Key points of investment

Incident: In 2023, the company achieved operating income of 3,956 billion yuan, a year-on-year decrease of 13.39%, a year-on-year net profit of 629 million yuan, a year-on-year decrease of 15.51%, after deducting non-return net profit of 618 million yuan, a year-on-year decrease of 15.66%; the weighted average ROE decreased by 2.33 pct to 8.31% year on year.

Steady growth in operating revenue and optimization of profit structure. In 2023, the company's operating revenue was 3.140 billion yuan, up 11.36% year on year, and the gross operating profit margin was 46.39%, down 4.31 pct year on year, mainly due to the climbing slope of new projects and the need to pay raw material costs for some projects to mix industrial waste; construction revenue was 815 million yuan, down 53.33% year on year, and construction gross profit margin was 8.22%, up 0.15 pct year on year.

The company's share of operating revenue increased from 62% in 2022 to 79% in 2023. Profit structure optimization and increased share of high-margin business led to a year-on-year increase in comprehensive gross margin of 4.14pct to 38.52% in 2023? By 2024M1's waste incineration operation capacity exceeded 40,000 tons/day, expanding steam supply to optimize profits and improve cash flow. In 2023, the company put into operation 4 new waste incineration power generation projects, adding 4,600 tons/day. By the end of 2023, the company had 36 domestic waste power generation operation projects, with a treatment capacity of 39,500 tons/day. After the Jingxi Project (800 tons/day) was put into operation in January 2024, the operating treatment capacity exceeded 40,000 tons/day. As of 2024M1, there were no projects under construction. In 2023, the company disposed of 13.4468 million tons of household waste, an increase of 17.98%, achieving a feed-in capacity of 3,894 million kilowatts, an increase of 11.87%, and a ton of feed-in electricity of 290 kilowatts per ton, a decrease of 5.17%. This is mainly due to the expansion of steam supply affecting power generation. In 2023, the company achieved a steam supply of 428,600 tons, an increase of 42.00% over the previous year. The steam supply business was more profitable than excess power generation, and the cash flow from market-based transactions was paid in a timely manner.

Furthermore, the company will build a low-carbon environmental protection industrial park as a new business development direction, and set up a project team to focus on promoting the high-quality industrial relocation and low-carbon environmental protection industrial park project in Huanghetan District, Zhangqiu District, Jinan City. It officially signed an investment cooperation agreement in December 2023, which is expected to accelerate implementation.

The company's free cash flow turned positive, and the dividend ratio increased. 1) Cash inflow: The company's net operating cash flow in 2023 was 978 million yuan, down 19.17% year on year. This is mainly due to a year-on-year decrease in national reimbursement payments received in 2023, a decrease in cash received from the sale of goods and services compared to the same period last year, and increased pressure to repay garbage disposal fees. 2) Capital expenditure: $722 million in cash payments for the construction of fixed, intangible and other long-term assets, a year-on-year decrease of 41.48%. We measure free cash flow using “net operating cash flow - cash paid from fixed, intangible, and other long-term assets”. The company's free cash flow was corrected for the first time in 2023, and endogenous dividend capacity improved. The company's dividend ratio in 2023 was 33.22%, up 10.77pct from 2022, with a dividend of 0.15 yuan per share, an increase of 25% over the previous year.

The Changzhou project applied for a green certificate to seize opportunities in the green trading market. The company's Changzhou project successfully applied for a green certificate, opening a new chapter in electricity trading. Energy consumption assessments are getting stricter, and demand for green certificates is expected to accelerate. Currently, the green license price for waste-to-energy generation is underestimated at 0.03 yuan/degree, and the carbon reduction for waste incineration is 0.00132 tons. According to the carbon price of 60 yuan/ton, corresponding to 0.08 yuan/degree, the green certificate price is expected to match the real green value in the future.

Profit forecast and investment rating: The company's solid waste operations are growing steadily, projects under construction are slowing down, capital expenditure has dropped sharply, free cash flow is positive, and long-term cash flow values are highlighted to welcome revaluation. Considering the decline in construction and the slowdown in operating growth, we lowered net profit to mother in 2024-2025 from 9.83/11.09 to 6.67/716 million yuan. We expect net profit to be 768 million yuan in 2026, +6%/+7% year-on-year in 2024-2026, corresponding to 14/13/12 times PE, maintaining a “buy” rating.

Risk warning: insufficient amount of garbage, project construction progress falling short of expectations, extended accounts receivable period, etc.