Incident: The company released its 2023 semi-annual report. 2023H1 achieved revenue of 3.458 billion yuan, a year-on-year increase of 2.01% (adjusted), and net profit of 598 million yuan, a year-on-year increase of 63.4% (adjusted). Among them, in 2023Q2, the company achieved revenue of 2,407 million yuan, an increase of 8.6% over the previous year, and net profit of 439 million yuan, an increase of 85.0% over the previous year.

High-quality sewage and sludge treatment assets were injected, and the revenue of the sewage treatment business was +32.4% year-on-year. In March 2023, the company completed the change of shares in the purification company and industrial registration. The purification company became a wholly-owned subsidiary of the company, injecting high-quality sewage treatment assets and sludge treatment assets into the company. According to our statistics, the company's sewage treatment capacity in Zhengzhou has reached 2.78 million tons/day. Furthermore, the sewage treatment facilities that the purification company has not yet built and put into operation include the Xinqu Sewage Treatment Plant (Phase II) and the Nancao Sewage Treatment Plant. The total design treatment capacity is 450,000 m3/day. The company is expected to expand the treatment capacity to 3.23 million tons/day by 2024. By business, the company's PPP project shrank significantly. In the first half of the year, it achieved revenue of 2.06 billion yuan, or -11.1% year-on-year; the sewage treatment business achieved revenue of 971 million yuan, +32.4% year-on-year.

PPP projects and sewage treatment gross margins have all increased dramatically. At 2023H1, the gross margin of the company's PPP project/sewage treatment revenue reached 20.2%/56.2%, respectively, an increase of 6.6 pct/18.7 pct over the same period last year. We believe that the decline in PPP project revenue but the increase in profitability may reflect that the company is shrinking the investment in PPP projects and optimizing the project structure; the increase in gross margin in the sewage treatment business may be due to the company's acquisition of purification companies to completely resolve competition issues in the industry, thereby marginally improving profitability. Subsequently, with the continuous advancement of the company's smart water service, gross margin is expected to increase further.

Accounts receivable have increased dramatically, and localized debt is expected to resolve the company's PPP project debt. In 2023H1, the company's accounts receivable reached 3.37 billion yuan, an increase of 117.7% over 2023Q1; financial expenses reached 370 million yuan, an increase of 51.2% over the previous year, mainly due to an increase in interest expenses due to increased borrowing. We believe that environmental PPP projects and accounts receivable issues will be expected to become the key direction of localized debt, and the risk of impairment of corporate accounts receivable may be effectively controlled; at the same time, reducing interest payment costs or becoming an important way to resolve debts is expected to reduce the company's financial expenses, thereby improving the quality of operations and strengthening profitability.

Investment advice and valuation: As a regional water leader, the company has acquired and acquired purification companies to double its sewage treatment capacity, fully benefited from the wave of investment in the water environment in Henan, and has both high growth potential and strong certainty. The company's revenue from 2023 to 2025 is estimated to be 8.150 billion yuan, 8.337 billion yuan, and 8.534 billion yuan respectively, with revenue growth rates of 31.1%, 2.3% and 2.4% respectively; net profit for returning to the group will be 811 million yuan, 1,039 million yuan, and 1,167 billion yuan respectively. The growth rates will reach 89.3%, 28.1% and 12.3% respectively, maintaining the “increase in holdings” investment rating.

Risk warning: Higher risk of interest-bearing debt ratio, higher risk of accounts receivable, risk of water environment treatment investment falling short of expectations, risk of reduced sewage treatment costs.