1H24 core profit is in line with our expectations

The company announced 1H24 results: revenue of 54.6 billion yuan, +0.9% YoY; net profit to mother of 2.57 billion yuan, -22.8% YoY, corresponding to earnings per share of 2.29 yuan, core profit of 3.26 billion yuan, and -16.6% YoY. The core profit of its basic business in China was 3.08 billion yuan, +9.5% YoY, and the company's core profit was in line with our expectations. The company plans to pay an interim dividend of HK$0.65 per share, which is +HK$0.01 per share compared to the previous year.

1H24's natural gas retail sales volume was +4.5% YoY to 12.71 billion square meters, gross margin of 0.54 yuan/square meter, +0.02 yuan/square; additional residents connected to 0.775 million households, and the gross margin of the connection business was -8.9ppt to 44.4% year over year, mainly due to the reduction in single-household connection costs for some residents/industrial and commercial users; the integrated energy business achieved sales of 19.74 billion kilowatt-hours, +26% year over year; the gross profit of the smart home business was 1.4 billion yuan, +23% year over year.

Development trends

The gas retail business 2H24 is expected to continue to recover. Benefiting from the positive gas volume growth rate and the increase in gross margin, 1H24's gross profit ratio of natural gas retail business was +7% to 3.14 billion yuan. Looking ahead, considering that urban gas projects such as Yancheng to which the company belongs have completed residential gas price adjustments since July, and natural gas prices are declining or driving demand recovery from some industrial and commercial users, we believe 2H24's natural gas retail margin is still likely to be repaired month-on-month. The gross profit margin of the natural gas retail business is expected to meet the company's current +10% YoY guideline.

Moderately slow down the pace of capital expenditure. 1H24's capital expenditure was 2.74 billion yuan, -21% YoY. Looking ahead, we judge that based on the current macroeconomic situation, the company may moderately slow down the pace of capital expenditure, gradually reduce the scale to 5-6 billion yuan/year, and reduce the scale of capital expenditure or lay the foundation for the company to further increase shareholder returns. Furthermore, the company currently has a 2024E dividend yield of 5.6%, which we believe is already attractive to long-term investors.

The valuation gap compared to peers is likely to gradually close. After the recent sharp correction, Xinao Energy is currently trading at 2024E about 8x P/E, with a 20-30% valuation discount compared to companies such as China Resources Gas/Kunlun Energy. We believe that the valuation discount is mainly due to the current macro environment, and the market is concerned about the company's industrial and commercial gas competition pattern/medium- to long-term return on comprehensive energy business. Looking ahead, we believe that as economic improvements drive the recovery of downstream energy demand, the company's valuation discounts compared to peers may gradually subside.

Profit forecasting and valuation

Due to the decline in gross margin of the connectivity business, we lowered our 2024/2025 profit forecast by 3.0%/4.7% to 6.91 billion yuan/7.52 billion yuan. The current stock price corresponds to 2024/2025 7.9x/7.3xP/E. Maintaining an outperforming industry rating, we lowered our target price by 12.5% to HK$70, corresponding to the 2024/2025 10.3x/9.5x P/E due to lower profit forecasts and a downward shift in the market valuation center. There is 30.8% upside compared to the current stock price.

risks

Natural gas prices have risen sharply, and the smooth price progress has fallen short of expectations.