The company’s core earnings dropped 14% YoY to HK$449m in 1H23, 5% below our forecast. While its gas sales did well, its consolidated new connections dipped 27% YoY as the fall in property investment hurt. Given the tough operating environment of some potential clients, the company will slow down the development of its distributed solar business. We cut our 2023/24/25 earnings forecasts by 19%/3%/17% after post-results adjustments. Despite this, we reiterate our BUY call with target price reduced to HK$4.58 given its low valuations.
　　Key Factors for Rating
　　The reported net profit of Towngas Smart Energy (TGSE) grew 7% YoY to HK$1,115m in 1H23 as it booked a HK$600m net gain from the disposal of its 25% stake in Shanghai Gas. Its core earnings dropped 14% YoY to HK$449m mainly on lower new connections and higher corporate expenses. The 7% YoY depreciation of RMB against HK$ also resulted in lower earnings in HK$.
　　While its total new connections still grew 5% YoY to 0.43m HH in 1H23, its consolidated new connections dropped 27% YoY to 0.18m HH. This resulted in a 25% YoY fall in operating profit of its new connections.
　　Its natural gas sales surged 9% YoY in 1H23, beating the 6.7% YoY growth in gas demand in China. The decent growth was mainly driven by the 37% YoY growth in wholesale gas and gas sold to power plants. Dollar margin stayed flat at RMB0.50/m3.
　　Its distributed solar business posted a small net profit of HK$3m in 1H23, a turnaround from a HK$53m net loss in 1H22. The company’s total installed distributed solar power capacity reached 1.12GW by the end of 1H23. This business has started generating revenue from selling power as well as carbon management.
　　Looking ahead, we expect the company’s core earnings in 2H23 to grow 5% HoH. Its distributed solar business should achieve much higher earnings as installed capacity continues to increase. It should also see higher dollar margin as more of its projects increase the residential gas price. It should be partly offset by higher corporate expenses.
　　Key Risks for Rating
　　Faster-than-expected fall in new connections.
　　Execution risk of its distributed solar business.
　　Valuation
　　Given the cuts in our earnings forecasts, we lower our DCF-based target price from HK$5.32 to HK$4.58. This will put us at 9.7x 2023E P/E.