Core view: The annual report and the first quarterly report fell short of expectations. The rating was lowered to “increase” the Daqin Railway's annual report, which achieved revenue of 81 billion yuan (yoy +7.0%) in 23, and net profit of 11.9 billion yuan (yoy +6.6%). The latter was lower than our expectations (12.9 billion yuan). The company also disclosed a quarterly report. It achieved revenue of 18.3 billion yuan (yoy -7.9%) and net profit to mother of 3.05 billion yuan (yoy -16.7%) in 1Q in '24, which was lower than our expectations ($3.38 billion). Tighter coal safety inspections in Shanxi compounded the impact of imported coal. We expect the freight volume of the Daqin Line to drop to 410 million tons in '24 ('23:422 million tonnes). We expect the company's net profit to be 109/113/117 billion yuan in 2024/2025/2026 (previous value: 127/123 billion yuan).

The company's average PE for 2014-2023 was 9.5x. Considering falling interest rates and strong dividend style, we gave a 30% premium on the historical center 9.5x and adjusted the target price to 7.66 yuan (previous value 7.73 yuan) based on 12.4x 2024E PE (previous value 9.2x2023E PE). Downgraded to “Overweight” rating.

23-year review: Imported coal emissions brought competitive pressure, and the investment income of the Shuohuang Line fell short of the expected completion volume of 422 million tons (yoy +6.4%) of the Daqin Line in 23; among them, 1-3Q traffic decreased 1.2% year on year; 4Q traffic increased 37.6% year on year, mainly due to the low impact base of the epidemic in the same period in '22.

China's raw coal production and coal consumption increased by 3.4% and 5.6% year on year in '23 (Bureau of Statistics), and economic recovery has driven steady growth in demand for coal. However, lower overseas coal prices spurred an increase in import demand. Coal imports increased 61.8% year on year in '23, seizing the share of the southeast coastal coal market and putting competitive pressure on the “West Coal East Transport” railway. There was no increase in revenue for the Shuohuang Railway. Revenue/net profit to mother changed +2.6/ -7.9% year-on-year in '23, or due to increases in repair costs and labor costs. The Shuohuang Railway contributed 2.47 billion yuan in investment revenue in 23 years. After reversing losses in '22, the Haoji Railway contributed 76 million yuan in investment revenue in '23 (+199% year over year).

24Q1 review: Coal safety regulations in Shanxi are getting stricter, and coal mine production cuts dragged down strong demand for electricity and coal in railway freight 1Q. Thermal power generation increased 6.6% year on year, but demand for non-electric coal was weak, and crude steel/cement production fell 1.9/11.8% year on year. On the supply side, China's coal production fell 4.1% year on year in the 1st quarter, and safety supervision intensified to curb production. The amount of coal imported in 1Q increased 14% year over year, still putting competitive pressure on railways. Production contracted significantly in Shanxi due to the “Three Super” reforms. Coal production fell 18.9% year on year; coal production in Shaanxi/Inner Mongolia increased 0.1/2.9% year on year. Since Shanxi is the main source of goods on the Daqin Line, the 1Q Daqin Line freight volume decreased by 6% year on year, which in turn reduced 1Q gross profit by 22% year on year.

The company plans to pay the 2023 dividend according to a 58% dividend ratio. The dividend rate is moderate. The company plans to distribute the 2023 dividend of 6.93 billion yuan, with a dividend ratio of 58%. Since the bond conversion period is in the share conversion period, the company plans to adjust DPS with the total share capital on the day of equity registration. Based on the total share capital at the end of March '23, the DPS is 0.44 yuan; based on the total share capital at the end of March '24, the DPS is about 0.39 yuan/share, with a dividend rate of 5.3%; assuming that all convertible bonds are converted to shares before dividends, the DPS is about 0.35 yuan/share, the dividend rate is 4.7%, and the dividend rate is moderate. The company also proposed a shareholder return plan for 2023-2025, promising a dividend ratio of not less than 55%.

Risk warning: Demand for coal continues to be sluggish, Shuohuang/Haoji/Tangbao/Wari railway diversion volume, reduction in railway freight rates, and the conversion of Daqin to equity swaps and dilution of EPS.