Adjusted profit for the first half of 2023 fell 1.6% year over year
The company's 2023 interim results were broadly in line with our expectations. Shareholders' net profit for the first half of the year fell 21.2% year on year to $6.1 billion (HK$, same below), mainly due to: (1) Fluctuations in the RMB exchange rate caused total revenue to drop 27.5% year on year to $2.98 billion. After deducting related exchange effects, total revenue fell 21.7% year on year; (2) Interest expenses increased 13.4% year on year to $320 million due to higher interest rates on Hong Kong dollar loans. After deducting the increase in interest expenses and exchange effects during the above period, adjusted net profit fell by only 1.6% year on year to 770 million yuan.
Operating business continues to expand
The core business waste incineration power generation has taken shape, most projects have been put into operation, and construction activities have declined in recent years. As of June 30 this year, production capacity under construction/planning was 11,850 tons/day, down 20.2% and 29.3% respectively from the end of 2021 and 2022. As a result, construction revenue in the first half of this year fell 53.8% year on year to 1.0 billion yuan, accounting for 33.5% of the company's total revenue, a decrease of 19.0 percentage points.
The operating business continues to expand. In the first half of the year, electricity sales and total waste disposal volume increased by 19.2% and 18.3%, respectively, to 2.66 million megawatt-hours and 8.08 million tons. Revenue from electricity sales and waste disposal fees fell 1.8% year on year to $1.74 billion (Note: if settled in RMB, revenue increased 6.0% year on year to RMB 1.54 billion). The share of the company's total revenue rose 15.2 percentage points to 58.3%.
Major breakthrough in sanitation business
The newly developed sanitation business achieved a major breakthrough. In the first half of the year, revenue from sanitation and other services rose 52.6% year on year to 150 million yuan, accounting for an increase of 2.7 percentage points to 5.1% of revenue. Recently, the company has won bids for two major sanitation projects to support medium- to long-term development: (1) the RMB 3.26 billion TOT urban and rural sanitation project in Quyang County, Hebei, with a term of 25 years and is expected to begin operation in the second half of 2023; (2) the HK$2.82 billion Hong Kong North Lantau Waste Transfer Station and Outlying Islands Waste Transfer Facility Project, with a term of 10 years, is expected to take over operation in mid-March 2024.
Increase in overall gross margin
The gross margin of the construction business was 16.7%. In the first half of the year, it was still far lower than the 46.7% gross profit margin of the operating (electricity sales and garbage disposal) business. As a result, the company's total gross margin increased 7.7 percentage points to 38.0% year-on-year as a result of the decline in the share of construction revenue. As construction revenue continues to shrink, we expect the company's gross margin to rise by 9.5, 3.0, and 3.0 percentage points to 40.1%, 43.1%, and 45.1%, respectively, in 2023-25.
Reiterate the “increase in holdings” rating
Taking into account short-term exchange rate risks, we moderately lowered our 2023-24 shareholder net profit forecast by 8.4% and 2.5%, respectively. Due to changes in the company's business portfolio and structural rise in overall gross margin, the company should receive a higher valuation in the medium to long term. We raised our target price-earnings ratio for 2024 from 7.5 times to 8.5 times, and accordingly raised the target price from HK$4.60 to HK$5.10, corresponding to 11.8% increase. Maintain the “increase in holdings” rating.
Risk warning: (1) project development delays; (2) accounts receivable risk; (3) grid-connected electricity prices have dropped sharply.