Incident: The company's stock price has fluctuated greatly recently.
The number of projects under construction continues to decline, and the waste-to-energy industry has entered an existing operating period, accounting for more than 50% of the company's operating service revenue in 2023. As the waste power generation group led by Everbright Environment continued to expand production capacity over the past 20 years, the waste incineration capacity of China's large and medium-sized cities has become nearly saturated, and large-scale high-quality new construction projects have continued to decline. According to Polaris Solid Waste Network statistics, a total of 10 waste incineration power generation concessions were opened in the first half of 2024. Compared with the 27 projects that were tendered in the same period in 2023, the number fell 63%, and the construction scale fell 77%. The waste incineration industry will enter the operating period of stock projects during the 14th Five-Year Plan period. As the leader in the industry, the revenue structure of waste incineration power generation also changed from construction to mainly operation. In 2023, the company's operating service revenue accounted for more than 50% for the first time, reaching 58.4%.
Capital expenditure has declined, and the company's free cash flow is expected to improve. According to the accounting and measurement rules of the BOT business, the company recognizes construction revenue during the construction phase of the project, so the current year's construction revenue can be roughly regarded as annual capital expenditure. According to the company's announcement, the company's construction service revenue for 2021-2023 was HK$26.84/13.16/7.49 billion, respectively. Capital expenditure dropped sharply in 2023. Considering that the company has few projects under construction, it is expected that the company's capital expenditure will be further reduced in the late 14th Five-Year Plan period. Looking at cash flow from operating activities, the Hong Kong accounting standards classify most of the capital expenses related to BOT project construction as operating cash outflows. If this is adjusted, the company's adjusted net operating cash flow exceeds HK$7 billion in 2023, and the company's free cash flow is expected to correct this year.
The amount of national compensation arrears is large. If they are recovered one after another, the company's cash flow will improve further. In addition to the reduction in capital expenditure and the improvement in free cash flow, the company formed a large amount of accounts receivable in the past operating process. By the end of 2023, the company's accounts receivable and notes were HK$20 billion. It is expected that a large proportion of this amount will be national compensation arrears. If recovered one after another, the company's cash flow level will further improve. On March 12, 2024, Everbright Green (Everbright Environmental holds 69.7% of its shares) announced that from January 1 to March 8, 2024, 16 agricultural and forestry biomass power generation project companies received supplementary settlement notices. The total settlement amount was approximately RMB 1.534 billion (as of the end of 2023, Everbright Green had accounts receivable and notes of HK$7.9 billion). We believe that biomass power generation projects are difficult to operate, and that cash flow is dragging down the survival of enterprises. National compensation arrears are expected to be disbursed one after another. Everbright Environment currently accounts for a relatively high share of accounts receivable, and if subsidies are paid out, they will significantly improve the level of cash flow.
As the macroeconomic environment at home and abroad changes, we analyze the market's repricing of risk or as the core driving force for sector rotation for some time to come. Low-covariance and long-term assets are expected to continue to dominate. The profit stability of waste incineration power generation is high. The company's overall annualized ROE remains around 10%, which is less affected by the economy, and the mainstream method is expected to be commissioned operation after the project franchise expires, which basically conforms to the definition of low covariance and long-term assets. Moreover, as the number of projects under construction decreases and free cash flow recedes, the company's profit and cash flow will be more consistent. It is recommended to focus on investment opportunities in the solid waste industry due to the spread of the low-covariance industry. Also, from the perspective of the dividend rate, the company's average annual dividend rate remains around 30%, and the current dividend ratio for 2024-2026 remains at 5.7%, 5.9%, and 6.2%. It is recommended to focus on the dividend value.
Profit forecast and valuation: Considering the decline in construction revenue, we lowered the company's 2024-2026 net profit forecast to HK$4.14, 4.31, and 4.49 billion (4.573, 4.715, and HK$4.84 billion before the reduction), respectively. The PE corresponding to the current stock price is 5.3, 5.1, and 4.9 times, respectively. Assuming that the 2024-2026 dividend rate remains 30%, the company's dividend rates for 2024-2026 are 5.7%, 5.9%, and 6.2%, respectively, maintaining a “buy” rating.
Risk warning: Project commissioning progress falls short of expectations, subsidy policy changes