The pandemic disrupted the H2 recovery process, but revenue increased in the second half of the year (1.27 billion yuan, +6.8% year on year), and owners should account for 400 million yuan (+12.7%) of profit. H2 cemetery/funeral/other services achieved revenue of 10.2/2.0/0.7 billion yuan (+8.8%/+14.8%/-25.3%) respectively, and the overall operating profit margin was +0.4pct to 47.4% year-on-year, better than expected. The company's profitability is stable under the epidemic, and the pace of mergers and acquisitions after the epidemic is expected to accelerate year-on-year. In the long run, the specialized management capabilities and expansion advantages of industry leaders are outstanding, maintaining the “buy” rating.

The pandemic disrupted the H2 recovery process, and operating efficiency increased year over year. FY22's revenue was 2.17 billion yuan (-6.6%, vs. CITIC Securities Research Department forecast 2.32 billion yuan), and the profit attributable to owners was 660 million yuan (-8.5%, vs. 770 million yuan forecast by CITIC Securities Research). The Q4 pandemic crossed important periods such as the winter solstice, which affected the pace of H2 demand recovery, but revenue increased in the second half of the year (1.27 billion yuan, +6.8% year on year), and owners should account for 400 million yuan (+12.7%) of profit. By business, revenue from H2 cemetery services/funeral services/other services was 10.2/195/65 billion yuan respectively, +8.8%/+14.8%/-25.3% year-on-year respectively, accounting for 80.7%/15.4%/5.2% of revenue. With the gradual normalization of epidemic control, revenue in Shanghai increased 26.5% year-on-year to 640 million yuan in 2H22, verifying the business characteristics of timely reimbursement of deferred demand. The company's cost control was good in the second half of the year. Employee costs (20.0%) and depreciation and amortization (6.2%) expenses rates remained stable year over year, with a year-on-year decrease of 3.2 pcts and 2.4 pcts, respectively. The project cost rate was 5.7%, a significant decrease over the previous year (-4.7pcts), mainly due to a year-on-year decrease in funeral parlour construction services under the franchise agreement, the development of EPC business within the group saved external engineering costs, and adjusted the project construction schedule in due course according to market conditions. Overall, H2's operating profit margin increased 4.4 pcts to 49.1%; the company's net profit margin increased by 1.6 pcts and 2.2 pcts per month to 38.2%, better than expected (vs. CITIC Securities Research Department forecast 37.8%).

Deferred demand for cemeteries continues to make up for, and the structure of the funeral business is expected to improve. As of December 31, 2022, the company has entered 46 cities in 19 provinces and cities. Currently, it operates 31 cemeteries/+1 year over year, 30 funeral service facilities/same as year over year. ① Cemetery services: 22H2 operating cemeteries earned 920 million yuan (+11.3%). Structurally, the unit price was +8.3%, and the number of graves was +2.8%. It is expected that part of the demand will be made up in 23. Annual revenue from comparable cemeteries was 1.55 billion yuan (-7.3%), unit price +7.4%, number of graves -13.7%; revenue from newly acquired or newly built cemeteries was 12.16 million yuan. The increase came mainly from the Anhui Longmen project acquired in August 2021. ② Funeral services: 22H2 funeral service revenue was 200 million yuan (+20.1%), mainly driven by an increase in service volume (+22.0%), while the average price fell 1.6% year-on-year to 0.49 million yuan. Comparable facility revenue for the whole year was 340 million yuan (+4.1%), service volume +7.3%, and unit price -2.9%, mainly due to expanding the scope of cooperation with the government where some projects are located and new basic funeral farewell services were expanded, thereby lowering unit prices; additional facility revenue of 20.51 million yuan was mainly due to the Linquan Jiaheyuan Funeral Home Company built in 2021. ③ Other business: 22H2's revenue was 65 million yuan (-25.3%), mainly due to a large decline in revenue from funeral home construction services. Looking at the breakdown, revenue from funeral parlor construction services/construction service (EPC) revenues/professional design services/crematorizer business revenue under the franchise agreement was $0.16/0.19/0.26/0.2 billion yuan respectively. The company signed a total of 16,759 pre-life contracts (+21.8%) throughout the year, delivered 8 sets of environmentally friendly cremators to overseas customers, and the new business progressed steadily.

The recovery in demand in Shanghai boosted profit margins. The overall operating profit margin of FY22 company was 47.4% (+0.4pct), and the operating profit margin of H2 was 49.1%, +4.4pcts year on year, 1H22 +4pcts. Among them, the operating profit margin for cemetery services/funeral services/other services was 56.4%/13.5%/0.1%, respectively +0.9/-1.5/+17.5 pcts over the previous year. The increase in operating profit margins of cemetery services is mainly due to the rapid recovery of the business of weighted cemeteries in Shanghai after the epidemic, and their contribution to the cemetery division increased. The slight decline in profit margins for funeral services is mainly due to the fact that the business structure is still repeatedly affected by the epidemic. Some high-value-added projects are restricted by crowds and are difficult to provide. It is expected that the proportion of such projects will increase after the pandemic.

The pandemic has affected the pace of mergers and acquisitions, and key regions continue to be deployed. In 2022, the company completed the acquisition of the remaining 10% of the shares of Liaoning Guanlingshan Art Garden Cemetery Co., Ltd. and became a wholly-owned shareholder. This is the group's important strategic base in Northeast China; the second capital increase for Zhuolu Yuanbaoshan was completed, and the shareholding ratio reached 51%. The project is located at the junction of Beijing and Hebei Zhangjiakou, an important step in advancing the implementation of the Group's strategic plan in the Beijing-Tianjin-Hebei region. In addition, the company signed a strategic cooperation agreement with the Yunnan Wenshan Zhuang and Miao Provincial Civil Affairs Bureau. This cooperation is an important cultural development for the group in Yunnan. A geographically advantageous market service base It will speed up the Group's expansion plans to enter major provinces in the southwest region. The company also continued to expand its funeral service business in important provinces and cities such as Nanjing, Kunshan, Hefei, Hangzhou, Ningbo, and Nanchang in 2022.

Risk factors: Market expectations affect the operation of cemeteries and the provision of services; the risk that policy restrictions such as the “Funeral Administration Regulations” exceed expectations; the risk of increased competition in the industry; and the risk of company management and operation risks.

Profit forecasts, valuations and ratings: The company's profitability has been steady under the pandemic, and the pace of post-pandemic mergers and acquisitions is expected to accelerate year-on-year. The peak of the epidemic passed faster than previously anticipated, and it is expected that the company's deferred demand will continue to make up. At the same time, considering that the pace of post-pandemic mergers and acquisitions expansion is expected to accelerate, we raised the 2023/2024 EPS forecast to 0.38/0.45 yuan (the original forecast was 0.37/0.42 yuan), increasing the 2025 EPS forecast to 0.52 yuan. The current price corresponds to 2023-25 PE 13/11/10x, respectively. The comparable company SCI (SCI.N) PE is 18x (2023E, Bloomberg's unanimous forecast), and the corresponding medium- to long-term profit growth rate is in single digits. We should give the company 18 times PE in 2023, with a target price of HK$7.8 at the current exchange rate to maintain the “buy” rating.