Core views

(1) Three quarterly report results disclosure: The Q3 company achieved non-performance deductions of 1.39 billion yuan, -19% year-on-year and -32% month-on-month. The decline in earnings in a single quarter was mainly due to the effects of Ningxia base maintenance and narrowing product price spreads due to falling oil prices. There aren't many long-term factors.

(2) Long-term logic remains unchanged: by the end of 24, Inner Mongolia's 3 million-ton olefin project will be put into operation and will gradually contribute to performance. While greatly expanding olefin production capacity, the new project will further deepen the company's cost barriers. Overall, the company is still a first-line high-quality target in the industry.

occurrences

2024 three-quarter report: Total revenue for the first three quarters was 24.275 billion yuan, +19% year over year; net profit to mother was 4.536 billion yuan, +17% year over year.

The third quarter achieved revenue of 7.377 billion yuan, +1% year over year; achieved net profit attributable to mother of 12.3.2 billion yuan, -25% year over year; realized deducted non-net profit of 1.39 billion yuan, -32% month-on-month and -19% year over year; brief review

Maintenance impact+slight narrowing of price spreads affected third quarter results

The company's withholding performance declined month-on-month in the third quarter. It is estimated that this is mainly due to the following reasons:

① Volume: The company's polyolefin production and sales in the third quarter all declined significantly compared to the second quarter. According to the operating data of the Third Quarterly Report, however, the company's total production of polyethylene, polypropylene, and EVA in the third quarter was 0.5348 million tons, and sales volume was 0.5286 million tons. Compared with Q2, the month-on-month decrease was 0.1011 million tons and 114,400 tons, respectively. In Figure 1 below, it is calculated that the company's profit per ton of polyolefin is about 2,000 yuan/ton, plus additional costs due to labor, depreciation, and maintenance. The decrease in production and sales alone may cause the company's performance to decline by about 0.3 billion yuan month-on-month in the third quarter. This decline in production and sales may be closely related to the normal maintenance of the company's olefin production facilities.

② Price aspect: Crude oil prices in the third quarter were mainly due to a one-sided decline. The average price of continuous futures in a single quarter decreased by 7 US dollars/barrel from month to month, which put some downward pressure on olefin prices. According to operating data estimates, the average price of the company's polyolefin fell by about 150 yuan/ton in the third quarter compared to the second quarter. In addition, the prices of raw coal and thermal coal used by the company also rose slightly in the third quarter, and the prices of the company's by-products and fine chemical products also followed a slight decline in crude oil prices, all of which narrowed the overall price difference of the company's products.

In summary, the phased decline in third-quarter results is likely mainly due to short-term maintenance and product price fluctuations, and there are not many long-term factors. It was particularly noted that after the unilateral decline in the third quarter, due to continued geopolitical tension, international oil prices rose again to around 75-80 US dollars/barrel in the fourth quarter, providing stronger support for the comprehensive price spread of the company's products.

Olefins maintain a strong cost advantage; dynamic profitability remains steady

Baofeng Energy is located at the Ningdong base, one of the four major modern coal chemical demonstration bases in the country. It is close to high-quality and low-cost coal resources, and has an obvious location advantage. Currently, the entire coal → methanol → polyolefin industry chain has an annual equity of about 9.16 million tons of coal (coking coal, raw coal caliber), 5.9 million tons of methanol, and 1.2 million tons of polyolefin production capacity. At the same time, by-products such as C4 and C5 are further processed into fine chemical products, and the coal chemical industry chain is highly integrated. Coupled with the company's efficient management, the company has significant cost competitiveness. The product gross margin and ROE level have led the industry in recent years, and the overall profit level of coal-to-olefin projects is the highest in the industry. We calculate based on the company's historical financial data and industry conditions, as shown in Figure 1 below. Most of the time, the profit level of the company's olefin products is about 1,200-1500 yuan/ton ahead of other coal head and oil head companies (about 15-20% net interest rate).

From the perspective of prosperity, looking at the current industry supply and demand pattern, we believe that the boom in the olefin industry mainly depends on energy prices. Specifically, it is directly related to the oil and coal price gap. Since 24 years, international oil prices have remained high. Despite some twists and turns, Brent crude oil futures prices have remained around 75 US dollars/barrel. At this level, the dynamic profit per ton of olefins has remained high recently.

The Inner Mongolia base is about to be put into operation. It has the ultimate cost advantage+efficient capital expenditure. The 3 million-ton coal-to-olefin project in Inner Mongolia is expected to be put into operation in the fourth quarter of '24 according to the company's announcement. The project is a key growth for the company in the future. After the project is put into operation, it will more than double the company's olefin production capacity. It is expected to greatly increase the company's revenue and net profit, and at the same time fully reduce the cost of coal-to-olefin, further enhance the company's competitiveness.

The employee stock ownership plan was implemented, and the production capacity expansion period was further tied to employees' interests in March. The company announced an employee stock ownership plan: the total amount of capital to be raised will not exceed 0.149 billion yuan for the employee stock ownership plan. The proposed share repurchase price is 7.6 yuan/share. It is proposed that no more than 30 employees participate in the employee stock ownership plan, including middle and senior management, including CEO Liu Yuanguan, and core executives. The corresponding shares will be unlocked in four batches. The four unlocking periods correspond to the assessment year 2025/2026/2027/2028, respectively. Furthermore, company-level performance assessment targets are based on 2024 revenue, with revenue growth of no less than 20%/30%/40%/50% in 25/26/27/28, respectively. The company is currently constructing a 3 million ton olefin project at the company's Inner Mongolia base, which is at a critical stage of capacity expansion and company growth. At this point, the company implemented an employee stock ownership plan, which helps bind the interests of core employees and ensure the smooth development of the company.

Judging from the assessment goals of the shareholding plan, the assessment goals focus on the company's revenue level. Compared to profit, the company's operating income fluctuates less, especially when the company's core product, polyolefin, is relatively rare, and prices fluctuate greatly; at the same time, considering the company's expected production capacity investment scale, if production capacity is successfully put into operation, the growth rate of product production and sales can also fully match the performance assessment goals. Therefore, overall, we estimate that if the company's production, operation and project construction are stable, it should be able to relatively steadily achieve the company-level performance assessment goals in the employee stock ownership plan.

We believe that the current employee stock ownership plan is more in line with the actual development of the company: although coal chemicals are part of the commodity manufacturing industry, the accumulation of process efficiency is also critical to the company's continuous cost reduction and efficiency improvement. Retaining the company's core technology and management personnel is critical for the company — for example, Mr. Liu Yuanguan, the president of the company, is an excellent professional manager in the coal-to-olefin field, and has played a key role in the smooth commissioning of the company's MTO installation and continuous cost reduction and efficiency over the past many years. Compared to more aggressive performance assessment goals, we believe that more secure goals can also play a better role in binding the interests of core employees. Moreover, the value of the employee's shareholding plan is also sufficient to offset the corresponding financial expenses.

Profit forecasting and valuation

We forecast the company's net profit to mother for 2024, 2025, and 2026 at 6.769, 13.159, and 14.2 billion yuan, corresponding to PE 17.4, 9.0, and 8.3 times. We continue to make key recommendations and maintain a “buy” rating.

Risk warning

1. Risks such as weak demand due to macroeconomic fluctuations; the company's core products are polyolefin and coke, and downstream demand is closely related to macroeconomic performance. When macroeconomic fluctuations occur drastically, it may cause large fluctuations in the company's product demand and prices.

2. Risk of large fluctuations in crude oil prices: Against the backdrop of global geopolitical tension and the general low capital expenditure of large traditional energy companies, we can indeed expect crude oil to maintain a relatively high level for a long time to come, providing support for the company's profits. However, there are many factors affecting crude oil price fluctuations, and it is very difficult to predict. If the price of crude oil falls more than expected, it may cause the profit situation of the company's products to fluctuate greatly.

3. Risks associated with the construction of the Inner Mongolia project and coal mine support: Currently, the construction of the company's Inner Mongolia project is nearing completion, but there is still some uncertainty about the completion and production progress. Furthermore, the company plans to participate in the bidding for local coal mine resources, and there is also some uncertainty as to whether the company can successfully obtain prospecting rights through the bidding process.