You need to directly refer to the application settings that you are trying to override, and explicitly specify the property with the replaced value.
<configuration>
<configSections>
<sectionGroup name="applicationSettings" type="System.Configuration.ApplicationSettingsGroup, System, Version=4.0.0.0, Culture=neutral, PublicKeyToken=b77a5c561934e089">
<section name="appname.Properties.Settings" type="System.Configuration.ClientSettingsSection, System, Version=4.0.0.0, Culture=neutral, PublicKeyToken=b77a5c561934e089" requirePermission="false" />
</sectionGroup>
</configSections>
<applicationSettings>
<appname.Properties.Settings>
<setting name="setting1" serializeAs="String">
<value>new string value</value>
</setting>
</appname.Properties.Settings>
</applicationSettings>
</configuration>
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