalance sheet 20052006E 2007E 2008E Total revenue 132 221 324 401 96 271 156 34 31 66 58 72 Cost of goods sold (70) (115) (171) (209) 11 11 16 20 SG&A (36) (57) (81) (101) 107 82 98 106 R&D — — — — 246 430 329 231 Other operating profit / (expenses) (1) (1) — — 13 3 4 4 EBITDA 29 56 87 113 21 20 19 19 Depreciation & amortization (4) (8) (15) (23) 107 20 40 59 EBIT 25 48 72 90 3 152 283 459 Interest income 3 6 7 3 390 626 675 772 Finance charges (3) (10) (13) (11) Associate income (0) — 1 1 52 98 120 146 Others 25 2 — — 2 48 17 17 Pretax profits 50 47 67 83 34 37 57 82 Income tax (1) (1) (4) (10) 87 182 193 245 Minorities (3) (1) (1) (1) 105 211 194 177 Net income pre preferred dividends 46 45 62 72 0 — — — Preferred dividends — — — — 106 211 194 177 Net profits 46 45 62 72 193 393 387 423 Post tax exceptionals — — — — Net income 46 45 62 72 89 91 91 91 Net income (adjusted) 46 40 52 57 100 141 196 259 189 231 286 349 EPS (adjusted) 0.09 0.08 0.10 0.11 8 2 2 0 EPS (weighted average) 0.09 0.09 0.12 0.14 390 626 675 772 EPS (fully diluted) 0.09 0.08 0.11 0.13 0.37 0.45 0.55 0.68 DPS 0.01 0.01 0.01 0.02 Dividend payout ratio (%) 9.3 15.5 10.9 12.8 Free cash flow yield (%) (3.2) 2.4 (6.3) (9.9) 30.6 21.3 23.9 22.8 Growth and margins 13.3 8.8 9.5 10.0 Sales growth (%) 48.4 68.2 46.5 23.6 10.4 16.9 14.5 16.8 EBITDA growth (%) (12.3) 91.0 55.1 30.2 42.6 35.2 29.1 31.6 EBIT growth (%) (15.8) 91.7 49.9 24.9 87.7 80.4 70.2 59.4 Net income growth (%) 72.9 (3.3) 37.8 17.4 226.7 237.3 231.9 232.2 EPS growth (%) 61.9 (5.8) 37.8 17.4 5.6 Net cash 19.1 46.0 Gross margin (%) 47.2 48.1 47.2 47.8 NM 14.0 12.6 11.5 EBIT margin (%) 19.1 21.8 22.3 22.5 EBITDA margin (%) 22.3 25.3 26.8 28.2 Net margin (%) 35.2 20.2 19.0 18.1 Key earnings assumptions 20052006E 2007E 2008ECash flow analysis 20052006E 2007E 2008E Revenue breakdown (%) 46 45 62 72 EPC 97 93 92 89 4 8 15 23 BOT 2 7 6 10 3 1 1 1 Others 1 1 1 1 (5) 61 22 17 (22) 1 5 8 Orderbook 465 375 NANA 27 116 104 121 % yoy 99 (19) NANA (82) (59) (167) (220) Est. volume treated (mn m3) NM 21 45 75 — (27) — — % yoy NANA 115 65 12 — — — 12 — — — (57) (87) (167) (220) (4) (7) (7) (9) 29 152 (48) (17) 39 1 2 3 2 — — — 66 146 (52) (23) 35 175 (115) (123) Cash & equivalents Accounts receivables Inventory Other current assets Total current assets Total investments Intangible assets Net fixed assets Other long term assets Total assets Accounts payables Short-term loans Other current liabilities Total current liabilities Long-term loans Other long term liabilities Total long term liabilities Total liabilities Share capital & share premium Other reserves Total common equity Minority interests Total liabilities and equity Book value per share Ratios ROE (%) ROA (%) ROIC (%) Inventory days Receivables days Payables days Net debt / equity (%) Interest cover - EBIT (X) Net income pre preferred dividends DD&A add back Minority interests add back Net (inc)/dec working capital Others Net cash flow from operations Capital expenditures Net (inc)/dec investments Net (inc)/dec other assets Others Net cash flows from investments Dividends Debt drawdown (repayments) Common stock issuance Others Net cash flows from financing Net inc/(dec) in cash Source: Company data, Goldman Sachs Research estimates. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 32 RegAC I, Franklin Chow, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Investment profile The Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region's coverage universe. The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows: Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends. Quantum Quantum is Goldman Sachs proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets. Disclosures Coverage group(s) of stocks by primary analyst(s) Franklin Chow, CFA: China Utilities. China Utilities: Beijing Capital, GDPower Development, Guangdong Electric, Guangdong Investment, Shanghai Municipal Raw Water, Shenergy, Tianjin Capital. Company-specific regulatory disclosures The following disclosures relate to relationships between Goldman Sachs Gao Hua Securities Company Limited ("Goldman Sachs Gao Hua") and companies covered by the Investment Research Division of Beijing Gao Hua Securities Company Limited ("Gao Hua Securities") and referred to in this research. There are no company-specific disclosures for: Beijing Capital (Rmb4.84), Guangdong Investment (HK$2.98), Hyflux (S$2.14), Kelda (850.00p), Nalco Holding Company ($16.65), Northumbrian Water Group (252.00p), Pennon (1,435.00p), Pentair, Inc. ($30.30), Severn Trent (1,232.00p), Shanghai Municipal Raw Water (Rmb5.25), Sinomem Technology (S$0.78), Tianjin Capital (HK$1.78) and Veolia Environnement (€40.65) Ratings, coverage groups and views and related definitions Buy (B), Neutral (N), Sell (S) -Analysts recommend stocks as Buys or Sells for inclusion on various regional Investment Lists. Being assigned a Buy or Sell on an Investment List is determined by a stock's return potential relative to its coverage group as described below. Any stock not assigned as a Buy or a Sell on an Investment List is deemed Neutral. Each regional Investment Review Committee manages various regional Investment Lists to a global guideline of 25%-35% of stocks as Buy and 10%-15% of stocks as Sell; however, the distribution of Buys and Sells in any particular coverage group may vary as determined by the regional Investment Review Committee. Regional Conviction Buy and Sell lists represent investment recommendations focused on either the size of the potential return or the likelihood of the realization of the return. Return potential represents the price differential between the current share price and the price target expected during the time horizon associated with the price target. Price targets are required for all covered stocks. The return potential, price target and associated time horizon are stated in each report adding or reiterating an Investment List membership. Coverage groups and views: A list of all stocks in each coverage group is available by primary analyst, stock and coverage group at . The analyst assigns one of the following coverage views which represents the analyst's investment outlook on the coverage group relative to the group's historical fundamentals and/or valuation. Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. July 25,2006 China: Utilities: Water Gao Hua Securities Investment Research 33 Not Rated (NR). The investment rating and target price, if any, have been removed pursuant to Gao Hua Securities policy when Goldman Sachs Gao Hua is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS). We have suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). We have suspended coverage of this company. Not Covered (NC). We do not cover this company. Not Available or Not Applicable (NA). The information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded. Ratings, coverage views and related definitions prior to June 26,2006 Our rating system requires that analysts rank order the stocks in their coverage groups and assign one of three investment ratings (see definitions below) within a ratings distribution guideline of no more than 25% of the stocks should be rated Outperform and no fewer than 10% rated Underperform. The analyst assigns one of three coverage views (see definitions below), which represents the analyst's investment outlook on the coverage group relative to the group's historical fundamentals and valuation. Each coverage group, listing all stocks covered in that group, is available by primary analyst, stock and coverage group at . Definitions Outperform (OP). We expect this stock to outperform the median total return for the analyst's coverage universe over the next 12 months. In-Line (IL). We expect this stock to perform in line with the median total return for the analyst's coverage universe over the next 12 months. Underperform (U). We expect this stock to underperform the median total return for the analyst's coverage universe over the next 12 months. Coverage views: Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. Current Investment List (CIL). We expect stocks on this list to provide an absolute total return of approximately 15%-20% over the next 12 months. We only assign this designation to stocks rated Outperform. We require a 12-month price target for stocks with this designation. Each stock on the CIL will automatically come off the list after 90 days unless renewed by the covering analyst and the relevant Regional Investment Review Committee. General disclosures This research is disseminated in China by Gao Hua Securities. This research is for our clients only. This research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Other than some industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's judgment. Goldman Sachs Gao Hua, an affiliate of Gao Hua Securities, conducts an investment banking business. Gao Hua Securities, Goldman Sachs Gao Hua and their affiliates have investment banking and other business relationships with a substantial percentage of the companies referred to in this document. Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. Gao Hua Securities and its affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research. This research is not an offer to sell or the solicitation of an offer to buy any security where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments. Copyright 2006 Beijing Gao Hua Securities Company Limited No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Beijing Gao Hua Securities Company Limited.

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