Incident: The company released its annual report for the year 23, achieving revenue of 3,966 billion yuan, an increase of 20.6% over the previous year, including toll revenue of 3.841 billion yuan, an increase of 20.3% over the previous year. Net profit attributable to mother was 765 million yuan, up 68.9% year over year, lower than expected. It was mainly due to an impairment loss of 100 million yuan accruing from the investment in the Shantou Bay Bridge. Excluding this impact, the company's performance was in line with expectations.

Most of the holding and participating companies achieved double-digit revenue growth: the sharp increase in company tolls in '23 was mainly due to two reasons. First, Lanwei Expressway was combined in November '22. In '22, revenue was only calculated for more than a month, while in '23, revenue was calculated for the whole year. Second, benefiting from the fact that the industry was greatly affected by the epidemic in '22, the revenue base was low. After getting out of the shadow of the epidemic, traffic and revenue on most sections of the company saw a clear year-on-year increase. Excluding the influence of the Lanwei Expressway, the original road production achieved revenue of 3,532 billion yuan in '23, an increase of 11.8% over the previous year.

In terms of road distribution, only Xu and Lanwei's highway revenue grew negatively. The main reason was that the surrounding road section was restricted in '22, and some trucks were diverted to Wei Xu and Lanwei. As a result, the revenue base was high in '22, and the revenue for the road section fell back to normal levels after the restrictions were lifted. Revenue from the Han'e Expressway increased 7.8% year on year, and the growth rate was low. The main reason was that the parallel section of the Wuhuang Expressway was exempted from tolls on December 10, '22, which diverted the Han'e Expressway. With the exception of these three road sections, all holding road properties achieved double-digit revenue growth.

With the exception of the Shantou Bay Bridge, participation in road products achieved double-digit revenue growth. Revenue from the Shantou Bay Bridge fell 24.9% year on year. The main reason was that the Shantou Bay Tunnel was opened at the end of September '22 and free access to buses formed a strong diversion of the Bay Bridge. As a result, the company calculated an impairment loss of 100 million yuan for the Shantou Bridge.

Operating costs have increased steadily, and financial expenses have gradually declined: in terms of costs, the company's operating costs increased 15.9% year-on-year, mainly due to the Lanwei Expressway merger. Road production operating costs outside the Lanwei Expressway increased 5.24% year over year.

In terms of financial expenses, the company's total financial expenditure for 23 years was 562 million yuan, down 10.1% from 625 million yuan in the same period in '22. The overall weighted average interest rate fell from 3.60% at the end of '22 to 3.28% at the end of '23.

Considering that China is still in a cycle of interest rate cuts this year, it is expected that there is room for the company's financial expenses to continue to drop.

The North Ring Expressway expires, and the investment income for 24 years is expected to decline: the company's investment income in '23 was 277 million yuan, a significant increase from $172 million in '22. It is mainly due to the recovery of traffic after participating in road production. However, it is expected that the company's investment income will decline to a certain extent in 2024. First, the Humen Bridge, where it is a shareholder, will be affected by the opening of the Shenzhen-China Corridor, and traffic will be diverted; second, the toll period for Guangzhou Beihuan Expressway, which is a shareholder, expires on March 22 this year, and will not be able to contribute to revenue in the future.

The renovation and expansion of the Guangzhou North Second Ring Expressway is about to begin, and it is not expected to have a direct impact on revenue in the short term: the company's main road product, the Guangzhou North Second Ring Expressway, is expected to officially begin renovation and expansion within the year. This will be the company's most important investment project in the next few years. Although the length of the North Second Ring Expressway is less than 40 kilometers, the renovation and expansion involves the transformation of more than 10 large-scale overpasses. Construction is difficult, so the cost of renovation and expansion is high.

Corresponding to the high cost, the benefits brought about by the renovation and expansion are also very impressive. The North Second Ring Expressway is one of the busiest highways around Guangzhou. The average daily revenue per kilometer exceeds 70,000 yuan (in comparison, the average daily revenue per kilometer of most road production controlled by the company is less than 20,000 yuan), and its revenue generation capacity far exceeds that of conventional highways. Currently, traffic flow is saturated at the North Second Ring Road. After improving traffic capacity through renovation and expansion, traffic will continue to increase, and the charging period will also be greatly extended. Therefore, we believe that although the initial investment in this project is large, the return is rich, and the company's ability to continue operating will be significantly improved after the project is completed.

The planned construction period of the project is 5 years. We expect that the renovation and expansion will not have a significant impact on the flow and revenue of the North Second Ring Road in the early stages of the project. Based on the experience of existing renovation and expansion cases, the impact of renovation and expansion projects on road revenue is generally concentrated around 1 year during the end of the construction period, and the impact is small during the rest of the period.

Profit forecast and investment advice: When estimating the 2024 results, we take into account positive factors such as the natural increase in the company's road production traffic, the continued decline in financial expenses, and the negative factors of the probability of a decline in investment income. The company's net profit after deducting non-return to mother in 24 years is expected to increase slightly compared to 23. We expect the company's net profit for 2024-2026 to be $9.07, 10.08, and $1,138 million, respectively, and corresponding EPS of 0.54, 0.60, and 0.68 yuan, respectively. The current stock price corresponds to 2024-2026 PE values of 7.1, 6.4, and 5.7 times, respectively. The company's 23-year dividend was HK$0.3 per share, with a dividend ratio of 59.8%. Under the 24-year profit assumption, the company's dividend ratio is approximately 7.3% based on a conservative 50% dividend rate.

We are optimistic about the continued growth of the company's performance and the prospects for the renovation and expansion of the Guangzhou North Second Ring Road Expressway, and maintain the company's “Highly Recommended” rating.

Risk warning: Major policy changes, economic growth has declined, revenue from the acquisition of road products has fallen short of expectations, and renovation and expansion costs have exceeded expectations.