LEADER ENVIRONMENTAL TECHNOLOGIES - Sell-down unwarranted (DMG)

BUY

Price S$0.162

Previous S$0.530

Target S$0.470

LET posted a strong set of 2Q11 results with RMB31.3m in revenue (+69.8% YoY) and RMB6.8m in net earnings (+55.9% YoY). Desulphurisation Engineering, Procurement and Construction (EPC) business continues to power growth, making up 85.5% of the group’s 1H11 sales. The bulk of its earnings (>80%) come in the second half. EPC order book currently stands at RMB100m, and we expect the group to secure another RMB250m worth of EPC contracts by the end of August. Reiterate BUY, with a TP of S$0.47 (previously S$0.53), based on 8.9x P/E (-1 SD industry P/E). The next key rerating catalysts of the stock are likely to be the green light to commence the Operate, Own and Transfer (OOT) business as well as its maiden contract breaking into the denitrification industry.

The right place to be in. Environmental protection industry, being top of the list of “seven strategic emerging industries”, will continue to receive tremendous support from the Chinese government in the next five years. With the recent approval of main pollutant emission control plan and the upcoming “Emission standard for air pollutants for thermal power plants”, more initiatives are being executed to meet the 12th Five-Year plan targets. LET is well-placed to tap on trends like the shift in desulphurisation demand and the upcoming denitrification market in this rapidly growing industry. Furthermore, once the OOT plan is approved, LET will gain a stable recurring revenue stream.

Unwarranted market panic, auditors give clean bill of health. The share price has dived more than 30% since May. It is clear to us now that the recent panic sell-down was unwarranted, making LET a bargain. There are two main reasons behind our belief on top of the group’s solid fundamentals. First, none of the major pre-IPO investors have reduced their shareholding even though the blockout period is over, casting their vote of confidence in LET. Second, both their external and internal auditors, Ernest & Young and Grant Thornton respectively, have audited LET’s account recently and have given it a clean bill of health.

Awaiting the green light to take off. LET has successfully negotiated and entered into an agreement with a state-owned power plant to purchase four sets of its desulphurisation systems to kick start its OOT business. As the deal involved purchasing stated owned assets, it is now under the state counsel’s review. Since it is in the government’s long term interests to offload SOE’s environmental responsibility and to support the growth of clean environmental businesses, we opine that there is a high chance for the deal to be approved.

Riding the wave of change. On July 19, Premier Wen Jia Bao ended China’s National Leading Group’s environmental conference with an approved main pollutant emission control to reduce China’s production of sulphur dioxide. It is to be cut by 8% in five years, with 1.5% target set for 2011. According to Changjiang Securities, up to 74% of thermal power plants are now inbuilt with desulpherisation system but only 10-20% of iron ore sintering machines have desulpherisation capabilities. This represents a shift of environmental responsibility from thermal power plants to steel manufacturers, a potential market size of close to RMB20 billion. With its proven capabilities and established track record, we believe that LET can benefit greatly from this tide of change. The benefits are already showing, with a successful RMB50m project with a current subsidiary of Shougang Steel, one of the largest steel companies in China.

Breaking new grounds. A lucrative RMB200 billion denitrification market is about to be born. With China set to finalise the “Emission standard for air pollutants for themal power plants” in the coming months, and China’s 12th Five-Year plan target of 10% cut in ammonia nitrogen and nitrogen oxides emission, the thermal power plants have to take the lead in the creation of the denitrification market. As of 2010, total installed capacity of thermal power is 706,630 mw but only 50,000 mw (7.1%) are implemented with denitrification devices. ZheJiang University, owner of one of China’s leading SCR denitrification technology, has begun to partner with LET to bid for new denitrification projects.