The net profit of Towngas Smart Energy (TGSE) surged 63% YoY to HK$1,575m in 2023, 3% below our forecast. Its core earnings grew 16% YoY mainly because its renewable business swung from loss to profit. Looking ahead, we expect its core earnings to surge 39% YoY in 2024 as we expect rapid growth from its renewable business after breaking even. We reiterate our BUY call given its depressed valuation. We increase our target price to HK$4.10.

Key Factors for Rating

TGSE's core earnings grew 16% YoY to HK$1,190m in 2023. The growth primarily came from the renewable business which recovered from a net loss of HK$119m in 2022 to a net profit of HK$78m in 2023 as power generation jumped 6x YoY to 0.94bn kWh as more projects came on stream. For the gas business, core net profit was flat at HK$1,841m. The benefit of 8% YoY growth in gas sales volume and RMB0.01/m3 YoY improvement in dollar margin was offset by depreciation of RMB. The profit in RMB terms actually grew 5% YoY.

For 2024, we expect its core earnings to surge 39% YoY mainly on the rapid growth of its renewable business. The company plans to increase its on-grid distributed photovoltaic generation capacity by 1GW to 2.8GW by the end of the year and the power generation to double to 1.9bn kWh. More importantly, the company plans to introduce investors as partners of its renewable business. This will help to finance further investment in this business and reduce the burden on its balance sheet.

For the gas business, the company guides 8% YoY growth in gas sales volume in 2024, higher than our original forecast of 6% YoY growth. The decent growth will mainly come from industrial clients as the company secured a few new big industrial clients. Nevertheless, the company may have to make concession in terms of pricing and hence it guides for flat dollar margin in 2024.

The company's shares are trading at 6x 2024E P/E, the lowest among its peers. Key Risks for Rating

Execution risk of its renewable business.

Faster-than-expected fall in new connections.

Valuation

Although we trim our 2024/25 earnings forecasts by 7%, we increase our DCF valuation from HK$4.00 to HK$4.10 as we roll over our base year from 2023 to 2024. This means we are one year closer to the end of high capex period for its renewable business. In addition, the impact of small cuts in earnings is not that much on free cashflow.