The company's recent situation

Xinao Energy announced 1-3Q24 business situation briefing, 1-3Q24 retail gas volume 18.82 billion square meters, YoY +4.8%, including industrial and commercial gas volume 14.84 billion square meters, YoY +5.7%, retail gas gross margin 0.54 yuan/square meter, YoY +0.04 yuan/square; added 1.104 million households, YoY -19.1%; comprehensive energy sales volume 29.668 billion kilowatt-hours, YoY +21.4%. We estimate the core profit of Xinao Energy's domestic basic business YoY +10-15% in 1-3Q24, which is a further increase in growth compared to 1H24 (+9% YoY).

reviews

The 4Q24 gas volume growth rate/gross margin improvement trend is expected to continue. Considering 1) if the temperature does not fluctuate greatly, China's gas supply and demand will be relaxed in 4Q24; 2) the contract gas volume price for the heating season of upstream gas wholesalers is steady to moderate and downward; we believe that gas demand from some of the company's cost-sensitive industrial and commercial customers may return, which is beneficial to the overall improvement in 4Q24 gas volume growth; in terms of gross margin, considering that there is still some room for improvement in residents' net prices (59% of the company's household gas volume surplus price ratio as of 3Q24), we judge that the overall gross margin of the company may reach 0.54-0.55 yuan/square meter in 2024.

The improvement in the gas volume growth rate may be expected to boost the company's valuation, and the dividend ratio is quite attractive. Xinao Energy is currently trading at about 8.6x P/E in 2024E. Compared with China Resources Gas, we believe that the main reason is that the market is concerned about the profit recovery situation in the company's natural gas retail business. We believe that with the further improvement of the company's 4Q24 gas volume growth rate and gross margin, the company's short-term valuation may still have some room for repair.

Furthermore, the current stock price corresponds to the 2024E dividend rate of about 5.1%, which we think is still attractive.

The return of utility attributes and the increase in dividend payment capacity may favor the upward shift in the medium- to long-term industry valuation center. We believe that from 2H21, the urban fuel industry's valuation was systematically downgraded from 15-20x P/E to about 8-10x P/E currently due to market expectations 1) the cyclical strengthening of the business model of urban combustion companies due to poor cost transmission; 2) the connection business will continue to be pressured by the downturn in the real estate cycle. At this point, we believe that 1) Benefiting from the increase in the commercial gas price ratio and the return of natural gas prices to a reasonable range, the utility attributes of gas companies are gradually returning. 2) As the real estate industry is still under pressure, most gas companies have made strategic adjustments. By reducing the scale of expansionary capital expenditure and emphasizing increasing the return level of stock projects, it is expected that free cash flow and the scale of dividends will increase steadily. We believe that in the medium term, the return of utility attributes and the increase in dividend payout capacity are expected to drive the gas company industry valuation center back to around 15x P/E.

Profit forecasting and valuation

The profit forecast for 2024 and 2025 remains unchanged. The current stock price corresponds to 2024/2025 8.6x/7.6x P/E. Maintaining an outperforming industry rating and a target price of HK$70, corresponding to 2024/2025 10.3x/9.2x P/E, with 20.9% upside compared to the current stock price.

risks

Natural gas prices fluctuated greatly, and the return on the comprehensive energy business fell short of expectations.