Epure - Reiterate BUY at fair value estimate of S$0.55

In view of the current focus of the PRC Government towards environmental protection, we remain bullish on the potential developments of the water industry. Epure’s 1st quarter 2009 results show that its earnings have been rather resilient, with regards to the current economic situation, and posted a 32% year-on-year increase in net profit attributable to shareholders. We maintain our buy rating and, based on our free cash flow to equity model (Exhibit 2), have revised our fair value upwards to S$0.55 from our previous fair value estimate of S$0.44, which has already been achieved in the past few weeks.

Epure announced a net profit increase of 32% year-on-year for the first three months ended 31 March 2009 (1Q09). The rise in earnings were due mainly to (1) its existing engineering, procurement and construction (“EPC”) projects, (2) contribution from Beijing Hi-Standard Water Treatment Equipment Co Ltd (“Hi-Standard”), which the Group acquired last year and (3) a foreign exchange gain of RMB4.7 million due to the Chinese Yuan appreciating against the Singapore Dollar.

Gross profit margins declined slightly from 37.8% in 1Q2008 to 35.4% in 1Q2009. Although there is a drop of slightly more than 2 ppts for 1Q2009, the nature of turnkey projects and its revenue recognition are based on percentage of completion. This means that on a quarterly basis, we should see fluctuating margins and it would be more appropriate to view the Group’s margins on an annual basis. Over the last few years, the Group’s gross profit margins have been at a stable 30% or so.

Since our report earlier this year, the Group has incorporated a wholly-owned subsidiary to invest in a Build, Operate and Transfer (“BOT”) project located in Shaanxi Province, Hancheng City. It has also established a joint venture with BJ Sound Enviro for a BOT project in Lanzhou City in Gansu Province. These two projects will add to its portfolio of three wholly-owned BOT projects.

We believe that in the short term, industrial EPC projects should weaken with the economic downturn still in the background, however, the municipal segment should continue to see growth. We have not made any changes to our EPC revenue forecast, we did however make changes to our equipment fabrication and design service contracts segments to arrive at our upgraded fair value estimate of S$0.55. It is also good to note that we have not forecasted the Group’s BOT earnings in our valuation. According to a recent Reuter’s report, the PRC Government has intentions to raise water prices in Beijing due to the capital’s useable water being only a third of the national rate, along with 110 other cities. This price increase should subsequently be applied across China, which will lead to higher returns for BOT projects in the respective areas. We remain confident of China’s water sector and reiterate our BUY rating with a revised fair value estimate of S$0.55 based on our free cash flow to equity model. This represents a 23.6% upside potential from the last traded price of S$0.445.

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