3 Stocks To Ride China’s Green Wave

China's shrouded skyline is a constant reminder of the pollution crisis that it has long been grappling with. It is home to some of the world's most polluted cities, and the severity of its environmental issues has inspired multinationals and start-ups to cash in on the country's insatiable appetite for pollution control, renewable energy and environmental protection equipment. Even the once inconceivable idea of selling bottled fresh air is now a reality, with consumers willing to pay as much as RMB 130 for a few breaths of fresh air from anywhere but their own smog-choked country.

As the government continues to enforce tougher policies to tackle its pollution crisis, environmental stocks will certainly be amongst the winners in the country's push towards a cleaner and greener economy. Here are three "green" companies that are worth a closer look.

1. BYD To Benefit From China's Green Vehicle Push

As part of China's efforts to tackle its perennial air pollution issue, policymakers have made it a national priority to shift towards a low-carbon transport system, with extensive financial support provided to both consumers and manufacturers of battery electric vehicles and plug-in hybrids – collectively known as new energy vehicles (NEV). The nationwide implementation of stricter emission standards has also heaped further pressure on conventional gasoline automobile manufacturers to develop NEVs in order to comply with regulations. As a result of strong policy support and lavish incentives, China's NEV market has enjoyed robust growth over the past few years, with more than 300,000 NEVs sold in 2016, representing a sharp increase from just a few hundred NEVs sold in 2010 – the statistics are certainly impressive.

Chart 1: Robust Growth In China's NEV Market Over Past Few Years

In this nascent market, BYD (HKEX.1211) enjoys first mover advantage and is currently the largest electric vehicle manufacturer by sales volume in 2016, with a market share of about 25.7%. Geely Automobile is BYD's closest rival in the NEV market, but it trails way behind BYD with a market share of about 14.8%. BYD plied its trade as a rechargeable battery maker when it was first incorporated in 1995, but has since ventured into the handset components and automobile manufacturing businesses, leveraging on its expertise in advanced technology and manufacturing know-how. It has also devoted much of its attention to the development of its electric vehicle business in recent years, with sales from this particular segment accounting for about 34.0% of its total revenue in 2016, and is slowly becoming a major source of profit. BYD's success in China's electric vehicle market has not gone unnoticed, with the company counting among its investors Buffett-helmed Berkshire Hathaway.

While cumulative sales of NEVs in China is close to 600,000 since 2010, the sector has further room to expand. China has huge ambitions for the domestic deployment of NEVs – it wants five million NEVs on its streets by 2020. As such, BYD's focus on its NEV business should continue to underpin revenue growth over the next few years. While competition is likely to heat up in this sector, it may take some time before its rivals, which face a steep learning curve, can achieve the scale and low-cost advantage that first mover BYD currently enjoys. The public transportation sector also presents further opportunities for BYD, with NEVs gaining traction among taxi and bus fleets. Its newly established monorail business will start contributing to overall earnings this year, and could be a potential long-term growth driver and catalyst if it takes off successfully.

2. Longyuan Powers Ahead With Wind Farms

With environmental protection on the top of China's agenda, the gradual shift towards a low-carbon transport system is certainly a huge step in the right direction. NEVs, however, are only as clean as the power supply that drives them. China has traditionally relied on coal-fired power plants for its electricity needs, but its coal addiction has grown the country's air pollution levels to epic proportions. Despite the government's efforts to clamp down on coal-fired plants, they continue to play an essential role within the power system, accounting for approximately 65.2% of the country's electricity production in 2016 (Table 1). As China gets serious about air quality and shifts its dependence away from coal power, the renewable energy industry is likely to benefit.

Table 1: China's Total Electricity Production In 2016

An approximate RMB 2.5 trillion has already been earmarked by the government for investment into renewable power generation by 2020, with about RMB 700 billion expected to go towards boosting wind energy capacity. In the wind energy space, China Longyuan Power Group (HKEX.916) is a potential candidate that investors may wish to consider for their portfolios. Longyuan is the largest wind power producer in China, with a consolidated installed capacity of 17.4 GW across 32 provinces (total installed wind power capacity in China is 148.6 GW). It accounted for 12.4% of China's total electricity output from wind power in 2016. Unlike other renewable pure-plays like Huaneng Renewables (HKEX.958) or Datang Renewable (HKEX.1798), Longyuan derives about 31.8% of its revenues from traditional coal-fired power generation.

Based on estimates jointly released by the International Energy Agency and the National Development and Reform Commission, China's wind power generating capacity could reach 1,000 GW by 2050, providing as much as 17% of the nation's electricity output. As one of China's leading wind power producers with the largest installed capacity, Longyuan is likely to benefit from supportive policies aimed at accelerating growth in the country's wind power generation. The management has guided for an additional 1.6 GW of new wind power capacity this year, representing a 9.2% increase, and its low gearing ratio relative to its peers suggests a higher potential for capacity expansion over the next few years. In general, wind power operators that can keep costs down, while having higher utilisation levels, are able to recover their operating costs faster, leaving more hours to contribute to net income. It is worth noting that Longyuan has one of the highest utilisation hours and lowest unit operating costs for its wind farms compared to its competitors (Table 2).

Table 2: Longyuan Leads Market With Largest Capacity And Strong Cost Control

3. The Conglomerate That Turns Thrash Into Cash

How about a little bit of everything? Then perhaps China Everbright International (HKEX.257) fits the bill. The environmental conglomerate is a major player in the solid waste treatment industry, with 65 projects (as of end December 2016) that collectively boast a daily waste processing capacity of 50,950 tonnes, and from which Everbright derives the main bulk of its total revenue (Chart 2). The company also has a strong presence in the wastewater and reusable water treatment sector. Its greentech business, operated through its subsidiary China Everbright Greentech (HKEX.1257), which was recently spun off in an initial public offering, is primarily engaged in the construction and operation of alternative energy projects including biomass, solar energy and wind power. Everbright's envirotech segment involves research and development projects, as well as the sale of environmental protection equipment, though revenues from this business constitute only a small proportion of overall turnover.

Chart 2: Diversified Portfolio Of Projects Across Various Sectors

China's continued economic growth, increasing urbanisation and rising disposable incomes over the years have come at an environmental cost. The nation churned out an estimated 520,548 tonnes of waste daily in 2012, and this amount is expected to more than double by 2025, based on statistics compiled by the World Bank – what a waste! As landfills take up valuable land and causes severe environmental pollution, the waste-to-energy (WTE) treatment method, which helps reduce the volume of waste and generates electricity in the process, has slowly emerged as the preferred solution to China's growing waste problem. The development of water infrastructure and wastewater management technologies are also in great demand, especially since reliable sources of water are scarce in China due to pollution.

Everbright secured a record-high of 44 new projects in 2016, and its revenue growth over the next few years will be driven by a robust pipeline of projects (Chart 3). As the government continues to tackle its pollution crisis in China, an increasing number of environmental projects are expected to be made available. Everbright's market leadership places it on a strong footing to benefit from the government's supportive policies. Moreover, the company is partially owned by state-owned China Everbright Holdings, allowing it to leverage on its credibility and strong ties with the government to secure more projects effectively in China.

Chart 3: Robust Project Pipeline To Drive Future Growth

Growth And Protection Not Polar Opposites

Does environmental protection come at the expense of economic growth? Not necessarily. With billions of dollars expected to be channelled towards China's pollution fix, the government's drive to clean up the country's air and water could actually provide an economic boost, creating jobs and increasing investments in green technology. Moreover, pollution is also one of the leading causes of premature deaths in China, and that could jeopardise the sustainability of its economic growth, as productivity is dampened and wages are lost. The locals will also be able to stroll the streets without the need for any pollution masks. Environmental protection is a win-win situation in the long-run, but for now, "green" stocks are clearly the stand-out winners in China's war on pollution.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.