After four months of sideways trading with sufficient chip exchange, China Water (00855) may be poised to initiate a new round of market movement. This speculation is based on two key considerations.

First, from a market perspective, the Hong Kong stock market has maintained strong momentum since April. Within less than five months, the Hang Seng Index achieved a maximum cumulative gain exceeding 33%, with the index breaking through 25,918 points on August 25, reaching a four-year high. Behind the sustained strength of Hong Kong stocks lies the resonance of three major driving forces: "valuation repair + policy dividends + southbound capital flows," with southbound capital particularly becoming a major force driving Hong Kong stock gains.

Data shows that as of August 26, southbound capital recorded cumulative net inflows exceeding 970 billion Hong Kong dollars year-to-date, significantly surpassing the total amount for the entire year of 2024. The full-year 2025 net inflow is expected to potentially break through 1.2 trillion Hong Kong dollars, or even challenge 1.3 trillion Hong Kong dollars.

From market performance, southbound funds show strong preference for high-dividend assets, with insurance capital leading key allocations in banking, energy, and utilities sectors. As southbound capital continues to increase, companies with stable operations, relatively low stock prices, and high dividends are expected to be accelerated into portfolios. China Water, as a leading cross-regional water utility leader in China, perfectly fits these criteria.

This explains the frequent news exposure of China Water receiving shareholder investments and stake increases in recent months: Great Wall Life Insurance increased its holdings in China Water, becoming China Water's third-largest shareholder; China Water's subsidiary Beijing Yinlong received a 1.5 billion yuan equity investment from Taikang Life Insurance; and ORIX Corporation increased its China Water shareholding to 20.28%.

Although utilities have not been the leading sectors in recent A-share and Hong Kong stock rallies, with AI enthusiasm driving electronics and computer sectors to market favor, and semiconductors becoming a capital pursuit hotspot leading multiple trading days in this wave, recent market style is quietly changing. The current market shows clear characteristics of sector rotation.

On August 27, among 28 industries with net outflows of major funds, electronics and computer industries led net outflows, both exceeding 14.5 billion yuan. From capital flow perspective, among Shenwan Level-1 industries, 3 industries received net inflows of major funds, with utilities leading net inflows at 1.023 billion yuan. This may indicate that capital will gradually increase allocation in high-dividend utility industries, from which China Water is expected to benefit.

Second, from China Water's operational perspective, its fundamentals remain solid with positive future development and expected continued improvement in dividend payout ratios. Based on macroeconomic environment changes and its own development process having passed the construction peak period, China Water began strategic transformation in 2023, gradually shifting toward operation-centered business structure with greater focus on cash flow management and asset quality improvement.

In fiscal year 2025 (12 months ending March 31), although China Water's total revenue declined 9.4% to 11.656 billion Hong Kong dollars mainly due to decreased urban water supply construction service revenue, adjusted EBITDA recorded 5.257 billion Hong Kong dollars, up 1.8% year-over-year, indicating China Water's actual profitability achieved modest growth. This was primarily due to improved profitability and reduced expenses during the reporting period.

According to analysis, in fiscal year 2025, China Water's comprehensive gross margin improved 0.7 percentage points to 37.8%. By business segment, profit margins for urban water supply/pipeline direct drinking water/environmental protection improved 3.2, 2.7, and 3.4 percentage points year-over-year respectively.

Regarding expenses, China Water's sales/administrative/financial expense ratios changed -0.2, -0.4, and +1.7 percentage points year-over-year respectively during the reporting period, with only financial expenses increasing. This was mainly due to the company's high proportion of US dollar debt. With subsequent domestic and international interest rate cut cycles and debt replacement measures, financial expenses have obvious room for future decline.

The steady actual profitability improvement represents positive results from China Water's gradual shift toward operation-centered business structure. Beyond this, the first-time positive free cash flow also represents significant achievements after business structure transformation, providing China Water with a foundation for high dividend payouts.

Benefiting from natural downward inflection in capital expenditure after the construction peak period, China Water's capital expenditure decreased by 1.9 billion yuan year-over-year to 3.4 billion Hong Kong dollars in fiscal year 2025, with free cash flow turning positive according to calculations.

China Water increased dividend payout efforts during the reporting period, with dividend payout ratio improving 12 percentage points year-over-year to 42%, demonstrating the company's determination and capability to continuously reward investors.

Looking ahead to fiscal year 2026, China Water's development is expected to remain stable with positive momentum. On one hand, China Water currently has 977,000 tons/day of under-construction capacity, expected to be fully operational in fiscal year 2026, driving continued improvement in water sales volume.

On the other hand, as the domestic listed water supply company with the highest proportion of tap water revenue, accelerated promotion of water price adjustment projects will inject new momentum into China Water's urban water supply business development.

Industry analysis indicates that water price adjustment project approvals have accelerated nationwide this year. For example, Shenzhen held hearings on April 11, announced water price increases on May 16, and began implementation on July 1, suggesting domestic water price reforms may accelerate.

China Water had only 2 water supply projects with price adjustments implemented in fiscal year 2025, while the company expects 8 to 10 water supply projects to receive price increase approvals in fiscal year 2026.

From April 2025 to present, 5 water supply projects have already received price increase approvals, with combined daily water supply capacity of approximately 720,000 tons. As of August 17, China Water added two water supply projects entering the hearing stage, meaning the company now has 4 projects in the hearing stage. At this pace, the number of projects receiving price increase approvals in fiscal year 2026 may exceed expectations.

It is foreseeable that with improved water supply volume and significant growth in water price adjustment projects, China Water's net profit attributable to shareholders in fiscal year 2026 is expected to recover rapidly. Multiple securities firms currently predict China Water's fiscal year 2026 net profit attributable to shareholders will achieve double-digit rapid growth, with some estimates reaching 1.372 billion Hong Kong dollars, representing a substantial 27.64% year-over-year increase.

Given positive fundamental expectations and continued high dividend style, China Water is expected to provide investors with excess return opportunities under the trend of southbound capital accelerating allocation to high-dividend assets.

Analysis maintains a "Buy" rating for China Water, giving the company a 10x target PE with a target price of 7.8 Hong Kong dollars, representing nearly 30% upside potential compared to the closing price of 6.21 Hong Kong dollars on August 29. The water supply business volume and price increases are expected to materialize simultaneously for China Water in fiscal year 2026.