CEE’s share price suffered in the past two years on lacklustre REF payment and concerns of deteriorating local government fiscals. As new project construction slows down, CEE’s profitability is moving closer to actual figure as IFRIC 12’s accounting impact wanes. The company is on track to report its first positive FCF in history this year, strengthening its balance sheet and dividend payout capability, if not willingness. We upgrade CEE from HOLD to BUY rating with a new TP of HK$4.50, implying 5.4% 2024 dividend yield.
　　Key Factors for Rating
　　Operations update. Mgmt. sees the worst situation in 2022-23 has passed and receivable days for waste treatment fees are within budget YTD. The company aims to add 3,000tpd waste-to-energy (WTE) project and 255ktpd waste water treatment (WWT) in 2024, representing 2.2% and 4.6% YoY growth respectively. The slowing expansion caps CEE’s capex at c.HK$6bn in 2024, with adjusted OCF on track to exceed HK$8bn. CEE may achieve its first positive FCF since inception (2023: -HK$280m FCF). The robust cash flow may help CEE to gradually replenish its balance sheet (140% adjusted net gearing at end-2023) while comfortably maintaining current payout ratio (30-32%), if not raising it at some point of time in the absence of major M&A.
　　Continued cost savings from refinancing offshore loans. CEE’s finance expenses have peaked in the last two years, and may start to decline in the coming years as 1) capex slows down; 2) active refinancing activities are carried out. According to the management, the company has refinanced most of its offshore HK$/USD borrowing to either onshore or offshore RMB. With onshore borrowing generally costing between 2.7-2.8% p.a., the active management should help to achieve further savings in 2024, in our view.
　　Dividend yield offering. We believe CEE’s core WTE and WWT segments are relatively stable businesses in the environmental sector, with limited off-BS risk exposures and operational fluctuations. Its earnings visibility is increasing as construction revenue/profits under IFRIC 12 declines, which translates into DPS visibility that should be welcomed by yield-gap-seeking investors, in our view.
　　Key Risks for Rating
　　Lower-than-expected operational margins; value-destructive M&A. Valuation
　　Upgrade to BUY. We leave our forecasts largely unchanged while hiking DCF-based TP to HK$4.50 largely on lower cost of debt assumption. Our new TP implies 5.4% 2024E dividend yield, which we deem still reasonable against CEE’s stabilising operational environment.