Duoyuan Global Water (DGW) is up significantly since its IPO, but this pure play on water treatment in China still offers a compelling value. Given a confluence of factors in China, water treatment should become a booming business and Duoyuan looks well-positioned to benefit.

Duoyuan Global Water Inc. [[DGW]] gained nearly 12% yesterday and now is trading at a staggering 74% over its June 24th, 2009 IPO price of $16 per share.

The market is clearly optimistic about the China-based domestic water treatment equipment supplier, but given the share price’s meteoric rise, is there any upside left?

Company Overview

Founder in 1992, Duoyuan offers 80 products for water treatment in three categories: circulating water treatment, water purification, and wastewater treatment. The company has integrating manufacturing and assembly operations and its own in-house research and development.

Water Treatment in China: A Growth Industry

Duoyuan is clearly in the right industry in the right place at the right time. Water is increasingly being recognized as a valuable and finite resource – and this only amplified in China due to its myriad of environmental issues combined with an arid climate in many regions and ever increasing water demand.

China has also introduced new policies, Standards for Drinking Water Quality, effective July 1, 2007, to improve drinking water standards, including limiting the level of microbe content, organic matter and disinfectants in drinking water. In testing tap water for contaminates, the new drinking water standards raised the number of items classified as potential pollutants from 35 to 106.

Besides the need to treat water for consumption, China also has a largely ignored need to treat wastewater before releasing it back into ecosystems. According to the National Surface Water Quality Monthly Report of February 2008 issued by the China National Environmental Monitoring Center, 49% of China’s major water bodies were designated as unsuitable for humans – this means that, more than being unsuitable as a drinking water source, these bodies of water should not be swam in. A November 2006 circular of the Chinese Ministry of Water Resources stated that of the 71.7 billion tons of wastewater drained into various bodies of water in China in 2005, two-thirds were released without being treated.

Freedonia Group, a market research firm, estimates the demand for water treatment products in China will increase nearly 15.5% per year through 2012 – and if a more aggressive stance is taken towards wastewater treatment this growth could be even greater.

Moreoever, the goals laidout in the Chinese government’s National Urban Wastewater Treatment and Recycling Facilities Construction Five-Year Plan will necessitate nearly $50 billion of spending on wasterwater treatment infrastructure including water treatment equipment.

Valuation: Was the IPO Underpriced or is the Stock Overpriced?

Duoyuan had net income of $19.6 million in 2008 on sales of $86.7 million. Revenues increased by 40% from a year earlier and net income grew by a staggering 62.7%. Looking at just the first three months of 2009 year-over-year, revenues again grew 39% and net income grew by an impressive 92%.

With a current P/E of 37.32, a projected forward P/E of 29, and a 5-year PEG of only 1.85 assuming a very conservative, given previous results, sustained 20% growth rate.
David Peltier of TheStreet.com commented late last June that he thinks Duoyuan could have legs to $32/share – but even this basic analysis makes it look like even $40/share isn’t out of reach.

$40 per share?

With net income have increased by at least 50% year-over-year since 2006 and by 92% over the first quarter of the year compared to last year, Duoyuan shares could have legs. Even the global economic downturn may not be much to worry about – not only is China shaking it off better than any other nation, with second quarter GDP up 7.9%, but China’s economic stimulus package has in excess of $13 billion tagged for wastewater treatment plant construction.

CONTACT: 888-288-5215 · Please read our Full Disclaimer pertaining to this article.