China Galaxy Securities: Concentrated heating industry is on the rise, focus on stocks with high dividends and target assets injection.

China Galaxy Securities released a research report stating that the centralized heating industry has stable growth and high dividend advantages, and recommends focusing on three investment themes: ZJMI Environmental Energy (603071.SH) and Luenmei Quantum (600167.SH), which have low valuation levels and significant dividend advantages; Beijing Jingneng Thermal (002893.SZ), which benefits from asset injection commitments and large installation space; and GCL Energy Technology (002015.SZ), which actively expands its industrial chain. The report points out that the industry's gross profit margin is expected to reach 26.5% in the first half of 2024. With the decline in coal prices, profits are expected to rebound in 2025, coupled with excellent cash flow and a dividend payout ratio of 50%, the sector's allocation value is highlighted. China Galaxy Securities' main viewpoints are as follows: The prospects for centralized heating applications are broad, with prominent energy-saving advantages. Centralized heating has multiple advantages such as fuel savings, pollution reduction, land savings, and improved heating quality, making it increasingly widely promoted. Combined heat and power generation is an important production method for centralized heating, with an efficiency of up to 75-80% using waste heat, far higher than the 35-37% level of coal-fired power plants, highlighting its energy-saving advantages. (1) Residential heating: With the stable growth trend of the urbanization rate, the area of urban centralized heating in China has increased by an average of 6.04 billion square meters annually from 2014 to 2023, with an annual compound growth rate of 7.3%; (2) Industrial heating: The large base of industrial parks provides growth opportunities for centralized heating. From 2014 to 2022, China's steam supply capacity increased from 84,700 tons/hour to 125,500 tons/hour, with an annual compound growth rate of 5.0%. The steam pricing mechanism is mature, and combined heat and power generation has strong profitability and high stability. Combined heat and power generation follows the "thermal determines electricity" operating model, with steam accounting for 80-90% of revenue. Electricity prices follow government pricing, ensuring high revenue certainty, while steam prices are adjusted according to cost linkage modes such as coal-heat linkage and gas-heat linkage, reducing the volatility of fuel price fluctuations. Taking ZJMI Environmental Energy as an example, when the market coal price changes by 25 yuan/ton (corresponding to 31.8 yuan/ton of standard coal), the steam price changes by 4 yuan/ton. Assuming that one ton of standard coal produces 7 tons of steam, and 100% of the heat is used to produce steam, the coal-heat linkage mechanism can hedge about 90% of coal price fluctuations, significantly reducing the risk of profitability fluctuations caused by coal price increases. Compared to traditional coal-fired power plants, the combined heat and power generation industry has a high and stable gross profit margin level, with the average gross profit margin range of listed companies' heat and power businesses from 20-32% since 2020, while the average gross profit margin range of coal-fired power companies during the same period is -3~17%. The cash flow of the combined heat and power generation industry is excellent, and dividends and dividend yields are attractive. The analysis of some listed companies in the heat and power generation industry shows: (1) Strong profitability and high stability: Since 2020, the average gross profit margin of heat and power businesses has been between 20-32%, reaching 26.5% in the first half of 2024, and with the decline in coal prices, profitability is expected to improve in 2025; (2) Excellent cash flow: The annual average net profit cash content and the average operating cash ratio are 140-160% and 110-120% respectively, with excellent profit quality and repayment ability; (3) High dividend levels: The average dividend payout ratio in the industry is about 50% in 2023, with an average dividend yield of about 3%; (4) Valuations are somewhat differentiated: Based on the current closing prices, the average PE (TTM) of the industry is slightly above 20 times, with an average PB of about 2.7 times, where Ningbo Energy Group, Luenmei Quantum, and ZJMI Environmental Energy have PB ratios of 1.12, 1.18, and 1.30 respectively, showing significant undervaluation advantages. Risk warning: Macroeconomic volatility risk; Product price fluctuation risk; Fuel price fluctuation risk; Industry policy change risk.