According to the research report released by Huafu Securities, as the economy is presenting a trend of recovery, the revenue scale of the environmental protection industry has been improved. In the first quarter of 2024, the gross margin and net margin of the environmental protection industry were 27.39% and 10.45% respectively, with a year-on-year growth of 1.42pct and 1.68pct respectively. Due to the further deepening of industry cost reduction and efficiency enhancement, the profitability of relevant enterprises has continued to increase. Looking forward to the second half of the year, in the high-quality development stage of the environmental protection industry, there are three main lines recommended around the "dual-carbon" and circular economy: stable volume and price increase in the water affairs industry, the peak of garbage incineration and power generation has passed, cash flow has significantly improved, and it has high dividend potential; benefiting from the "replacement of old with new", the recycling of resources and lithium battery recycling industry are expected to usher in new development opportunities; in addition, under the background of the construction of a new type of power system, the flexible transformation process of thermal power is expected to accelerate.

Huafu Securities' main points are as follows:

Review of 1H24: Significant differentiation in sectors.

From January 2, 2024 to June 26, 2024, the performance of various sectors in the environmental protection industry market showed significant differentiation. In the first quarter of 2024, the environmental protection industry achieved operating revenue of 74.419 billion yuan, a year-on-year increase of 3.24%; operating costs were 54.032 billion yuan; net profit attributable to shareholders was 7.778 billion yuan, a year-on-year increase of 13.84%. As the economy is presenting a trend of recovery, the revenue scale of the environmental protection industry has been improved. In the first quarter of 2024, the gross margin and net margin of the environmental protection industry were 27.39% and 10.45% respectively, with a year-on-year growth of 1.42pct and 1.68pct respectively. Due to the further deepening of industry cost reduction and efficiency enhancement, the profitability of relevant enterprises has continued to increase.

With improved cash flow, sustainable dividends are feasible.

Due to two consecutive years of drought from 2022 to 2023 and a decrease in the total amount of water resources, attention to water resource security is increasing. Water treatment and water resource regeneration still have broad prospects. From January 2017 to March 2024, the price of water for urban residents in 36 key cities has increased from 2.15 yuan/ton to 2.35 yuan/ton, but the overall price is still low, with great potential for upward growth, and it is expected to increase the profits of water supply companies. The peak production of garbage incineration and power generation has passed, and the capital expenditures of related enterprises have decreased significantly. Coupled with the promotion of the cogeneration mode, cash flow has improved significantly, and it has the ability to increase dividends.

Adhering to the dual-carbon national policy and implementing circular economy.

Several provinces and cities have successively issued relevant policies for "replacing old with new". The early new energy vehicle power batteries have gradually entered the stage of upgrading and replacing. Taking Shandong province as an example, 2024-2025 will usher in the first peak of new energy urban buses, electric buses and power battery upgrading. With the rapid increase in the penetration rate of new energy vehicles in recent years, the number of retired batteries is expected to grow rapidly, and related automobile disassembly and lithium battery recycling enterprises are expected to benefit. Under the background of circular economy, the industry of resource regeneration, including recycled plastics, metal resources, and biodiesel, is expected to usher in new development opportunities.

The flexible transformation process of thermal power is expected to accelerate.

Due to limited local consumption capacity, some western regions still have high wind and photovoltaic power abandonment rates. On the other hand, with high summer temperatures and an increase in overall electricity consumption, some regions still lack sufficient peak shaving capabilities. The flexible transformation of stock thermal power units to improve the range of output regulation is currently a suitable way for the structure of the Chinese power system. The flexible transformation cost of thermal power is relatively low, and it has good economic advantages. Under the background of the construction of a new type of power system, relevant policies have determined the "should-have" responsibilities to be borne by power sources within the power generation side and user side and among different power sources within the power generation side. A reasonable auxiliary service price transmission mechanism is expected to accelerate the flexible transformation process of thermal power.

Investment recommendations: In the high-quality development stage of the environmental protection industry, around the "dual-carbon" and circular economy, there are three main lines recommended: stable volume and price increase in the water affairs industry, the peak of garbage incineration and power generation has passed, cash flow has significantly improved, and it has high dividend potential. It is recommended to focus on the water element sector, Chongqing Water Group (601158.SH), Chengdu Xingrong Environment (000598.SZ), and Joint Water Affairs (603291.SH), and focus on the solid waste sector, Chongqing Sanfeng Environment Group Corp. (601827.SH), Yongxing Shares (601033.SH), Grandblue Environment (600323.SH), Wangneng Environment (002034.SZ). Benefiting from the "replacement of old with new", the recycling of resources and lithium battery recycling industry are expected to usher in new development opportunities. It is recommended to focus on High Energy Environment (603588.SH), Yingke Recycling (688087.SH), Miracle Automation Engineering (002009.SZ); biodiesel demand is expanding, and it is recommended to focus on Longyan Zhuoyue New Energy (688196.SH), Shandong High-Speed Renewable Energy (000803.SZ).

The water element sector has stable volume and price increase, and the peak of garbage incineration and power generation has passed, cash flow has significantly improved, and it has high dividend potential. It is recommended to focus on Chongqing Water Group (601158.SH), Chengdu Xingrong Environment (000598.SZ), and Joint Water Affairs (603291.SH). In the solid waste sector, it is recommended to focus on Chongqing Sanfeng Environment Group Corp. (601827.SH), Yongxing Shares (601033.SH), Grandblue Environment (600323.SH), and Wangneng Environment (002034.SZ).

Benefiting from the "replacement of old with new", the recycling of resources and lithium battery recycling industry are expected to usher in new development opportunities. It is recommended to focus on High Energy Environment (603588.SH), Yingke Recycling (688087.SH), Miracle Automation Engineering (002009.SZ); biodiesel demand is expanding, and it is recommended to focus on Longyan Zhuoyue New Energy (688196.SH), Shandong High-Speed Renewable Energy (000803.SZ).

Against the background of the new electrical power system construction, the process of flexible transformation of thermal power is expected to accelerate. Wuxi Huaguang Environment & Energy Group (600475.SH) and Qingda Environmental Protection (688501.SH) are recommended with caution.

Risk warning: policy promotion is slower than expected; pressure on local finance; fluctuations in commodity prices.