Parched Asia buoys China Water Inc

HONG KONG (Reuters) - Water is the new gold -- for investors at least. Acute shortages and worsening pollution across Asia, the world's most populous region, should buoy demand for clean water and sewage treatment -- and the services of operators providing them -- for years to come.

China's $14.2 billion water industry especially is a long-term, virgin investment reservoir. But slipshod management, scattershot policy and the snail's pace of the market's opening to foreign firms demand patience initially, say fund managers, executives and analysts.

So despite eye-catching rallies in some Asian water-industry stocks over the past year, a number of global funds have sprung up across the region arguing that water remains a solid long-term -- like 10-year -- bet.

"The great thing about water is there is no substitute for it. You can't replace water," said Anthony Wilkinson, a fund manager with CLSA Capital Partners.

"We expect water tariffs generally to inflate, as the scarcity problem across Asia Pacific is becoming more obvious in countries like China and India," said Wilkinson, co-principal and head of research for the Clean Water Asia fund, which CLSA says is Asia's first dedicated water and waste management fund, holding shares in companies from Japan to India.

Per-capita water resources in China, the world's fourth-largest economy, stand at 2,200 cu m (77,690 cu ft), less than a third of the global average, prompting Premier Wen Jiabao to warn of a threat to "the survival of the Chinese nation".

With a fifth of the globe's population, China has just 7 percent of its water resources.

"We expect tariff hikes and privatization have kicked off a multi-year theme in the growth of urban water supply and sewage treatment in China," Morgan Stanley said this week.

POTENTIAL UNLEASHED

Global interest among investors in water kicked off -- as shown through the birth of water-focused funds then -- in the 1990s, but China got a late start, investors say.

Beijing cracked opened its water utilities industry only in 2004, and its plan to invest US$130 billion in water and waste-water treatment in 2006-10 sparked an influx of foreign buyers such as Veolia Environment (VIE.PA), while cultivating a clutch of fledgling local players.

About US$25 billion of that investment would be used to pump water from China's southern rivers to its arid north.

By end-2006, private and foreign players had around a joint 15 percent market share in water supply and 30 percent of sewage treatment -- respectable numbers that far exceed industries such as financial services and minerals.

Yet executives say the market needs time to really take off.

Sino-French Water Development, a venture between Hong Kong's NWS Holdings Ltd. (0659.HK) and Suez (LYOE.PA), was one of the earliest to jump aboard.

Though it has become the largest water firm in China after Veolia and supplier to 7 million people across 17 cities, it complains of cut-throat competition.

"We certainly would like to speed up our investment but we have to wait for opportunities to arise," Chan Kam Ling, NWS's Chief Executive Officer said in a telephone interview.

"Players are now so eager to grab a piece of the action that they'll gladly pay top dollar," he said, noting Veolia paid triple what NWS's venture -- the second-highest bidder -- was willing to shell out for one city utility recently.

And investors might be discouraged initially if they took a closer look at a few charts.

Little-known rival China Water Industry Group Ltd. (1129.HK) led a sectoral rally of the past 12 months with shares rocketing 11-fold. Larger rival Guangdong Investment Ltd. (0270.HK) gained 29 percent over the period, outperforming the market.

Shares in China Water Affairs Group (0855.HK) have risen more than two-thirds this year after a more than seven-fold surge in 2006.

CONCEPT-DRIVEN

The key is to be selective.

Morgan Stanley rates Tianjin Capital Environmental Protection (1065.HK) (600874.SS) for its nationwide expansion, technology and management. Its shares in Hong Kong, at 32 times earnings versus an average of 34 for Chinese water firms and a global mean of 17, proffer a bargain, Morgan Stanley argued.

Unlike U.S., European or Australian utilities, Chinese players tend to be relatively young with untested management and operate in a changing, murky policy environment.

And the affordability of Chinese residents remains weak.

"The recent stock rally is purely concept driven," argued Y.K. Chan, a fund manager at Philip Capital Management.

"Valuation differentials will come through very quickly -- maybe not this year but certainly next year," said CLSA's Wilkinson.

($1=7.705 Yuan)