Freetech (6888 HK) China Puti Environmentally friendly ... · Environmentally friendly road doctor Rating Buy New initiation Target price HKD 4.50 Current price HKD 3.26 Upside +38%

Page 1 of 15

1 November 2013

Kenneth Li

[email protected]

(852) 2235 7619

Trading data

52-Week Range (HK$)

3 Mth Avg Daily Vol (m)

No of Shares (m)

Market Cap (HK$m)

Major Shareholders (%)

Auditors

Result Due

2.45/3.77

4.5

1,040

3,399

WP Sze (50.1%)

E&Y

FY13: March Company description

Freetech is the largest Hot-in-Place APM

servicing companies with 22 modular series out of

54 modular series in total in China. The second

largest market player only has 3 modular series.

Freetech is also the largest domestic

manufacturer of HIP APM equipment in China.

Freetech’s renown APM projects including Chang

An Street (长安街) in Beijing in advance of the

60th National Day processions, the Asian Games

(亚运会) project in Guangzhou and the Asian Bo

Ao Forum ( 亚 洲 博 鳌 论 坛 ) transportation

improvement project in Hainan Province.

Price chart

1.00 1.00 1.00 1.00 2.00 2.00 2.00 2.00 3.00 3.00 3.00 3.00 4.00 4.00 4.00 4.00 Jun-13

Aug-13

Oct-13

HK$

Environmentally friendly road doctor Rating Buy New initiation

Target price HKD 4.50

Current price HKD 3.26 Upside +38%

Largest recycling asphalt pavement solution provider in China Freetech is the largest Hot-in-Place APM servicing companies with 22 modular series out of 54 modular series in total in China. The second largest market player only has 3 modular series. Freetech is also the largest domestic manufacturer of HIP APM equipment in China. Freetech’s renown APM projects including Chang An Street (长安街) in Beijing in advance of the 60

th National Day processions,

the Asian Games (亚运会) project in Guangzhou and the Asian Bo Ao Forum (亚洲博鳌论坛) transportation improvement project in Hainan Province.

Self-proprietary and environmentally friendly HIP method Hot-in-Place is the most environmentally friendly and cost efficient technologies at present. It saves raw material costs/transportation costs/energy consumption/waste disposal by 35%/15%/40%/100%, reduce dust/carbon dioxide/sulphur dioxide/nitrogen dioxide emission by 96%/44%/83%/51% respectively. Compared to other HIP competitors, Freetech’s proprietary heating technique allows quick and in-depth heating for scarifying of asphalt pavement without breaking the aggregates in asphalt mixture and Freetech’s HIP uses LPG as source of heating which is more environmentally friendly.

Tapping new markets via joint ventures Freetech has established 11 joint ventures in China with local APM service providers to increase market penetration. By leveraging on its JVs, Freetech aims to further increase its penetration into cities and territories where penetration rate using Hot-in-Place recycling technology are still very low. We believe forming new JV partners will be catalyst for Freetech’s share price.

Robust growth in pavement maintenance industry Approximately 17% of high grade roads in PRC need repair works during 2011-15, up from 12.5% during 2006-10. The rate of recycling of damaged pavement materials in the PRC was only 5% in 2010. Government stipulates that the recycling rate should reach 70% and 90% for ordinary road and highway by 2015.The HIP recycling technologies accounted for merely 1-2% market share by area at present. We believe the market size growth for HIP can be explosive supported by increasing awareness of environmental protection.

Initiate at BUY with target price HK$4.50 We initiate Freetech with BUY and target price of HK$4.50 based on 14x FY14 PE, based on its average FY14 PE of China environmental plays listed in Hong Kong and Freetech has better technology than it’s a-share peer Anshan Senyuan.

HK$ m (Dec-end) FY10A FY11A FY12A FY13E FY14E

Revenue 233 281 486 785 1,047

Operating profit 42 89 194 321 430

Net Profit 27 62 147 230 336

Adjusted NP 27 62 147 250 336

EPS (HK$) - - - 0.24 0.32

Adjusted P/E (x) 126.4 54.6 23.1 13.6 10.1

Div yield (%) - - - 1.4 2.0 Sources: Company, CIRL estimates

Freetech (6888 HK)

China Puti

Page 2 of 15

Largest recycling asphalt pavement solution provider in China

Established in 1993, Freetech is the largest Hot-in-Place “HIP” Asphalt Pavement

Mantenance “APM” servicing companies with a total of 22 modular series, out of 54

modular series in total in China. The second largest market player only has 3 modular

series. Freetech is also the largest domestic manufacturer of HIP APM equipment.

Freetech’s renown APM projects including Chang An Street (长安街) in Beijing in

advance of the 60th National Day processions, the Asian Games (亚运会) project in

Guangzhou and the Asian Bo Ao Forum (亚洲博鳌论坛) transportation improvement

project in Hainan Province.

Freetech’s business operation consist of 1) APM service segment, which provides APM

services to repair damaged asphalt pavement surface and 2) manufactures and selling

of APM services equipment including standard series and modular series.

Exhibit 1:Sales growth of Freetech Exhibit 2: Composition of Freetech sales in FY12

196 204 298

516 723

38 78

198

269

324

0

200

400

600

800

1000

1200

FY10 FY11 FY12 FY13E FY14E

Provision of road maintenance services

Manufacturing and sale of maintenance equipment

CAGR 45%

234282

496

785

1,047

Provision of

road

maintenance

services, 60%

Manufacturing

and sale of

maintenance

equipment, 40%

Source: Company, CIRL estimates Source: Company, CIRL

Exhibit 3: Market share of modular series sold in 2012 in China Exhibit 4: Market share of modular series owned and used in China

Freetech, 36%

Anshan

Senyuan, 24%

Wirtgen, 22%

Others, 18%

Freetech, 36%

Shandong

Highway &

Bridge, 6%Beijing

Chuangfei, 6%

Others, 52%

Source: CCID, CIRL Source: CCID, CIRL

Page 3 of 15

Source: CCID, CIRL

SSource: Companies, CIRL

According to CCID, Freetech has the largest market share of 40% in standard series

equipment using the Hot-in-Place technology in terms of sales volume in China for

2012.

Freetech’s 46% CAGR in sales during 2010-2012 consisted of 23% CAGR in provision

of road maintenance service and 129% CAGR for manufacturing and sale of equipment

divisions. We expect both divisions to have strong growths due to opening of new

production plant in late 2013 which will increase production capacity for modular series.

As modular series are self-used or sold to JV partners, it will help to boost revenue in the

services segment.

Exhibit 5: Comparison of major Hot-in-Place asphalt pavement maintenance equipment manufacturers and service providers

Company

Freetech

Anshan Senyuan

Shandong Highway & Bridge

Wirgen

Beijing Chuangfei

Huayu Road & Bridge

Liaoning Datong

NICSR

Modular series

YES

YES

YES

YES

NO

NO

NO

NO

Standard series

YES

YES

NO

NO

NO

NO

NO

NO

APM servicing

YES

NO

YES

NO

YES

YES

YES

YES

Exhibit 6: Comparison of Freetech’s equipments

Equipment Selling price Target customers Servicing speed

Modular series Rmb13m-Rmb27m per set Joint venture companies 3,000-5,000m2/day

Standard series Rmb0.8m-Rmb3.1m per unit PRC Government and private

enterprises

30-50 m2/day

Page 4 of 15

Exhibit 7: Overview of production plant Exhibit 8: A finished pavement recycler ready for delivery

Source: Company, CIRL Source: Company, CIRL

Exhibit 9: Site visit of current APM project in Nanjing Exhibit 10: Pavement of fully blended recycled mixture on the

Source: Company, CIRL Source: Company, CIRL

Exhibit 11: Compacting the pavement Exhibit 12: Onsite pavement recycler

Source: Company, CIRL Source: Company, CIRL

Page 5 of 15

Exhibit 13: APM servicing – Modular series process

Source: Company, CIRL

Exhibit 14: APM servicing – Standard series process

Source: Company, CIRL

Page 6 of 15

Exhibit 15: Applicable for various working environment Exhibit 16: Applicable under extreme temperatures

Source: Company, CIRL Source: company, CIRL

Page 7 of 15

Self-proprietary Hot-in-Place technology

Freetech’s equipments use Hot-in-Place recycling technology which is the most

environmentally friendly and cost efficient non-traditional asphalt pavement

maintenance technologies at present. Compared to traditional technology, Hot-in-Place

saves 35% in raw material costs, saves 15% in transportation costs. Environmentally, it

saves energy consumption by 40%, reduce waste disposal by 100% and reduce

dust/carbon dioxide/sulphur dioxide/nitrogen dioxide emission by 96%/44%/83%/51%

respectively. In addition, among the non traditional methods, Hot-in-Place is the most

cost efficient and environmentally friendly.

Most importantly, compared to competitors like Anshan Senyuan (300210 CH) and

Wirgen which also use the Hot-in-Place technology, Freetech’s proprietary heating

technique allows quick and in-depth heating for scarifying asphalt pavement without

breaking the aggregates in asphalt mixture. Compared to Wirgen which uses steel alloy

and maximum temperature can reach 600 degrees, Freetech uses ceramic heating

surface which temperature can reach 900 degrees. Higher temperatures enable faster

and more in-depth asphalt heating. Compared to Anshan Senyuan, Freetech’s

High-in-Place uses LPG as source of heating which is more environmentally friendly.

Furthermore, comparing to traditional methods, Freetech’s HIP method is very quite

even operating at night time.

A key question from investors is whether Freetech’s self-proprietary HIP technology can

be copied competitors. Management commented that competitors have tried to copy but

without success and gave-up. The key to Freetech’s technology is its precision or its

core heating equipment and computer system. Management believe large heavy

equipment producers such as Sany Heavy Equipment and Zoomlion have also have the

technological know-how to build the HIP modular series. However, they lack the

expertise in road maintenance industry and require long testing period and acceptance

period from customers. As such, management estimates it may take 4 to 5 years if these

players are to catch up.

Exhibit 17: Small-scale on-site servicing using traditional asphalt pavement maintenance services

Source: Company, CIRL

Page 8 of 15

Exhibit 18: Small-scale on-site servicing using Hot-in-Place recycling technology

Source: Company, CIRL

Exhibit 19: Comparison among different asphalt pavement maintenance technologies

Source: CCID, CIRL

Page 9 of 15

Tapping new markets via joint ventures

Since 2011, Freetech has established 11 joint ventures in China with local APM service

providers and a third-party investor to increase market penetration. Joint ventures are

required to purchase equipments solely from Freetech. By leveraging on the

cooperation with local APM service providers, Freetech aims to further increase its

penetration into cities and territories where penetration rate using Hot-in-Place recycling

technology are still very low as it aims to enter into new markets, broaden its customer

base as well as market shares.

Exhibit 20: Revenue breakdown from service segment Exhibit 21: Customer composition in service segment

32

51 56

6 13

35

13

106

0

20

40

60

80

100

120

2010 2011 2012

PRC government agencies Privately-owned companies

Joint venture companies

HK$ m

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012

PRC government agencies Privately-owned companies

Joint venture companies

84%

16%

66%

17%

16%

28%

18%

54%

Source: Company, CIRL Source: Company, CIRL

China is a huge road maintenance market with many different local government bodies.

Some markets are easy to break into, and Freetech will provide road maintenance

service directly with the local government. On the other hand, other markets are hard to

break into as the existing maintenance providers have strong connections or interests

with local government which entering through JV format is suitable. As such, Freetech

takes precarious approach in selecting JV partners in China. The PV partners are

normally local road maintenance services providers which has strong connection with

local governments. Freetech will usually sets key performance indicators such as next

two years turnover with JV partners to ensure that these targets can be met.

Although some JVs formed in 2012 have encountered some delays of project tendering,

which was mainly due to tight government budgets and time needed for JV to ramp up,

management believes this is short term and believe the JVs will bear strong results for

Freetech starting in 2005. On the other hand, Freetech is still actively exploring other

partnership opportunities, such as with central-owned SOEs or agents of local

governments. We believe forming new JV partners will be catalyst for Freetech’s share

price.

The common concern from investors is Freetech’s high account receivables. Freetech’s

account receivable increased from HK$268m in FY12 to HK$407m in 1H13, this was

because most of Freetech’s services projects are still in progress. Furthermore, the

increase in trade receivables was also as a result of three modular series sold in 1H13.

Management guided most of the sales proceeds will be collected in 2H13 and year-end

account receivable will be controlled at around HK$500m.

Page 10 of 15

In addition, Freetech is aware of investor concern on long receivable days from local

government, and the company has set up new criteria in selecting the projects which

they will provide service to. Management commented that they will channel check with

local maintenance firms to find out the track record on the particular local government in

regards to receivable days. Given the road maintenance market is large, Freetech

prefer to select projects which local government has good record in paying account

receivables on time.

Robust growth in pavement maintenance industry

Compared to other pavement materials, asphalt is more flexible and easier to construct.

Asphalt roads accounted for high proportion of highways. According to the Ministry of

Transport “MoT”, 63.7% of the highways in China were paved with asphalt, up 19.6ppt

from 2006. Based on National Road Plan 2013-2030, total expressway length will reach

118,000km from 96,000km as of 2012 and 90% of newly constructed highways in China

are paved with asphalt.

According to MoT, approximately 12.5% of high grade roads in PRC received major or

medium level repair works during 2006 to 2010, and it is forecasted that more than 17%

of total high grade roads in PRC need major or medium level repair works during 2011

to 2015. According to CCID, the average rate of recycling of damaged pavement

materials in the PRC was lower than 5% as of the end of 2010. However Government

stipulates that the average rate of recycling of damaged pavement materials in the PRC

should reach at least 50% by the end of 2015 and at least 90% by the end of 2020, and

the average rate of recycling of damaged pavement materials should reach at least 70%

and 90% for ordinary road and highway, respectively, by the end of 2015.

The Hot-in-Place recycling technologies accounted for merely 1-2% market share by

area at present. Given the technology is still new and not widely use, Freetech is

actively making industry standard with central government and provincial government

such as Jiangsu province. Latest industry standards and government guidance have

included Freetech as sole technology adviser and industry standards provider. We

believe the market size growth for Hot-in-Place recycling technology can be explosive

supported by increasing awareness of environmental protection.

Exhibit 22: China total highway mileage Exhibit 23: Composition of road pavements in China

45,339 53,913

60,302 65,055

74,113 84,946

96,000

118,000

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2006 2007 2008 2009 2010 2011 2012 2030F

KM

10.1% 11.2% 11.8% 12.7% 13.5% 14.4% 15.1%

18.7%23.7% 27.4% 31.9% 34.3% 36.8% 39.0%15.3%14.7%

14.2%13.8% 13.1%

12.5% 11.9%

55.9% 50.4% 46.5% 41.7% 39.1% 36.3% 34.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010 2011 2012

Asphalt paved Cement paved Paved using simple technology Unpaved road

Source: NBS, CIRL Source: NBS, CIRL

Page 11 of 15

Exhibit 24: Percentage of high grade roads that need maintenance Exhibit 25: Expenditure for total pavement maintenance in China

12.5%

17.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

2006-2010 2011-2015

224

263

100

120

140

160

180

200

220

240

260

280

2010 2011

Rmb b

17% growth

Source: Ministry of Transport, CIRL Source: 12th 5 year plan for transport, CIRL

Financial analysis and valuation

We forecast revenue growth to be driven by APM services. We forecast total

revenue growth of 58% yoy in FY13 and 33% in FY14. In particular, we forecast APM

service to enjoy faster growth of 73%/40% for FY13/FY14 as Freetech secures new

servicing contracts in China. We forecast APM equipment sales to grow by 36%/21% in

FY13/FY14 as its new plants will allow Freetech to increase production capacity.

Gross margin to trend down due to higher revenue contribution from APM service

segment. We forecast both APM service and APM equipment sales segment gross

margin to remain the same for FY13/FY14. However, due to higher revenue contribution

of APM service segment, overall gross margin to trend down from 54.1% in FY12 to

52.4% in FY13 and further to 51.6% in FY14.

Stable EBIT margin despite lower gross margin. We forecast EBIT margin to be

stable from 39.9% in FY12 to 40.9% in FY13 and 41.1% in FY14 due to operating of

scale, despite lower gross margins.

Surge in net profits. We expect net profit to reach HK$230m or HK$250m if listing

fees are excluded in FY13, representing adjusted net profit growth of 72% yoy. We

forecast net profit to grow by 35% yoy to HK$336m in FY14.

We initiate Freetech with BUY at 14x FY14 PE, target price HK$4.50. We initiate

Freetech with BUY and target price of HK$4.50 based on 14x FY14 PE, based on its

average FY14 PE of China environmental plays listed in Hong Kong.

Page 12 of 15

Exhibit 26: Peers comparison

Source: Bloomberg, CIRL

Exhibit 27: Key assumptions

Source: Company, CIRL estimates

FY10A FY11A FY12A FY13E FY14E

Turnover HK$ m

APM service 196 204 298 516 723

APM equpment sales 38 78 198 269 324

Gross margin (%)

APM service 34% 46% 44% 44% 44%

APM equpment sales 43% 62% 69% 69% 69%

APM service area (m2) 1,850,000 1,950,000 2,760,000 4,692,000 6,568,800

ASP (HK$) 106 105 108 110 110

Standard series sales (unit) 47 45 34 45 55

Modular series sales (unit) 1 8 9 10

Standard series ASP (HK$ m) 1 1 2 2 2

Modular series ASP (HK$ m) 13 17 19 20

bloomberg Mkt Cap Price PER (x) P/B (x)

code (HKD mn) (HKD) FY12A FY13E FY14E FY12A FY13E FY14E

ALPHALT PAVING MACHINE PEERS

ANSHAN SENYUAN-A 300210 CH 3,294 24.45 31.1 21.4 15.9 4.5 3.9 3.2

Average 3,294 31.1 21.4 15.9 4.5 3.9 3.2

ENVIRONMENTAL & WATER CONSERVATION PLAYS

FREETECH 6888 HK 3,399 3.26 23.3 13.6 10.1 15.4 3.2 2.5

CHINA EVERBR INT 257 HK 31,335 7.73 26.1 24.6 19.9 4.6 3.8 3.3

JINGNENG CLEAN-H 579 HK 19,803 3.22 17.7 12.7 8.8 1.4 - 1.5

BJ ENT WATER 371 HK 29,104 3.45 31.8 24.3 19.4 2.9 2.7 2.4

GUODIAN TECHNO-H 1296 HK 11,946 1.97 14.1 12.5 7.8 1.1 0.9 1.0

CHINA WATER AFFA 855 HK 4,088 2.91 14.8 17.1 13.4 1.4 1.3 1.2

Average 19,255 3.9 20.9 18.2 13.9 2.3 1.7 1.9

Page 13 of 15

Exhibit 28: Financial summary

Source: Bloomberg, CIRL

Income statement Cash flow

Year to Dec (HK$ mn) FY10A FY11A FY12A FY13E FY14E Year to Dec (HK$ mn) FY10A FY11A FY12A FY13E FY14E

Revenue 233 281 486 785 1,047 Pre-tax profit 38 83 193 329 442

Gross profit (reported) 83 141 263 411 540 Taxes paid (5) (20) (38) (72) (97)

EBITDA 52 101 208 342 459 Depreciation 10 12 13 21 29

Depreciation (10) (12) (13) (21) (29) Associates 1 2 3 4 5

EBIT 42 89 194 321 430 CFO bef. WC change 60 109 207 356 477

Net interest income (exp.) 0 0 0 0 0 Change in working cap (21) (47) (48) (226) (192)

Associates 0 0 (0) 7 9 Cashflow from operation 39 62 158 130 285

Exceptionals/others 0 0 0 0 0 CAPEX (17) (15) (20) (110) (110)

Profit before tax 38 83 193 329 442 Free cash flow 22 47 138 20 175

Tax expenses (11) (21) (43) (72) (97) Dividends (10) (14) (47) (46) (67)

Minority interest 0 0 (4) (6) (9) Balance sheet adj. 1 2 3 4 5

Adjusted net profit 27 62 146 250 336 Sharse issued 0 0 0 625 0

Dividends 13 60 0 46 67 Others 1 2 3 4 5

Net cash flow 10 115 (5) 521 5

Balance sheet Net cash (debt) start 8 18 135 131 652

Year to Dec (HK$ mn) FY10A FY11A FY12A FY13E FY14E Net cash (debt) at year-end 18 133 130 652 657

Cash & equiv 19 136 131 652 657

Trade receivables 86 137 268 510 628 Ratios

Other receivables 6 9 17 17 17 Year to Dec (HK$ mn) FY10A FY11A FY12A FY13E FY14E

Inventories 19 34 41 75 193 Growth rate (%)

Other current assets 3 4 0 0 0 Revenue 20.6 72.8 61.5 33.4

Fixed assets 94 101 128 217 298 EBITDA 93.2 105.0 64.8 34.2

Intangible assets 0 0 0 0 0 EBIT 111.3 118.7 65.6 34.1

Investment, associates etc 4 21 50 50 50 Adjusted net profit 130.3 135.9 71.7 34.5

Total assets 231 442 636 1,522 1,844 Fully diluted EPS 130.3 135.9 71.7 34.5

Margins (%)

Account payables 33 41 74 123 167 Gross margin (reported) 35.5 50.1 54.1 52.4 51.6

Other payables 30 38 45 45 45 EBITDA 22.5 36.0 42.7 43.6 43.9

Short-term debt 77 59 78 78 78 EBIT 18.0 31.5 39.9 40.9 41.1

Other current liabs 24 72 19 19 19 Net margin 11.5 22.1 30.2 29.3 32.1

Long-term debts 5 162 178 178 178 Other ratios

Deferred tax and others 5 8 17 17 17 ROE (%) 43.2 89.7 66.5 21.8 25.2

Other long-term liabs (5) (8) (17) (17) (17) ROA (%) 11.6 14.1 23.0 15.1 18.2

Total liabilities 169 372 394 443 487 Net gearing (%) 95.3 (110.4) (20.5) (53.6) (42.8)

Interest coverage (x) 9.5 14.8 48.2 53.5 71.7

Share capital 0 0 0 46 693 Receivables days 129.2 145.0 152.3 181.0 198.4

Reserves 62 69 220 385 642 Payables days 819.7 96.0 94.1 96.3 104.6

Shareholders' equity 62 69 221 1,057 1,334 Inventory days 377.5 69.7 61.7 56.6 96.2

Minorities 0 0 22 22 22 Effective tax rate (%) 28.6 25.2 22.1 22.0 22.0

Total equity 62 69 243 1,079 1,356

Net cash (debt) (59) 76 45 566 571

Page 14 of 15

Risk factors

Slowdown in PRC Government expenditures on road maintenance projects

Slowdown in PRC government expenditures on road maintenance projects will have

adverse consequence on the growth prospect of the business.

Failure to collect trade receivables

Freetech may not be able to collect trade receivables in a timely manner and some of

the customers may delay payments due to various reasons beyond the company’s

control.

Risk in joint ventures

There is risk of joint venture fails to carry out business plan or fail to secure maintenance

service projects from the Government.

Fluctuation or shortage of raw material and components

Sudden fluctuations in the prices or shortage of raw materials and components could

cause disruption to Freetech’s business.

Page 15 of 15

Rating Policy

Rating Definition

Stock Rating Buy Outperform HSI by 15%

Neutral Between -15% ~ 15% of the HSI

Sell Underperform HSI by -15%

Sector Rating Accumulate Outperform HSI by 10%

Neutral Between -10% ~ 10% of the HSI

Reduce Underperform HSI by -10%

Analysts List

Antony Cheng Research Director (852) 2235 7127 [email protected]

Hayman Chiu Senior Research Analyst (852) 2235 7677 [email protected] Kenneth Li Senior Research Analyst (852) 2235 7619 [email protected]

Lewis Pang Research Analyst (852) 2235 7847 [email protected] Susanna Chui Research Analyst (852) 2235 7131 [email protected]

Analyst Certification

I, Kenneth Li 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 / were, is /

are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note.

Disclaimer

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