China Gas Utilities. The inflection point has come. Time to turn positive

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1 China Gas Utilities The inflection point has come. Time to turn positive We assume coverage of China gas utilities with a positive view. This has been the worst performing subsector within China utilities in the past year, with shares declining by 17%, underperforming HSCEI by 22%. The key reason for the underperformance was weakening gas demand. However, we believe the sell-off is overdone and recommend buying ahead of a potential gas price cut in September, margin expansion and improving gas demand in 1H16. Our top pick is China Gas Gas demand to stabilize in Natural gas consumption has hit an inflection point where demand returned to positive territory in June (from negative growth in April and May) and will stabilize in the next 12 months, in our view. The improvement will be driven by lower gas prices from Sept onwards and industrial users conversion from coal to gas, as directed by the government. Price cut of 10-20% in September. Natural gas prices are currently c30% higher than alternative fuel prices. Based on the NDRC natural gas price formula, NG prices should be cut by c40%. We expect the actual cut, when it s announced in August and implemented in September, will be 10-20% (or Rmb /m3) to mitigate the impact on upstream producers. Interim results may surprise on the upside. We think ENN s 1H15 net profit growth will beat consensus estimates by 5% due to margin improvement and more new connections. We expect inline results for the other names. Rating upgrade and PT changes. We upgrade ENN to OW on back of margin improvement, new connection growth and attractive valuation (P/E of 14x vs historical average of 16x). We lift our PT on China Gas to HK$17.5 and maintain our OW rating on back of resilient EPS growth of c25%. We are OW on CR Gas (on M&A growth) and BJ Enterprises (undemanding valuation of 11x P/E vs historic average of 16x). Risks to our view. Delays in gas cost cut, lower-than-expected gas demand, no margin improvement, and changes to government s plan to increase gas consumption. Hong Kong, China Utilities Elaine Wu AC Bloomberg JPMA EWU <GO> Boris Kan (852) boris.cw.kan@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited Figure 1: Summary of rating and PT PT Price Upside Company Ticker Rating (HK$) (HK$) (%) BJE 392 HK OW China Gas 384 HK OW CR Gas 1193 HK OW ENN 2688 HK OW Kunlun 135 HK N Towngas 1083 HK N Source: Bloomberg; J.P. Morgan. Priced at 30/7/15 Figure 2: China utilities 1-year share performance vs HSCEI 20% 15% 10% 5% 0% -5% -10% -15% -20% 16% 15% 6% 5% Source: Bloomberg; J.P. Morgan. -17% Equity Ratings and Price Targets Mkt Cap Rating Price Target Company Ticker (HK$ mn) Price (HK$) Cur Prev Cur Prev Beijing Enterprises Holdings Limited 392 HK 71, OW n/c China Gas Holdings Limited 384 HK 64, OW n/c China Resources Gas Group Limited 1193 HK 48, OW n/c ENN Energy Holdings Limited 2688 HK 53, OW N Kunlun Energy Company Limited 135 HK 58, N n/c Towngas China Company Limited 1083 HK 17, N n/c Source: Company data, Bloomberg, J.P. Morgan estimates. n/c = no change. All prices as of 30 Jul 15. See page 61 for analyst certification and important disclosures, including non-us analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Table 1: Valuation of our covered gas utilities Company Ticker Mkt Cap P/E (x) Net gearing (%) Yield (%) P/B (x) ROE (%) US$Mn FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E BJE 392 HK 9, China Gas* 384 HK 8, CR Gas 1193 HK 6, ENN 2688 HK 6, Kunlun 135 HK 7, Towngas 1083 HK 2, Average 6, Source: J.P. Morgan estimates, Bloomberg. *FY16/17 used for China Gas, fiscal year end 31 Mar Figure 3: Regional gas sector comp sheet based on consensus estimates Price (LC*) Mkt cap (US$MM) Liquidity (US$MM) Source: Bloomberg. *Local currency. **FY16/17 used for China Gas, fiscal year end 31 Mar P/E FY15E P/E FY16E P/B FY15E P/B EV/EBITDA EV/EBITDA FY16E FY15E FY16E ROE FY15E ROE FY16E EPS FY16E growth Company Ticker HK-listed Beijing Enterprises 392 HK , % China Gas** 384 HK , % CR Gas 1193 HK , % ENN 2688 HK , % HKCG 3 HK , % Kunlun 135 HK 7.3 7, % Towngas China 1083 HK 6.8 2, % Beijing Jingeng 579 HK 2.6 2, % Newocean Energy 342 HK % Suntien 956 HK % Average 6, % Median 6, % China-listed Chongqing Gas Group CH , NA 37.7 NA NA NA NA NA NA NA Sichuan Datong Gas Development CH NA NA % Shaanxi Provincial Natural Gas CH , NA NA % Shenzhen Gas CH 9.4 3, % Average 2, % Median 2, % International comps Korea-listed Korea Gas Corp KS 42,150 3, % SK Gas KS 84, % Seoul City Gas KS 140, % Australia-listed DUET Group DUE AU 2.2 3, % APA Group APA AU 9.0 7, % Ausnet Services AST AU 1.4 3, % Japan-listed Tokyo Gas 9531 JP , % Nippon Gas 8174 JP 4,290 1, NA NA % US-listed AGL Resources Gas US , NA NA NA NA % Atmos Energy ATO US , % Northwesst Natural Gas NWN US , NA NA 7.5 NA 3% Southwest Gas SWX US , NA NA NA NA % Average 4, % Median 3, % 2

3 Table of Contents Investment summary...4 Gas utilities underperformed by 20%. Time to re-enter...5 Weak demand growth already priced in...7 Reasons for weak demand in 1H Reason #1: Weaker GDP growth...9 Reason #2: Lower gas-fired power generation...10 Reason #3: Uncompetitive natural gas price...11 Gas utilities volume growth YTD...12 Positive catalysts to spur demand...13 Gas cost cut in September likely...13 Demand growth from coal-to-gas boiler conversion...16 China s long-term plan to increase natural gas usage...18 Potential margin improvement...19 Stepwise tariff for residential users...19 Margin may improve from lower gas costs...19 Low penetration rate drives organic growth...20 Operations analysis...21 Valuation analysis...23 Company profiles...27 Beijing Enterprises Holdings Limited...28 China Gas Holdings Limited...32 China Resources Gas Group Limited...39 ENN Energy Holdings Limited...43 Kunlun Energy Company Limited...47 Towngas China Company Limited

4 Investment summary Top picks (in order of preference): China Gas: Our bullish view on the company rests on 1) strong EPS growth of 23% pa for FY16-18E backed by a young portfolio with >270 projects, 2) a solid management team whose incentives are aligned with stock options tied to profit and market cap targets, 3) potential upside from expansion in value-added service and improvement in the LPG segment. Our EPS estimates are 6-11% higher than consensus. ENN: Shares of ENN have de-rated from 16x one-year forward P/E to 14x currently, which we think is unjustified considering we think the company can maintain >15% EPS growth in FY15E-16E from new household connections, improving gas margins and gas volume growth of c13%. Catalysts will come from better-than-expected interim results on 19 Aug. CR Gas: CR Gas is on an acquisition winning streak this year having bagged three major acquisitions in Dalian, Qingdao and Qinhuangdao. Acquisition growth will likely account for >50% of its gas volume growth in E. Currently, there are about 50 prefecture level cities (with population of >5MM) that are up for tendering. If CR Gas wins half of these, it could add ~25 cities in the next three years which would allow it to maintain 15-20% EPS growth pa. BJ Enterprises: We think BJE is an inexpensive way to gain exposure to 1) growth in Beijing s gas demand (via increase in gas-fired capacity), 2) China Gas (via its 22% stake in the listco), and 3) Beijing Enterprises Water (via its 46% stake). BJE s stakes in CG and BEW are trading at a c30% discount to market price. We think its valuation is attractive as BJE s shares are trading at 11x 2016E P/E, below its historical average of 16x. Table 2: JPM EPS estimates vs consensus JPMe EPS (reporting curr) JPMe EPS yoy growth Consensus EPS (reporting curr) JPM vs Consensus EPS Company Ticker Rating FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E Comments BJE 392 HK OW % 16% % -2% JPM estimates are largely inline with consensus China Gas* 384 HK OW % 23% % 11% Consensus estimates have not fully factored in China Gas' 23% gas volume growth and growth from value-added service segment, in our view CR Gas 1193 HK OW % 18% % -1% JPM estimates are largely inline with consensus ENN 2688 HK OW % 14% % 2% Consensus estimates have not factored in potential margin improvement and higher household connections, in our view Kunlun 135 HK N % 9% % -8% We assume limited recovery in oil E&P segment and a 5% growth in the natural gas pipeline business. Hence, our 2016E estimates are lower than consensus Towngas 1083 HK N % 12% % -3% JPM estimates are largely inline with consensus Source: J.P. Morgan estimates, Bloomberg. *FY16/17 estimates for China Gas 4

5 Gas utilities underperformed by 20%. Time to re-enter China gas utilities have been the worst-performing subsector within China utilities the past year, with shares declining by an average of 17% and underperforming the Hang Seng China Enterprises Index by 22%. The key reason for the underperformance was weakening gas demand, in our view. However, we believe the selloff is overdone as demand growth has already returned to positive territory in June 2015 and should stabilize in 2H15. Figure 4: China utilities 1-year share price performance Gas -17% HSCEI 5% Wind 6% Water IPP 15% 16% -20% -15% -10% -5% 0% 5% 10% 15% 20% Source: Bloomberg. Gas utilities P/E multiple has de-rated to 12x The average one-year forward P/E multiple for China gas utilities has de-rated to 12x from 14x one year ago. This was the result of the market pricing in a weaker gas demand outlook. However, we believe investors have overlooked potential margin improvements from lower gas cost and growth from new household connections. We expect our favored gas utilities (ie ENN, China Gas, CR Gas and BJE) to continue to generate EPS growth of 15-20% in FY15-16E. Figure 5: China utilities 1-year forward PE multiple by sector (x) x Water 12x Gas 11x Wind 8x IPP Gas Water IPP Wind Source: Bloomberg. 5

6 Of the China gas utilities, Kunlun has been the worst performer, with shares declining by >40% the past year, vs the HSCEI s 5% growth. This is because Kunlun is most vulnerable to declining oil prices (via its oil E&P division) and declining gas demand (midstream gas transmission is its largest earnings contributor). Figure 6: China gas utilities 1-year share price performance vs HSCEI Kunlun Towngas Beijing Entperises China Gas ENN CR Gas HSCEI -50% -40% -30% -20% -10% 0% 10% Source: Bloomberg. 6

7 Weak demand growth already priced in In May 2015, NDRC announced its first record of negative natural gas consumption growth, with demand declining by 6% in April. That was followed by May s negative growth of -5%. In June, gas consumption returned to positive territory and overall growth for June and 1H15 was 2%. We expect gas demand growth to stay at 2-4% for the remainder of the year. Figure 7: China natural gas consumption yoy growth 12% 11% 10% 8% 6% 4% 3% 2% 2% 2% 0% -2% -4% -6% -8% -6% -5% Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Source: NDRC Figure 8: China monthly natural gas consumption (B m3) Source: NDRC Figure 9: China natural gas consumption yoy growth 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% Jul-11 Sep-11 Natural gas consumption volume (yoy growth) Jan Feb Mar Apr May Jun Nov-11 Jan-12 Mar-12 May-12 Jul natural gas consumption volume (B m3) 2014 natural gas consumption volume (B m3) Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 China natural gas consumption (yoy growth) May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Source: NDRC 7

8 We believe weakening gas volume demand was the key reason for gas utilities weak share performance. However, the underperformance has more than captured weakening gas consumption in China, in our view. Based on our sensitivity analysis, a 5% drop in gas consumption would result in a 1-4% decline in the gas utilities' EPS. However, gas utilities shares have fallen by an average of 17% the past year. This has more than priced in the demand weakness, in our view. Figure 10: China gas utilities' EPS impact from 5% decline in gas volume 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% -3.0% -3.5% -4.0% -4.5% -3.8% Source: J.P. Morgan estimates. -2.8% -1.8% -1.7% -1.3% ENN CR Gas Beijing Enerprises Enterprises China Gas Towngas -5% piped gas sales volume impact on EPS Figure 11: Gas utilities shares fell by 10-20% last 12 months, vs estimated -4% EPS impact from weaker sales 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -30.0% -3.6% -2.8% -13.2% -11.0% -1.8% -1.7% -1.3% -20.9% -19.2% -24.3% ENN CR Gas Beijing Enerprises Enterprises China Gas Towngas -5% piped gas sales volume impact on EPS 1-year share performance Source: J.P. Morgan estimates, Bloomberg. 8

9 Reasons for weak demand in 1H15 Reason #1: Weaker GDP growth Year 2015 has been a unique one for the natural gas sector because this is the first time we saw China GDP growth slowing to 7.0% vs 7.4% in This resulted in slowing industrial activities and lower natural gas consumption by industrial users, with apparent gas demand climbing by only 2% in Jan-Jun J.P. Morgan Oil & Gas Team has lowered its 2015 apparent gas demand growth forecast to 4% in 2015 and expects 2016 demand to be at a similar level. We believe gas demand will stabilize in 2H15 and 2016 as our economists expect China GDP growth to stabilize at 7.0% in 2015 and Figure 12: China natural gas consumption vs GDP growth 10.0% 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 21.3% 20.9% 13.0% 12.9% 5.6% 2.1% 4.0% 4.0% H E 2016E China GDP yoy growth China natural gas consumption yoy growth (RHS) 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source: NDRC, Bloomberg, J.P. Morgan estimates. Figure 13: China natural gas demand (MCM) 19,000 18,000 17,000 16,000 15,000 14,000 13,000 12,000 11,000 10,000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: J.P. Morgan estimates, Bloomberg. 9

10 Figure 14: China natural gas production % 10% 5% 0% -5% -10% -15% Jan-13 Mar-13 May-13 Aug-13 Oct-13 Jan-14 Mar-14 Jun-14 Aug-14 Nov-14 Jan-15 China Natural Gas Monthly Production (bcm) yoy growth (RHS) Source: CEIC, J.P. Morgan. 20% of natural gas consumption is from residential demand Within China s natural gas consumption mix, ~50% of total consumption is dependent on the manufacturing and mining sectors, which have been negatively impacted by slowing GDP growth. However, the remaining half of the consumption pie comprises of more resilient demand from residential consumers and the transportation, telecom, commercial and utilities sectors. Figure 15: China natural gas consumption breakdown by sector (2012) Mining Residential 9% 20% Other industries 2% Wholesale, retail, accomodation, catering 3% Transport, storage, Manufacturing postal, telecom 39% 11% Source: National Bureau of Statistics Power, gas, water production 16% Reason #2: Lower gas-fired power generation Currently, ~15% of natural gas demand comes from power generation, on our estimates. Gas-fired generation is used for peak load demand and its utilization rate can be impacted by other types of power generation, including hydropower, wind power and nuclear power. In 1H15, China s power consumption was flat at 1%. The amount of power generation from thermal, which includes gas-fired power, fell by 3% in the same period because hydropower rose by 13% and nuclear rose by 35%. We estimate every 10% fall in gas-fired power generation would have a 1.5% impact on China natural gas consumption. 10

11 Figure 16: China power generation by type in 1H15 40% 35% 35% 30% 25% 20% 15% 13% 10% 5% 1% 0% -5% -10% -3% China on-grid power Hydropower Thermal power Nuclear generation Source: CEC Reason #3: Uncompetitive natural gas price Another reason for weaker natural gas consumption in 1H15 was because natural gas prices were less competitive than other alternative fuels such as fuel oil, which is 25% cheaper than natural gas. This was especially damaging for industrial users like glass manufacturers whose fuel cost comprises >50% of their total cost of goods sold. Some of these companies switched to other types of fuels as a way to save costs. Other industrial users may have delayed their switch to using natural gas seeing that the prices were not competitive. Figure 17: China natural gas prices vs alternative fuels (US$/mmBTU) Coal Brent Fuel oil LPG Natural gas (avg city gate price) Source: J.P. Morgan estimates, Bloomberg. 11

12 Gas utilities volume growth YTD On average, city gas distributors volume sales have grown at a faster rate than the national consumption growth of 2% in 1H15. According to latest updates from the companies, the five listed city gas distributors on average recorded 5M15 gas volume sales growth of 5-15%. However, because the growth rate was lower than what they previously expected, some distributors including China Gas and Towngas China have lowered their 2015 guidance. We believe ENN and China Resources Gas will likely revise down their growth targets during interim results announcement in Aug. Beijing Enterprises: Beijing Enterprises saw c28% yoy growth in gas volume sales in 5M15 due to a surge in consumption from gas-fired power plants in Beijing. Beijing Enterprises currently is the best positioned to meet its 2015 gas volume growth target of 25-30%, in our view. China Gas: The second-best performer in terms of volume sales is China Gas, which saw volume rising by ~15% in 5M15. Management has guided FY16 (ending Mar 2016) volume growth of 23% and 25% for FY17. ENN: In 5M15, ENN gas volume sales grew by 10%. We believe the company may need to revise down its full year 2015 guidance of 15% growth because it s unlikely it can achieve a 20% growth rate in 2H15. However, we expect ENN will increase new household connection and improve on margins to make up for the shortfall in slower-than-expected volume growth. CR Gas: China Resources Gas volume sales grew by 6-8% in 5M15, short of its full year target of 20%. However, the company has announced some major acquisitions this year which may help it achieve double-digit growth. Towngas China: Management revised down its 2015 growth guidance to high single digits after seeing weak demand growth of the same magnitude in 5M15. Figure 18: Gas distributors' gas volume growth YTD vs 2015 target 30% 25% 20% 15% 10% 5% 0% 28% 25-30% 23% 20% 15% 15-20% 10% 8% 5-10% High single digit Beijing Enterprises Enerprises China Gas* CR Gas ENN Towngas Gas volume sales YTD 2015 growth guidance Source: Company management and J.P. Morgan estimates. *May 2015 gas volume sales and FY16 target for China Gas 12

13 Positive catalysts to spur demand Natural gas price formula Price of natural gas (Rmb/m³) = 0.85* x [ 0.6 (FO**, fuel oil) (LPG***)] x (1+0.13) *To encourage switching, an 0.85 ratio is applied to give a discount for natural gas to the calorific-equivalent cost of alternative fuels which is LPG and fuel oil (different from the Guangdong/Guangxi discount of 10% or 0.9 ratio). **FO =Ratio of the calorific values of natural gas to fuel oil multiply with average import cost of fuel oil ***LPG = Ratio of the calorific values of natural gas to LPG multiply with average import cost of LPG Calorific value: Fuel oil 10,000kcal/kg, LPG 12,000kcal/kg, Natural gas 8,000kcal/kg. VAT for natural gas is 13% Gas cost cut in September likely NDRC has been adjusting natural gas prices about every six months based on a formula that takes a 15% discount on the weighted average import cost of oil and LPG. The natural gas prices were last adjusted on 1 April 2015 and we believe the next adjustment will be on 1 September 2015, with the announcement to be made in August. If we apply the current market prices of oil and LPG to the NDRC formula, natural gas prices would have to be revised down by c40% to Rmb1.5/m3 from the current Rmb2.5. However, it is likely that NDRC would adopt a more conservative approach and opt for a 10%-20% reduction, or Rmb /m3, from the current price of Rmb2.5/m3. A smaller reduction could help ensure upstream gas producers would still be incentivized to invest in gas infrastructure. Table 3: Natural gas price based on NDRC formula Fuel oil costs (US$/bbl)* LPG costs (US$/bbl)* Natural gas price based on formula (Rmb/m³) Apr-15* May-15* Jun-15* Jul-15* Aug-15* Sep-15* Source: J.P. Morgan estimates.*based on trailing six-month average prices Figure 19: China natural gas prices after adjustments (in RMB/m3) Before Jul 2013 Jul Aug 2014 Sep Mar 2015 From Apr 2015 From Sep 2015 (JPMe) Incremental gas* Existing gas Weighted average Source: NDRC, J.P. Morgan estimates. 13

14 Table 4: Previous NDRC gas price adjustments Announcement Implementation Details date date 26-Feb-15 1-Apr-15 Slight gas cost cut. Existing and incremental gas prices were aligned. Average city-gate prices for non-residential users declined by 4% to Rmb2.5/m3 10-Aug-14 1-Sep-14 Gas cost hike. City gate natural gas prices of existing gas supplies for nonresidential users increased by Rmb 0.4 /m3, or 31%, to Rmb2.5/m3 28-Jun Jul-13 Gas cost hike. Separate prices for existing and incremental gas supplies were set. Source: NDRC The NDRC raised upstream natural gas (city gate) prices for nonresidential users, where (1) existing gas supplies increased by not more than Rmb0.4/m3 and not more than Rmb0.25/m3 for fertilizer gas and (2) incremental gas supplies increased to a level equal to 85% of the costs of alternative fuels (60% fuel oil /40% LPG mix) in 2H2012. Our estimate of a Rmb0.3/m3 reduction in gas price is inline with a news report from the Independent Chemical Information Services that NDRC may lower natural gas price in 2H2015 by RMB /m3, mainly due to the decline of prices in alternative fuels. The cost of alternative fuels from Jul 2014 to Apr 2015 has decreased by 18% compared to 2014, the report said. After factoring the exploration and import cost, as well as adjusting the 15% discount to 10%, a source close to the NDRC said they expected the city gate price to be lowered by RMB /m3. Based on our estimates, a natural gas cost cut of 12%, or Rmb0.3/m3, would reduce the city gate price for non-residential gas to Rmb2.2/m3, or US$9.6/mmBTU. This would make natural gas more competitive to other types of fuels like fuel oil. Figure 20: China natural gas price could be more competitive after a 12% cut US$/mmBTU Coal Brent Fuel oil LPG Natural gas Natural gas with 12% price cut Source: Bloomberg, J.P. Morgan estimates. 14

15 Lower imported gas prices help support a gas cost cut China s LNG and piped gas import prices have declined YTD by 20-25% to cus$8/mmbtu due to lower oil prices. This will help support a gas cost cut for distributors. Figure 21: China LNG and piped gas import prices (US$/mmBTU) Source: J.P. Morgan estimates, Bloomberg. Figure 22: China total gas supply - BCM Source: J.P. Morgan estimates, Bloomberg. 15

16 Demand growth from coal-to-gas boiler conversion In Apr 2014, NDRC expressed support for the construction of gas-for-coal boiler substitution and, by 2020, to meet the demand of coal to gas substitution of accumulated consumption of 112 billion m3, or 30% of the projected natural gas consumption in This move is especially evident in the northern part of China. In Beijing, Tianjin and Hebei the Air Pollution Prevention and Control Action Plan has called for the replacement of coal-fired boilers and tea bath furnaces with clean energy fuel. The replacement will be done in batches in 2015 and It is expected that use of natural gas as an industrial fuel will increase to 41% of total by Gas fired power generation In 2014, gas-fired power generation contributed to 2% of China's total power consumption and 15% to total natural gas consumption. Going forward, these ratios will increase on back of the government s plan to increase gas-fired power capacity. Figure 23: China gas-fired power capacity E 2025E 2030E 100 Gas-fired power generation capacity (GW) Source: Company data; National Energy Administration. Figure 24: Natural gas consumption from power generation E 2025E 2030E Natural gas consumption from power generation (bcm) % to total natural gas consumption (RHS) 35% 30% 25% 20% 15% 10% 5% 0% Source: China Electric News Net, J.P. Morgan estimates. 16

17 Beijing a beneficiary of increased gas-fired capacity Based on our estimates, power generation will contribute to 30% of China s total natural gas consumption by 2030, up from 15% in We ve already seen how this has benefited city gas distributors. In Beijing, natural gas consumption rose by c28% in 1H15 after two gas-fired plants started operation at the end of This is part of the government's effort to reduce air pollution by replacing coal-fired plants with gas-fired plants. Table 5: Major gas-fired plants in Beijing Location Operator Installed capacity Date of Commission (MW) Northwest Jingneng / Guohua 1,430 Jun 14 Southwest Jingneng 840 Mar 13 Southeast Huaneng 923 Dec 11 Northeast Jingneng / Guohua 1,800 2H 2015 Zhengchangzhuang Huadian Jingke Jingneg 255 NA Gaojing Datang 1, Xiexin CR Gas/ GCL 150 NA Zhengdong Zhengdong Group 120 NA Total 7,406 Source: Government information, State Grid Beijing Electric Power Company 17

18 China s long-term plan to increase natural gas usage China has a long term plan to increase annual natural gas consumption to 230 bcm by 2015, 360 bcm by 2020 and 550 bcm by If these targets were achieved, this would imply 9% CAGR in natural gas consumption in the next five years. With the weaker than expected gas consumption in 1H15 at 906mcm, it seems unlikely the 230bcm target would be achieved this year. However, we believe the central government will continue to promote policies to encourage natural gas consumption as a way to lower air pollution in China. It wants natural gas to account for 10% of the country s total energy consumption by 2020, up from 6% in Figure 25: China natural gas consumption expected to rise by 9% CAGR during E 2020E 2030E China natural gas consumption (bcm) Source: NDRC, J.P. Morgan estimates. Figure 26: China energy consumption breakdown by fuel Oil, 18.5% Figure 27: China energy consumption breakdown by fuel 2020E Oil, 13% Non-fossil fuel, 11.3% Non-fossil fuel, 15% Natural Gas, 6.3% Coal, 63.9% Natural Gas, 10% Coal, 62% Source: CNPC Source: State Council 18

19 Potential margin improvement Stepwise tariff for residential users We expect average residential tariff to increase gradually because the NDRC has a policy to implement stepwise pricing for residential tariffs by end The reason for this is to minimize resource wastage and better align the true value of the fuel to residential prices, which are currently ~20% lower than commercial and industrial users tariffs. Based on this policy, higher volume users will be charged a higher tariff. Below is the guideline set by NDRC. Of our covered gas utilities, CR Gas will benefit the most from this as it is most exposed to residential users, which account for 26% of its total gas sales. Table 6: Stepwise residential tariff system User type Usage within 80% of average Usage within 95% of average Usage at >95% of average Source: NDRC Tariff 1.0x tariff 1.2x tariff 1.5x tariff Margin may improve from lower gas costs Normally, city gas distributors need to apply for gas tariff adjustments when there s a change in city gate price. This process typically takes 1-3 months. In the past, most of the adjustments were upward revisions, which meant higher tariffs for end-users. However, we expect the NDRC will issue a directive for a city gate price cut starting in September. There s a potential for some margin improvement for certain gas distributors if there is some time lag in passing through the price cut or if the cut they pass through to end-users is smaller. Figure 28: China gas utilities could see 2-3% EPS upside from every Rmb1 cent increase in dollar margin 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Source: J.P. Morgan estimates. 2.9% 2.8% 2.3% 1.9% 1.8% CR Gas ENN China Gas BJE TCCL FY16E EPS impact from Rmb1 cent chg in dollar margin 19

20 Low penetration rate drives organic growth With the exception of Beijing Enterprises, which operates in a matured market, the gas utilities under our coverage have a penetration ratio of 45-50%. This means they can still grow by connecting new users at their existing projects. In the past, their focus has been more on connecting to new residential buildings. Going forward, we expect they will start connecting more old residential buildings which still do not have piped gas. Figure 29: City gas penetration rate 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 80% 49% 44% 45% Beijing Enterprises Enerprises ENN China Gas Towngas CR Gas City gas penetration rate FY14 42% Source: J.P. Morgan estimates. Figure 30: City gas volume sales 14,000 12,843 12,000 11,671 10,000 8,975 8,000 7,188 7,032 6,000 4,000 2,000 - Beijing Enterprises ENN China Gas Kunlun Towngas Gas volume sales (MM m3) FY15E Source: J.P. Morgan estimates. Figure 31: City gas volume growth outlook 35% 30% 25% 20% 15% 10% 5% 0% 29% 18% Beijing Enerprises 12% 25% 19% 19% 15% 15% China Gas CR Gas ENN Kunlun Towngas FY15E FY16E 5% 7% 8% 9% Source: Company reports and J.P. Morgan estimates. 20

21 Operational analysis Figure 32: Towngas China has the biggest exposure to commercial and industrial customers 80% 76% 73% 70% 65% 62% 60% 50% 40% 30% 20% 10% 0% Source: J.P. Morgan estimates. Figure 33: Towngas China is the most reliant on connection fee as a source of income 70% 60% 50% 40% 30% 20% 10% 0% Source: J.P. Morgan estimates. Figure 34: ENN has the highest average dollar margin Source: Company reports. Towngas China Gas ENN CR Gas 64% Commercial and Industrial gas sales (% of total) FY15E 53% 47% 44% Towngas CR Gas ENN China Gas % of operating earnings from connection fee in FY15E ENN China Gas CR Gas BJE Average dollar margin (Rmb/m3) in FY

22 Gas utilities profit breakdown Figure 35: Beijing Enterprises 2014 net profit breakdown Figure 36: China Gas FY15 operating profit breakdown Brewery 7% Water 14% China Gas 11% Sales of LPG 6% Fortune Gas 14% Zhongyu Gas 3% Sales of piped gas 33% Other piped gas sales 27% Source: Bloomberg and J.P. Morgan. NG transmission 41% Gas connection 44% Source: Bloomberg and J.P. Morgan. Figure 37: CR Gas 2014 operating profit breakdown Figure 38: ENN 2014 gross profit breakdown Others 2% Gas connection 52% Sales of gas fuel and related products 48% Gas connection fees 46% Sales of piped gas 44% Vehicle gas refueling stations 8% Source: Bloomberg and J.P. Morgan. Source: Bloomberg and J.P. Morgan. Figure 39: Kunlun 2014 operating profit breakdown E&P 11% Natural gas sales 12% Natural gas pipeline 73% LNG terminal and processing 4% Figure 40: Towngas 2014 operating profit breakdown Gas connection 61% Sale of piped gas 39% Source: Bloomberg and J.P. Morgan. Source: Bloomberg and J.P. Morgan. 22

23 Valuation analysis PE band charts Figure 41: Beijing Enterprises 1-year forward PE standard dev P/E(x) Figure 42: Beijing Enterprises 1-year forward PE band chart HK$ sd +1sd Avg -1sd -2sd x 20x 16x 13x 9x Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Source: Bloomberg Figure 43: China Gas 1-year forward PE band chart standard dev P/E(x) Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 +2sd +1sd Avg -1sd -2sd Source: Bloomberg Figure 44: China Gas 1-year forward PE band chart HK$ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 64x 44x 23x 2x Source: Bloomberg Figure 45: CR Gas 1-year forward PE band chart standard dev P/E(x) Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 +2sd +1sd Avg -1sd -2sd Source: Bloomberg Figure 46: CR Gas 1-year forward PE band chart HK$ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 26x 20x 13x 7x Source: Bloomberg Source: Bloomberg 23

24 Figure 47: ENN 1-year forward PE band chart standard dev P/E(x) Source: Bloomberg Figure 49: Kunlun 1-year forward PE band chart standard dev P/E(x) Source: Bloomberg Figure 51: Towngas 1-year forward PE band chart standard dev P/E(x) Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-07 Jul-07 Jan-08 Source: Bloomberg Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd -2sd Figure 48: ENN 1-year forward PE band chart HK$ Source: Bloomberg Figure 50: Kunlun 1-year forward PE band chart HK$ Source: Bloomberg Figure 52: Towngas 1-year forward PE band chart HK$ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Source: Bloomberg 23x 20x 16x 13x 10x 22x 18x 13x 9x 5x 41x 30x 20x 10x 24

25 P/B band charts Figure 53: Beijing Enterprises 1-year forward PB standard dev P/B(x) Source: Bloomberg Figure 55: China Gas 1-year forward PB band chart standard dev P/B(x) Source: Bloomberg Figure 57: CR Gas 1-year forward PB band chart standard dev P/B(x) Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd Figure 54: Beijing Enterprises 1-year forward PB band chart HK$ Source: Bloomberg Figure 56: China Gas 1-year forward PB band chart HK$ Source: Bloomberg Figure 58: CR Gas 1-year forward PB band chart HK$ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul x 1.6x 1.3x 1.0x 0.8x 3.7x 2.9x 2.1x 1.3x 0.5x 4.7x 3.5x 2.3x 1.1x Source: Bloomberg Source: Bloomberg 25

26 Figure 59: ENN 1-year forward PB band chart standard dev P/B(x) Source: Bloomberg Figure 61: Kunlun 1-year forward PB band chart standard dev P/B(x) Source: Bloomberg Figure 63: Towngas 1-year forward PB band chart standard dev P/B(x) Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-07 Jul-07 Jan-08 Source: Bloomberg Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd -2sd +2sd +1sd Avg -1sd -2sd Figure 60: ENN 1-year forward PB band chart HK$ Source: Bloomberg Figure 62: Kunlun 1-year forward PB band chart HK$ Source: Bloomberg Figure 64: Towngas 1-year forward PB band chart HK$ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Source: Bloomberg 3.9x 3.3x 2.7x 2.1x 1.5x 2.9x 2.4x 1.9x 1.3x 0.8x 1.9x 1.5x 1.2x 0.8x 0.5x 26

27 Company profiles 27

28 Overweight 0392.HK,392 HK Price: HK$55.50 Price Target: HK$70.00 Previous: HK$75.00 Hong Kong Utilities Elaine Wu AC Bloomberg JPMA EWU <GO> Boris Kan (852) J.P. Morgan Securities (Asia Pacific) Limited Price Performance HK$ Jul-14 Oct-14 Jan-15 Apr-15 Jul HK share price (HK$) R-CHIP (rebased) YTD 1m 3m 12m Abs -12.4% -7.2% -26.6% -22.0% Rel -13.2% 1.1% -5.2% -15.2% Beijing Enterprises Holdings Limited Undervalued gas conglomerate We see BJE as an inexpensive way to gain exposure to 1) growth in Beijing s gas demand (via increase in gas-fired capacity), 2) China Gas (via its 22% stake in the listco), and 3) Beijing Enterprises Water (via its 46% stake). BJE s stakes in CG and BEW are trading at a c30% discount to market price. BJE s shares are trading at 11x 2016E P/E, below its historical average of 16x. Strong gas volume growth in 2015: BEH has achieved gas volume sales growth of c28% in 5M15, in line with its full year guidance of 25-30%. The strong growth was driven by the commissioning of two gas-fired power plants in 4Q14 in Beijing. Gas volume growth will be 15% in 2016 and 5-10% in as per management guidance. In addition, utilization of gas-fired power plants may increase if there s a gas cost cut in 2H15. Winter heating may increase gas use: Currently, there are ~5,000 heating companies in the Beijing area. The switch to using gas for winter heating may result in more volume growth for BJE. Jingneng s and BJE s parent companies are involved in this business. Heating fee is partly subsidized by NDRC. Shaanxi-BJ pipeline growth at <10%: Volume growth from the pipeline slowed to 6% in 5M15 due to slowing demand from nearby city gas projects. In Hebei in particular, with lower LNG prices, the demand for piped gas declined. Management guided for full-year growth target of <10%. However, the transmission segment should see an improvement in ASP in 2015 because the proportion of sales to customers with long distances rose this year. We believe the weak growth has been factored into current share price. Waste projects injection into BJ Development possible in 2H15: BJE may inject its solid waste treatment projects (with treatment capacity of 13,000 tons/day) into Beijing Development (154 HK, Not Covered) by end-2015, in our view. With the injection, BJD will have 17,000 tons/day of waste treatment capacity, making it a top ten solid waste treatment company in China. Company Data Shares O/S (mn) 1,284 Market Cap (HK$ mn) 71,281 Market Cap ($ mn) 9,195 Price (HK$) Date Of Price 30 Jul 15 Free Float(%) 40.0% 3M - Avg daily vol (mn) M - Avg daily val (HK$ mn) M - Avg daily val ($ mn) 13.7 R-CHIP 4, Exchange Rate 7.75 Fiscal Year End Dec Beijing Enterprises Holdings Limited (Reuters: 0392.HK, Bloomberg: 392 HK) HK$ in mn, year-end Dec FY13A FY14A FY15E FY16E FY17E Revenue (HK$ mn) 42,361 47,936 58,118 66,314 73,547 Net Profit (HK$ mn) 4,184 4,832 5,674 6,575 7,506 EPS (HK$) DPS (HK$) Revenue growth (%) 19.1% 13.2% 21.2% 14.1% 10.9% EPS growth (%) 26.8% 4.7% 17.0% 15.9% 14.2% ROCE 4.6% 3.5% 3.7% 4.0% 4.1% ROE 9.0% 8.7% 9.6% 10.3% 10.8% P/E (x) P/BV (x) EV/EBITDA (x) Dividend Yield 1.5% 1.6% 1.8% 2.1% 2.4% Source: Company data, Bloomberg, J.P. Morgan estimates. 28

29 Key catalysts for the stock price: Upside risks to our view: Downside risks to our view: Gas sales volume movement Change in gas cost Higher-than-expected ASP for the gas transmission business Lower-than-expected gas cost Lower-than-expected gas sales Lower gas transmission fee Key financial metrics FY14 FY15E FY16E FY17E Valuation and price target basis Revenues (HK$MM) 47,936 58,118 66,314 73,547 Our Dec-16 PT is determined based on sum-of-the-parts valuation Revenue growth (%) 21.8% 22.8% 22.9% 21.1% methodology to value each segment. Our PT implies 13x FY16E P/E and EBITDA (HK$MM) 5,682 6,526 7,191 7, x FY16E P/B. EBITDA margin (%) 11.9% 11.2% 10.8% 10.4% Tax rate (%) -9% -9% -9% -9% Net profit (HK$MM) 4,832 5,674 6,575 7,506 EPS (HK$) EPS growth (%) 4.7% 16.9% 15.9% 14.2% FY14 net profit breakdown DPS (HK$) BVPS (HK$) Operating cash flow (HK$MM) 854 6,997 8,391 9,354 Free cash flow (HK$MM) (599) 3,274 4,813 5,698 Interest cover (x) Net margin (%) 10.1% 9.8% 9.9% 10.2% Sales/assets (X) Debt/equity (%) 54.6% 55.9% 46.3% 46.1% Net debt/equity (%) 38.1% 35.9% 32.4% 27.8% ROE (%) 9% 10% 10% 11% Key model assumptions FY14 FY15E FY16E FY17E Gas sales volume (MM m3) 9,960 12,843 15,104 17,055 New household connections (MM) Brewery 7% Other piped gas sales 27% Water 14% China Gas 11% NG transmissio n 41% Source: Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates. Sensitivity analysis EBITDA EPS JPMe vs. consensus, change in estimates Sensitivity to FY15E FY16E FY15E FY15E EPS (LC) FY15E FY16E 1% rise in gas cost -3.6% -3.7% -5.6% -5.7% JPMe old % rise in piped gas volume 1.2% 1.2% 1.8% 1.8% JPMe new Rmb1 cent chg in dollar margin 1.2% 1.2% 1.8% 1.9% % chg -8% -7% Consensus Source: J.P. Morgan estimates. Source: Bloomberg, J.P. Morgan estimates. 29

30 Investment Thesis, Valuation and Risks Beijing Enterprises Holdings Limited (Overweight; Price Target: HK$70.00) Investment Thesis Beijing Enterprises is an infrastructure/utilities-focused conglomerate under the Beijing government. It owns Beijing Gas, which has over >5MM connected households and sells >10bcm of annual gas sales. The company owns a 40% stake in the BJ-Shaanxi gas transmission pipeline, a 46% stake in Yanjing Beer, a 44% stake in Beijing Enterprises Water, and a 22% stake in China Gas. We have an OW rating on the company because we believe the stock is undervalued, trading at discount to its historical average of 16x P/E and 1.3x P/B. We expect earnings to grow at 15-20% pa during Valuation Our Dec-16 PT of HK$70.0 is based on sum-of-the-parts valuation. Our PT implies 13x FY16E P/E and 1.3x FY16E P/B. Segment Valuation methodology Valuation discount NAV per share (HK$) % of total Piped gas DCF 20% % Yanjing Brewery JPM PT Rmb9.0 30% % BJE Water JPM PT HK$7.9 20% % China Gas JPM PT HK$ % % Solid waste treatment Replacement 0% % cost Net debt 0% (19.9) Minority interests 0% (9.6) Total % Source: J.P. Morgan estimates. Risks to Rating and Price Target Downside risks to our PT include lower-than-expected gas sales in Beijing and at its BJ-Shaanxi transmission pipelines and delays in the rollout of new gas fired power plants. 30

31 Beijing Enterprises Holdings Limited: Summary of Financials Income Statement Cash flow statement HK$ in millions, year end Dec FY13 FY14 FY15E FY16E FY17E HK$ in millions, year end Dec FY13 FY14 FY15E FY16E FY17E Revenues 42,361 47,936 58,118 66,314 73,547 Pre-tax profit 5,301 5,970 7,011 8,124 9,275 % change Y/Y 19.1% 13.2% 21.2% 14.1% 10.9% Depr. & amortization 2,254 2,351 2,501 2,660 2,808 EBITDA 5,951 5,682 6,526 7,191 7,656 Change in working capital 908 (6,938) (1,125) (740) (535) % change Y/Y 19.9% (4.5%) 14.9% 10.2% 6.5% Taxes (717) (625) (663) (769) (877) EBIT 3,698 3,331 4,024 4,531 4,848 Others (1,193) 610 (53) (104) (425) % change Y/Y 19.2% (9.9%) 20.8% 12.6% 7.0% Cash flow from operations 6, ,997 8,391 9,354 EBIT Margin 8.7% 6.9% 6.9% 6.8% 6.6% Net Interest (1,134) (1,172) (1,411) (1,552) (1,389) Capex (6,411) (2,514) (5,000) (4,982) (4,914) Associates 2,737 3,812 4,398 5,145 5,816 Disposal/(purchase) - Other Income Free cash flow 759 (599) 3,274 4,813 5,698 Earnings before tax 5,301 5,970 7,011 8,124 9,275 Other (314) (5,618) % change Y/Y 27.6% 12.6% 17.4% 15.9% 14.2% Cash flow from investing (6,725) (8,132) (4,621) (4,603) (4,535) Tax (545) (565) (663) (769) (877) as % of EBT 10.3% 9.5% 9.5% 9.5% 9.5% Equity raised/(repaid) Exceptional items - Debt raised/(repaid) ,128 3,700 (4,284) 2,922 Net income (reported) 4,184 4,832 5,674 6,575 7,506 Other (863) (2,440) (1,411) (1,552) (1,389) % change Y/Y 29.3% 15.5% 17.4% 15.9% 14.2% Dividends paid (864) (1,123) (1,305) (1,512) (1,726) Shares outstanding 1,160 1,279 1,284 1,284 1,284 Cash flow from financing (1,080) 8, (7,348) (193) EPS (reported) % change Y/Y 26.8% 4.7% 17.0% 15.9% 14.2% Beginning cash 11,516 10,132 11,208 14,567 11,007 Ending cash 10,795 11,208 14,567 11,007 15,633 DPS Balance sheet Ratio Analysis HK$ in millions, year end Dec FY13 FY14 FY15E FY16E FY17E HK$ in millions, year end Dec FY13 FY14 FY15E FY16E FY17E Cash and cash equivalents 10,795 11,208 14,567 11,007 15,633 EBITDA margin 14.0% 11.9% 11.2% 10.8% 10.4% Accounts receivable 4,393 5,321 6,451 7,361 8,164 Net profit margin 10.0% 10.1% 9.8% 9.9% 10.2% Inventories 5,661 5,393 6,539 7,461 8,275 Others 5,357 11,324 11,324 11,324 11,324 Current assets 26,207 33,246 38,881 37,153 43,396 Sales per share growth 16.8% 2.6% 20.8% 14.1% 10.9% Sales growth 19.1% 13.2% 21.2% 14.1% 10.9% LT investments 29,402 33,506 35,265 37,323 39,649 Net profit growth 29.3% 15.5% 17.4% 15.9% 14.2% Net fixed assets 38,997 39,321 41,819 44,141 46,247 EPS growth 26.8% 4.7% 17.0% 15.9% 14.2% Others 15,017 17,991 17,991 17,991 17,991 Interest coverage (x) Total Assets 109, , , , ,283 Liabilities Net debt to equity 22.2% 38.1% 35.9% 32.4% 27.8% Short-term loans 6,617 17,691 19,454 17,413 18,805 Sales/assets Payables 2,383 2,238 2,714 3,097 3,434 Assets/equity Others 16,904 15,188 15,863 16,572 17,316 ROE 9.0% 8.7% 9.6% 10.3% 10.8% Total current liabilities 25,904 35,118 38,031 37,081 39,556 ROCE 4.6% 3.5% 3.7% 4.0% 4.1% Long-term debt 18,386 19,439 21,376 19,134 20,663 ROA 4.2% 4.1% 4.4% 4.9% 5.3% Other liabilities 1,264 1,456 1,456 1,456 1,456 Total Liabilities 45,554 56,013 60,863 57,671 61,675 Shareholder's equity 54,021 57,176 61,545 66,608 72,387 BVPS Source: Company reports and J.P. Morgan estimates. 31