Due to a sharp rebound in passenger traffic to the island, the company's 2023H1 revenue increased significantly by 71.2% year on year, but non-aviation business revenue recovery was relatively slow. Among them, franchise revenue increased 41.2% year on year, or mainly due to the relatively slow recovery in the conversion rate of duty-free sales and passenger unit prices. The increase in the company's operating costs in 2023H1 was 16.2 pcts higher than revenue. It was mainly due to the increase in depreciation of usage rights assets due to changes in the lease contract with the parent company, which reduced gross margin by 7.9 pcts, and net profit loss increased by 0.4 million yuan to 50 million yuan over the same period last year. In July, the company's aircraft take-off and landing/passenger throughput was further restored to 106%/105% of the same period in 2019. The duty-free business actively carried out marketing activities while expanding luxury brands. Driven by passenger flow during the peak season, the company's performance in the second half of the year is expected to improve further.

The company will undertake the main increase in passenger flow to the island in the future. The channel advantages are obvious, and it is expected to fully enjoy the dividends of the construction of a free trade zone. Maintain a “buy” rating.

The company's 2023H1 revenue increased sharply by 71.2%, but due to pressure on the cost side, net profit loss increased by 40 million yuan year on year. We expect performance to pick up in the second half of the year. Benefiting from a sharp rebound in passenger traffic to the island, 2023H1 achieved revenue of 1.07 billion yuan, an increase of 71.2% year on year, but mainly due to leasing assets related to Meilan Airport Phase I and Phase II held by the parent company, added depreciation of usage rights assets. The company's operating costs increased 87.4% year on year, an increase of 16.2 pcts higher than the revenue increase for the same period, reducing gross margin by 79pcts to 8.8% year on year. Moreover, there was no HNA Group debt restructuring revenue of 0.2 billion yuan in the first half of this year (2022H1 was 0.2 billion yuan), and the company's net profit loss was 0.5 billion yuan, year-on-year. An increase of 0.4 billion yuan. Operational rehabilitation led to a net recovery in cash from the company's operating activities in 2023H1, and net inflows increased by 24.9% year-on-year. Due to changes in the leasing contract with the parent company and the company beginning to be responsible for the overall operation of Phase I and Phase II of Meilan Airport, the company's costs will increase markedly. We expect the year-on-year effect to be eliminated next year. With further restoration of passenger flow and active marketing and introduction of luxury brands in the duty-free business, the company's performance is expected to improve month-on-month.

The aviation business is recovering rapidly, but the non-aviation business is recovering slowly. Driven by marketing activities and peak season passenger traffic, airport duty-free sales are expected to pick up further in the second half of the year. 2023H1's aircraft take-off and landing/passenger throughput increased by 45.6%/83.6% year on year, recovered to 102.0%/96.4% in the same period in 2019, and further recovered to 105.5%/105.4% in July. The recovery in traffic led to a year-on-year increase of 132.5%/39.4% in the company's aviation business/non-aviation business revenue during the same period to 49/570 million yuan. In June 2023, the peak hourly capacity of Meilan Airport was adjusted to 30 flights/hour to 40 flights/hour. Increased production capacity will better meet the needs of peak tourist seasons in Hainan such as summer, National Day, and winter in the second half of the year. Franchise revenue from the company's non-aviation business was 330 million yuan, accounting for 56.9%, an increase of 41.2% over the previous year. The increase was less than the increase in passenger flow during the same period or was mainly due to the duty-free sales conversion rate and relatively slow recovery in passenger unit prices. In the second half of the year, the company is expected to join hands with China Free to promote consumption transformation through duty-free shopping festivals and marketing activities. Driven by several peak seasons, duty-free sales are expected to pick up further from month to month.

The increase in costs is mainly due to depreciation of usage rights assets due to changes in leasing contracts with the parent company. As passenger flow continues to recover, the company's profit margin is expected to increase. 2023H1's operating costs/sales expenses/management expenses were +87.4%/-16.7%/+15.7%, respectively, up 82.4% year on year to 1.02 billion yuan. The main increases in operating costs were depreciation expenses and amortization of intangible assets increased by 240 million yuan and labor costs increased by 160 million yuan year on year. The former was mainly due to the company leasing assets related to Meilan Airport Phase I and Phase II held by the parent company, and depreciation of new usage assets. The latter was mainly due to the company's overall increase in employment demand after operating the first and second phase of airport assets. As the company added leasing liabilities, 2023H1 financial expenses increased by 55.5% (0.3 billion yuan) year on year, and the balance ratio increased by 5.4 pcts compared to the end of 2022 (excluding this impact, the balance ratio increased 1.9 pcts year on year). The company's cost side is relatively rigid, and profit margins are expected to increase as passenger traffic continues to recover.

Duty-free luxury brands may be further expanded. The company's channel advantages are obvious, and it is expected that it will fully enjoy the dividends of building a free trade zone. According to the 2022 annual report exchange meeting at Meilan Airport, the company plans to cooperate with China Free to further introduce duty-free luxury brands in the T2 terminal this year, or add additional duty-free space. The optimization of the product structure is expected to drive sales growth. The company expects Meilan Airport to achieve 35 million passenger traffic in 2025. Currently, the third phase of the project is being planned and may be put into use around 2029. The company will undertake the main increase in passenger traffic to the island in the future. As an important traffic portal, the company has obvious channel advantages and is expected to fully enjoy the dividends of the construction of a free trade zone.

Risk factors: The recovery in civil aviation demand was weaker than expected; the increase in airport duty-free revenue fell short of expectations; a runway injection and fixed increase fell short of expectations, and the impact of the arbitration results on the company's operations exceeded expectations.

Investment suggestions: The company's 2023H1 aviation business recovered rapidly, but the non-aviation business recovered slowly. Costs increased significantly due to changes in the leasing contract with the parent company. Due to the slow recovery of sales conversion rates and customer unit prices at Meilan Airport duty free stores and higher than expected depreciation of usage rights assets in operating costs, we lowered the company's 2023/24/25 EPS forecast to 0.11/1.09/1.85 yuan (not considering the impact of arbitration, the original forecast was 1.09/1.96/2.71 yuan). Referring to Beijing Capital Airport shares, which is also a Hong Kong-listed company, the average PE (ttm) value for the 2 years before the pandemic was 12 times. We gave the company a PE valuation of 12 times in 2024. The discount corresponds to 2023 The target price is HK$15. It is recommended to pay attention to the impact of subsequent arbitration results on the company's operations and performance, and maintain the “buy” rating.