On February 16, 2024, Hang Seng Index Limited announced the results of the Hang Seng Index series quarterly review as of 31 December 2023. According to the Zhitong Finance App, 32 individual stocks have been removed from the Hong Kong Stock Connect Index. Among them, Conch Environmental (00587), a leading hazardous waste treatment company, is clearly on the list.

Reviewing the conch environmental K-line chart, the reason why the company was excluded from the Hong Kong Stock Connect is very intuitive. In 2022, at the beginning of the company's listing, the stock price rose to HK$15.1. Since then, the stock price has fluctuated for a long period of time. Recently, Hailuo Environmental's stock price dropped to HK$1.02, the biggest drop of more than 93% from its all-time high. The company's current market value is only around HK$2 billion, far from its peak of nearly HK$30 billion.

It is difficult to increase revenue and increase profit

The Zhitong Finance App learned that Conch Environmental Protection split from the Conch startup in March 2022. Currently, the actual controller is Conch Cement. The history of Hailuo Environmental Protection can be traced back to when Hailuo started investing in Yaobai Environmental Protection in 2015 and establishing Wuhu Haichuang Environmental Protection in 2016. Conch Environmental Protection's business mainly uses cement kiln collaboration technology to provide industrial solid and hazardous waste disposal services.

According to the Frost & Sullivan report, in 2020, Conch Environmental was the largest waste disposal service provider in China. In the same year, the company was also the largest service provider in China using cement kiln collaborative disposal technology to dispose of industrial solid waste and hazardous waste, accounting for about 21.7% of the total market share based on disposal capacity in operation; accounting for about 31.3% of the total market share in terms of disposal volume.

Unfortunately, after the listing of Conch Environmental Protection, the “innate advantage” of relying on Conch Cement did not allow the company's valuation to continue to increase in value. One of the main reasons for this is that the company has fallen into a situation where “it is difficult to increase revenue and profit.”

According to Hailuo Environmental's financial report, the company's revenue increased from 397 million yuan (RMB, same below) in 2018 to 1,698 million yuan in 2021, with a compound annual growth rate of more than 62.3%; during the same period, net profit attributable to the company's shareholders increased from 234 million yuan to 579 million yuan, with a compound annual growth rate of 32.3%. In 2022, the company achieved a year-on-year increase of 1.85% in revenue to 1.73 billion yuan, and net profit attributable to shareholders decreased by 44.25% to 360 million yuan. In the first half of 2023, the company's revenue reached 971 million yuan, up 11.79% year on year, and net profit attributable to shareholders fell 19.7% to 200 million yuan.

The growth rate of the industry is declining, and competitive pressure is increasing

According to the Zhitong Finance App, Hailuo Environmental Protection has experienced a situation where “it is difficult to increase revenue” or even “not increase profit” in recent years. One of the main external reasons is that the industry's growth rate is slowing down.

According to the Frost & Sullivan report, the total amount of hazardous waste disposal in China increased from 32.2 million tons in 2015 to 83.9 million tons in 2020, with a compound annual growth rate of 21.1%, and is expected to increase to 138.9 million tons in 2025, with a compound annual growth rate of 10.6%. The revenue of the cement kiln collaborative disposal industry increased from 600 million yuan in 2015 to 4.8 billion yuan in 2020, with a compound annual growth rate of 51.6%, and is expected to increase to 12.1 billion yuan in 2025, with a compound annual growth rate of 20.3%. According to Huatai Securities's estimates, the scale of the hazardous waste treatment market (centralized treatment by third-party certified enterprises) will reach 101 million tons in 2022 to 2035, with a compound annual growth rate of 7.4%.

On the other hand, in the process of development of the hazardous waste market, there is a gradual oversupply on the supply side. The compound annual growth rate of licensed hazardous waste treatment capacity reached 18.7% in 2016-2022, and the annual hazardous waste treatment capacity corresponding to the license reached 175 million tons at the end of 2022. Huatai Securities believes that although qualification growth has slowed in recent years, the overall hazardous waste treatment industry is still facing the dilemma of overcapacity. Supply-side adjustments are expected to be unavoidable, and prices may continue to be pressured until the adjustments are basically completed.

The Zhitong Finance App noticed that the competitive pressure brought about by oversupply in the hazardous waste treatment industry is reflected in the fundamentals of conch's environmental protection. Taking gross margin as an example, the gross margin of Conch Environmental Protection once reached 77.21% in 2018, and the gross margin fell to 52.62% in the first half of 2023.

According to the 2023 semi-annual report of Hailuo Environmental Protection, the company's business mainly covers three major sectors: industrial hazardous waste disposal services, industrial solid waste disposal services, and comprehensive utilization of resources. Among them, the general hazardous waste and industrial solid waste disposal service business in the industrial hazardous waste disposal service business are the company's main source of gross profit.

The gross margin of the general hazardous waste disposal service business in the first half of 2023 was 55.81%, down 2.5 percentage points year on year, mainly due to market competition intensifying price decline, and hazardous waste disposal prices declined in Guangdong, Jiangxi and other provinces; the gross margin of the industrial solid waste disposal service business was 51.41%, down 10.1 percentage points year on year, mainly due to intense competition in the contaminated soil business and insufficient entry into the factory. Overall, in the first half of 2023, the average price of the company's comprehensive disposal of hazardous waste was 1,157 yuan/ton, down 19.3% year on year and 12.9% month on month.

When will fundamentals rebound after bottoming out?

Under the influence of factors such as weak hazardous waste treatment prices, Hailuo Environmental's stock price continues to “find the bottom” reflecting changes in the company's fundamentals. In the future, whether the company's fundamentals can reach the bottom and rebound is a topic of concern for investors.

First, looking at the industry's growth prospects, the total amount of hazardous waste disposal in China is still growing steadily, which contains structural growth opportunities. According to Huatai Securities's forecast in 2023, the cement kiln collaborative disposal market is expected to reach a compound annual growth rate of 14.0% from 2022 to 2035. In the first half of 2023, the comprehensive disposal volume of environmentally friendly hazardous waste from conch reached 546,000 tons, an increase of 34.5% over the previous year. Among them, the collaborative disposal of cement kilns increased 43.6% year on year to 486,000 tons.

In terms of hazardous waste treatment prices, Huatai believes that since many large hazardous waste treatment companies have already lost money, after experiencing a continuous decline in 2018-2022, it is expected that hazardous waste treatment prices have basically bottomed out. However, until the supply-side reshuffle is completed, hazardous waste treatment prices are also less likely to rebound sharply in the short term.

In this context, Conch Environmental's ability to control costs is worth focusing on. According to information, Conch Environmental Protection uses a cement kiln collaborative disposal process, and other disposal methods (such as incineration) have obvious cost advantages. Therefore, when other industries lose money, Conch Environmental can still maintain profits. In the first half of 2023, benefiting from the release of scale effects brought about by good control and increased utilization, the company's collaborative disposal cost decreased by 18.3% year-on-year to 500 yuan/ton, and the cost advantage of the cement kiln collaborative disposal project was further consolidated.

Furthermore, in a fiercely competitive environment, some high-energy, high-polluting, and high-cost disposal companies using traditional processes may gradually withdraw, while disposal companies with collaborative disposal processes as the core are expected to gradually occupy a more important market position. This will help Conch Environmental to seize industry integration opportunities. Hailuo Environmental Protection said in its 2023 interim report that in terms of hazardous waste and sludge disposal business, the company will consolidate its core competitive advantage, seize opportunities for industry integration, carry out project acquisitions and mergers in due course, and further improve market network coverage.

As of the first half of 2023, Hailuo Environmental Protection had put into operation and built 66 environmental protection projects in 19 provinces, cities and autonomous regions across the country. The treatment scale involved was about 7.316,700 tons/year (not including projects submitted for approval and not yet built), of which 638,000 tons/year were under construction.

In the short term, abundant project reserves will help the company expand its economies of scale and consolidate its cost advantage. However, at a time when hazardous waste treatment prices are declining, favorable listing conditions are expected to help the company's fundamentals rebound, but there may still be a long way to go to achieve a reversal.