Revenue growth in the main business has slowed, and the earnings of associated companies have declined

Net profit attributable to the parent company of Hailuo Venture in 2023 was 2.46 billion yuan, -36% year-on-year, lower than our expectations (3.78 billion yuan), mainly due to: 1. The revenue that should be accounted for by associated companies was -43% to 1.66 billion yuan, which was weaker than our expectations; and 2. Core business revenue growth slowed (+1.5% YoY to $8.02 billion in 2023). We reduced the company's 2024/2025 EPS by 49.6%/45.9% to 1.40/1.51 yuan, respectively, and predicted that the 2026 EPS would be 1.61 yuan. Based on the segment valuation method, the company's target price was reduced by 41% to HK$9.9. We expect that the company has passed the stage of rapid expansion. With further optimization of project operations in the future, the company's future earnings quality and cash flow are expected to gradually improve, and the value attributes are expected to gradually be realized. Maintain a “buy” rating.

Waste disposal: Revenue declined somewhat, but the improvement in operational quality was effective. In 2023, the company's garbage disposal business revenue was 6.16 billion yuan, -6.2% year over year, mainly due to the decline in construction revenue (-31% to 2.69 billion yuan), while operating revenue with higher gross margin and more sustainable operating income was +29% to 3.46 billion yuan. The share of operating revenue increased further from 41% in 2022 to 56% in 2023. The waste-to-energy sector received a total of 16.04 million tons of domestic waste, +32% year-on-year; disposed of 13.71 million tons of domestic waste, +33% over the same period last year. Both reception and disposal volumes grew faster than capacity expansion (42,350 tons/day for waste-to-energy projects in transit at the end of 2023, +19% year over year). Feed-in electricity usage was 4.47 billion kilowatts, +29% year-on-year. In order to speed up the return of cash, the company further developed the steam supply business on the basis of the original project, and achieved sales of 57,000 tons of steam last year.

Supply and demand in the cement industry are under pressure, and the recovery of earnings from joint ventures may take longer. Although demand for cement has recovered month-on-month since the Spring Festival, the overall pace is slower than in the same period of the previous lunar calendar. In a context where demand continues to be under pressure, it is also difficult to see the effect of false peak production on improving the supply and demand relationship, and it may not be easy to improve the supply and demand relationship in the industry overnight. In this industry context, we anticipate that the recovery of affiliate earnings may and will still take longer.

Decelerating speed and improving quality will help the company move steadily and farther

The company plans to limit capital expenditure to around 2.5 billion yuan in 2024 (2023:4.6 billion yuan), mainly focusing on the construction of environmental protection projects such as waste-to-energy generation. With the improvement of the company's environmental protection business layout and production capacity investment in new energy materials projects, we expect the peak period of the company's scale expansion has passed. The improvement of operational quality and the release of market competitiveness may become the focus of the company's future development. We believe this will be more beneficial for the company to improve the quality of earnings, raise the level of free cash flow, and achieve steady and far-reaching progress in the face of challenges in market supply and demand.

Risk warning: Waste-to-energy subsidies were put in place later than expected, and the growth in demand for lithium batteries was weaker than expected.