Core earnings for the 2024 fiscal year retreated again. China Fuel's core profit for fiscal year 2024 (ending March) fell 4.3% year over year, which is about 10% lower than our expectations. Among them, the major differences are: 1) The increase in consumer retail sales during the period mainly came from the joint venture level (up nearly 5% year-on-year in the second half of the year), which was the main reason that gross profit fell short of our expectations; 2) financial costs were higher than expected by about 11% due to the increase in the cost of the company's non-RMB loans. The company's retail gas volume increased 2.2% year-on-year last year, with a gross margin of 0.5 yuan per square gas (RMB, same below), which is similar to expectations. Although the number of new connections from residents fell 28% year on year to 1.66 million households (higher than our estimate of about 220,000 households), operating profit margin still fell 1.3 percentage points year on year. Despite a weak profit level last year, the company's free cash flow increased further to HK$4.3 billion (+70% year over year). Furthermore, despite the year-on-year decline in core profit, the company maintained a final dividend of HK$0.40.

The gross margin in gas sales is expected to improve further, and the number of new connections has yet to stop falling. The company expects the gross margin to improve further in fiscal year 2025 with the optimization of procurement costs and an increase in the surplus price ratio of civil gas. We estimate that with procurement costs falling by 1 point year-on-year and the average sales price of gas consumption by residents increasing by about 3 points, the retail gas margin will improve to 0.53 yuan per square meter of gas. Furthermore, considering that there is still room for growth in the number of coal-to-gas ventilation households in the company's townships, and that industrial and commercial gas consumption began to improve in the second half of FY2024, we expect the year-on-year growth in the company's retail gas volume to accelerate to 4.2% in FY2025. Considering the objective environment, management is still conservative about the number of new connections to residents in FY2025, which is expected to be in the range of 1.2 to 1.4 million households (a decrease of 16-28% over the previous year).

Profits in the connectivity sector still need to be improved and remain neutral. We lowered our profit forecast for the 2025/26 fiscal year by 11.0%/3.6%, which mainly reflects a more conservative forecast for retail sales growth and another reduction in new connections. Currently, we forecast a 10% year-on-year increase in the company's core profit for FY2025, and the profit for the 2026 fiscal year is expected to increase 10.9% year-on-year as the gross margin in gas sales improves and the decline in new connections narrows. In terms of valuation, we moved the base year to 2025, maintained the valuation standard at 8.5 times the price-earnings ratio, and lowered the target price from HK$6.92 to HK$6.82, maintaining a neutral rating. At present, the operating profit share of the company's gas sales segment has stabilized at around 47%, and the connection sector accounts for 20%. The profit structure has stabilized compared to the past three fiscal years. We believe that an increase in the company's profit stability will improve investors' confidence and is an important catalyst for Zhongran's further valuation repair.