The company's stock price has been under pressure in recent months
The recent rise in HKD/USD interest rates and the depreciation of the RMB have limited the company's revenue growth rate. FY23 (year end: March 31) The company's revenue increased 9.6% year on year to $14.20 billion (HK$, same below). Excluding fluctuations in the RMB exchange rate, revenue increased 16.4% year on year. However, we believe that as US dollar interest rates stabilize, the recovery of the mainland economy and the explosion of direct drinking water from pipelines will support the company's long-term development.
Higher interest rates and exchange rate fluctuations erode short-term profits
Since this year, the rise in HKD/USD interest rates has led to an increase in interest expenses, but the company has continued to increase the share of RMB loans to obtain lower interest rates. FY23 RMB loans rose 26.1% year over year to $11.94 billion (HK$, same below), and the share of loans increased 7.2 percentage points year over year to 50.5%. Over the same period, HKD/USD loans fell 5.7% year on year to $11.7 billion, and the share of loans fell to 49.5%. Relevant interest savings benefits will have a positive effect on net profit in 2H FY24. We expect the year-on-year growth rate of net interest expenses to fall from 36.1% in FY23 to 31.6%, 12.1%, and 2.5% in FY24-26, respectively.
The company's financial statements are settled in Hong Kong dollars, so the depreciation of the renminbi will erode profits. According to market figures, the average exchange rate of RMB against the Hong Kong dollar fell 5.8% from 1.17 in 1H FY23 to 1.10 in 1H FY24. We expect the 1H FY24 results announced in November to be affected to some extent. However, due to the company's business in the mainland, this negative macro-factor did not affect the actual operation of the company.
However, economic recovery indicates an increase in demand for tap water use
The mainland economy has continued to recover in recent months, and statistics from various entities have improved. This may indicate an increase in social demand for tap water use, especially in the industrial and commercial industry. Total retail sales of social consumer goods increased 6.8% year on year in the first three quarters of 2023, up from 0.7% in the same period last year. The year-on-year growth rate of the country's power generation also reached 4.2% in the same period in 2023, an increase of 2.0 percentage points over the same period last year. We believe that the benefits of water demand will gradually become apparent starting with the company's 2H FY24. Economic recovery has also given the government a lot of room to raise water prices. Due to the recurrence of the epidemic, only four water supply projects of FY23 received price increases, which is less than 9 and 10 of FY21 and FY22, respectively. We look forward to the resumption of water price increase activities starting from 2H FY24.
Combining the above two factors, we expect revenue from tap water operations to shift from a 0.2% year-on-year decline in FY23 to a year-on-year increase of 8.4%, 2.4%, and 2.9% for FY24-26 to 3.64 billion, 3.73 billion, and 3.84 billion yuan, respectively.
Pipeline drinking water business is in a period of explosion
We believe the company's pipelined drinking water business is in a period of explosion. Since the official launch of this business in FY20, the share of total revenue has continued to grow, from 1.4% in FY21 to 5.4% and 9.2% in FY22-23, respectively. The company has given priority to allocating human and financial resources to this business to expand customer coverage. According to the Frost & Sullivan report, in terms of sales in 2022, the company has become the largest piped drinking water company in China, with a market share of 7.3%, higher than the second and third largest 4.1% and 3.1% respectively. Residents and non-residents from schools, hospitals, public places, government agencies, etc. are in high demand. We expect direct drinking water revenue from the FY24-26 pipeline to increase by 72.5%, 40.7%, and 38.5% year-on-year respectively to 2.26 billion, 3.18 billion, and 4.4 billion yuan, respectively, and the share of total revenue to 14.5%, 19.4%, and 25.7%.
The spin-off listing plan is expected to be completed within 2H FY24
In June of this year, the company submitted an application for listing on the main board of the Hong Kong Stock Exchange. It plans to spin-off its tap water and pipelined drinking water business, but maintain a controlling interest. We believe that the spin-off and listing plan is expected to be completed within 2H FY24, which can unlock the potential value of related businesses and enhance the company's overall market value.
Reiterate the “buy” rating
Considering the impact of rising interest rates and exchange rate fluctuations, we lowered the FY24-Y25 shareholders' net profit forecasts by 8.6% and 13.2%, respectively, and added the FY26 forecast. Accordingly, we reduced the target price from HK$8.80 to HK$7.60, corresponding to the target price-earnings ratio of 6.0 times FY24 and room for growth of 55.1%, and reaffirmed the “buy” rating.