China Gas Holdings (LHS)

Transcription

1 China / Hong Kong Company Guide Version 1 Bloomberg: 384 HK Equity Reuters: 0384.HK DBS Group Research. Equity 29 Sep 2017 Refer to important disclosures at the end of this report BUY (Initiate coverage) Last Traded Price ( 26 Sep 2017):HK$22.90 (HSI : 27,513) Price Target 12-mth: HK$27.10 (18% upside) Analyst Tony WU CFA tonywuh@dbs.com Patricia YEUNG patricia_yeung@dbs.com Price Relative HK$ Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 (LHS) Relative HSI (RHS) Relative Index Forecasts and Valuation FY Mar (HK$ m) 2017A 2018F 2019F 2020F Turnover 31,993 41,564 50,636 58,768 EBITDA 7,825 10,044 12,133 13,641 Pre-tax Profit 5,902 8,393 10,486 12,021 Net Profit 4,148 5,965 7,418 8,492 Net Pft (Pre Ex) (core profit) 4,475 5,965 7,418 8,492 EPS (HK$) Core EPS (HK$) EPS Gth (%) Core EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) Core PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): New New New Consensus EPS (HK$) Other Broker Recs: B: 14 S: 2 H: 5 ICB Industry: Utilities ICB Sector: Gas, Water & Multiutilities Principal Business: Investment, construction and operation of city gas pipeline projects Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Leading the village invasion Major beneficiary of rural coal-to-gas conversions Expect further cut in transmission tariffs, stimulating demand We forecast stronger than peers gas sales volume CAGR of 31% in FY17-FY20 Initiating coverage with BUY rating and HK$27.10 TP Growth leader in gas distribution. We initiate coverage on China Gas Holdings (CGH) with a BUY rating. CGH is the first mover and major beneficiary of the strong growth of rural coal-to-gas conversions, driving its earnings growth to the top of the industry at 27% CAGR from FY17 to FY20. Boosted by government's support to increase natural gas usage, we believe the re-rating cycle for Chinese gas distributors has more room to run and CGH will be in a solid position to ride on the uptrend. Where we differ. We are more bullish than the market on CGH as we are optimistic on the prospects of rural coal-to-gas conversions, which is the key driver in gas sales volume and connection fees. Potential catalyst. The potential announcement of a cut in intraprovincial pipeline transmission tariffs and our optimistic view on the progress of rural coal-to-gas conversions are expected to drive up sales volume growth, and share price. Valuation: We initiate coverage on CGH with a BUY rating. We derive a TP of HK$27.1 based on DCF valuation. We have assumed beta of 1.1, 7.2% WACC (equity risk premium of 7%, risk free rate of 3%, and 3.6% after tax cost of debt) and 1% terminal growth. Key Risks to Our View: Slowdown in the expansion of rural coal-to-gas projects from increasing competition or lack of government support. At A Glance Issued Capital (m shrs) 4,969 Mkt. Cap (HK$m/US$m) 113,779 / 14,564 Major Shareholders Beijing Enterprises Gp. Co. Ltd. (%) 24.8 Liu Ming Hui (%) 21.9 Chiu Tat Jung Daniel (%) 19.6 Chey Taewon (%) 15.7 Free Float (%) m Avg. Daily Val. (US$m) 15.8 ed- JS / sa- DL

2 China /Hong Kong Company Guide Table of Contents SWOT Analysis 3 Valuation 4 Aggressive industry leader 6 The right move at the right time 9 Financials 11 Appendix 12 Page 2

3 China/Hong Kong Company Guide SWOT Analysis Strengths One of the industry leaders with SOE backing Weaknesses Higher debt level than peers Strong project acquisition ability Optimal geographical mix with exposure to preferred regions Largest LPG distributor in China Opportunities Expanding market share for rural coal-to-gas conversions Lower pipeline transmission tariffs to boost demand Implementation of tier-pricing system to secure additional residential customers Threats Slowdown in execution of government policy Dollar margin compression Slowdown in industrial activities in China Source: DBS Vickers Page 3

4 China /Hong Kong Company Guide Valuation We initiate CGH with a BUY rating. We derive a TP of HK$27.1, based on DCF valuation. Our DCF assumptions are beta of 1.1, 7.2% WACC (equity risk premium of 7%, risk free rate of 3%, and 3.6% after tax cost of debt) and 1% terminal growth. The stock is currently trading at 15.3x FY19 PE, which is at a 25% premium to its peers. We believe the premium valuation is justified given its strong FY17-FY20 earnings CAGR of 27%, implying PEG of 0.99 compared to peers average of 1.2. We believe there is more upside to the current re-rating cycle as the market has not fully factored in the gas sales growth potential from rural coal-to-gas conversions and lower pipeline transmission tariffs. Compared to peers, we reckon CGH s more aggressive and proactive management style will allow CGH to quickly expand its market share from capturing opportunities from coal-to-gas conversions. In terms of geographic exposure, it has the most number of projects located in Beijing-Tianjin-Hebei region, where are our favoured regions for growth potential for coalto-gas conversion projects. CGH is subject to lower dollar margin risks due to its diversified business mix. More than 30% of its revenues come from other business segments (LPG and value-added services), compared to peers with less than 5%. Moreover, it has lower exposure to Fujian, Zhejiang, Liaoning, Shandong and Jiangsu, which we believe is subject to higher risks in terms of gas distribution margins. Peers PE vs EPS growth PE Kunlun Towngas BEH CR Gas 0 0% 5% 10% 15% 20% 25% FY17-19 EPS growth Source: Thomson Reuters, DBS Vickers ENN China Gas PE chart PB chart x Sep-08 Sep-09 +1SD: 21.1x Avg: 14.9x -1SD: 8.6x Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 x Sep-08 Sep-09 +1SD: 3.1x Avg: 2.3x -1SD: 1.4x Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Source: Thomson Reuters, DBS Vickers Source: Thomson Reuters, DBS Vickers Page 4

5 China/Hong Kong Company Guide Peers Table Mkt PE PE Yield Yield P/Bk P/Bk EV/EBITDA ROE ROE Price Ca p Fiscal 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F Compa ny Na me Code Local$ US$m Yr x x % % x x x x % % *# 384 HK ,563 Mar Enn Energy Holdings* 2688 HK ,400 Dec China Resources Gas Gp HK ,572 Dec Towngas China 1083 HK ,875 Dec Beijing Enterprises Hdg. 392 HK ,607 Dec Kunlun Energy 135 HK ,573 Dec # FY17: FY18; FY18: FY19 Source: Thomson Reuters, *DBS Vickers Peers comparison China Gas (384 HK) * ENN (2688 HK) Towngas (1083 HK) CR Gas (1193 HK) Sales mix Gas sales : 43% Connction fee : 18% Others : 39% Gas sales : 80% Connction fee : 16% Others : 4% Gas sales : 77% Connction fee : 23% Others : 0% Gas sales : 73% Connction fee : 23% Others : 5% FY16 Blended dollar margin (Rmb/m3) FY16 gas sales 12,224 14,329 7,120 16,272 volume (m m3) FY17/FY18 gas volume growth 40% / 30% 32%/ 26% 18% / 15% 20% / 15% FY 16 gas volume mix Commercial & Industrial (C&I) : 74% Residential : 16% Gas station : 10% C&I : 77% Residential : 13% Gas station : 11% Commercial : 18% Industrial : 55% Residential : 27% Avg ROA (exclude connection fee) 3% 3-4% 5% 4% Total # of projects Project distribution in China Strategy Eastern : 25% Central : 20% Northern : 20% Southern : 10% Western : 7% North Eastern : 18% Focus in coal-to-gas conversion projects, first mover in rural coal-to-gas conversion Eastern : 46% Central : 16% Northern : 14% Southern : 19% Western : 2% North Eastern : 3% Expand coal-to-gas conversion market shares and diversify into integrated energy solution business Eastern : 45% Central : 3% Northern : 6% Southern : 7% Western : 20% North Eastern : 19% Develop distributed gas energy projects, space heating in non-central heating regions such as J iangsu and Zhejiang C&I : 67% Residential : 22% Gas station : 11% Eastern : 36% Central : 17% Northern : 7% Southern : 14% Western : 13% North Eastern : 13% Tackle coal-to-gas conversion areas in Beijing- Tianjin-Hebei regions and the Bay areas * FY17 -> FY3/18 ; FY18 ->FY3/19 Source: Company, DBS Vickers Page 5

6 China /Hong Kong Company Guide Aggressive industry leader Strong project acquisition ability. CGH is one of the top gas distributors in China with the strong ability to secure projects. CGH is mainly involved in the construction and operation of city gas pipelines as well as the sale of natural gas and liquefied petroleum gas (LPG) in China. The company also invests in gas terminals, storage, transportation, logistics systems, and vehicle refilling stations. CGH has a solid track record in securing gas projects, which has enabled them to achieve higher growth than peers. As at the end of FY17, it owns 330 gas projects in 25 provinces with total piped gas sales volume of 12.2bn cubic metres (m3). The accumulated number of connected residential customers reached 20.7m as at the end of FY17 from 7.2m at the end of FY12, which implies a CAGR of 24%. We reckon the SOE background of CGH s shareholder will help the company to secure new projects since frequent negotiations with local governments are usually needed. Beijing Enterprises Group (BEG) became its major shareholder in 2012 with a stake of 19.7% at the time. In August 2013, BEG strengthened the relationship by signing a strategic cooperation framework agreement with CGH to jointly develop and invest in gas related projects as well as realise synergies by leveraging on its operations in upstream pipeline transmission, downstream supply and refuelling stations. Moreover, the 15.7% stake from one of the largest conglomerates in South Korea, SK Holdings ( KS), and 19.7% stake from upstream oil and gas player, Fortune Oil Limited, is a vote of confidence in China Gas solid business. Shareholding structure Accumulated number of customers 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 FY12 FY13 FY14 FY15 FY16 FY17 # of customers Source: Company Natural gas sale volume m m FY13 FY14 FY15 FY16 FY17 Liu Ming Hui Fortune Oil Limited Source: Company City gas Wholesale Beijing Enterprises Holding (392 HK) 21.9% 19.7% SK Holdings ( KS) 24.9% CGH (386 HK) 15.7% Source: Company Page 6

7 China/Hong Kong Company Guide Project list Eastern Number of projects Connectable Residential Households Accumulated Connected Residential Customers Penetration rate Length of Pipelines (km) Anhui 21 3,439,967 1,812,057 53% 7,135 Jiangsu 15 2,403,191 1,352,534 56% 6,506 Zhejiang 6 770, ,314 41% 2,277 Shandong 18 3,272,612 2,010,994 61% 6,900 Fujian 36 2,030, ,634 48% 8,460 Jiangxi 6 216,450 65,426 30% 769 Central Hubei 34 3,242,820 1,849,895 57% 6,104 Hunan 5 799, ,289 36% 1,278 Henan 25 1,809,188 1,032,056 57% 5,203 Shaanxi 5 960, ,675 55% 1,760 Northern Hebei 39 1,891, ,169 41% 4,599 Shanxi 2 124,737 14,247 11% 634 Tianjin 3 112,230 8,778 8% 280 Inner Mongolia 14 2,157,547 1,374,955 64% 4,701 Ningxia 2 249,566 69,446 28% 845 Southern Guangxi 17 4,098,163 1,772,791 43% 7,355 Guangdong 14 1,548, ,203 24% 3,395 Northeastern Liaoning 23 4,810,838 3,404,487 71% 11,907 Jilin 4 175,187 66,173 38% 363 Heilongjiang 27 3,939,867 2,232,333 57% 8,806 Western Gansu 6 170,321 2,330 1% 35 Guizhou 1 159,752 32,312 20% 26 Yunnan 3 91,809 15,227 17% 37 Xinjiang Uygur 2 57,276 2,486 4% 6 Chongqing 1 398, ,891 43% 1,310 Source: Company Well positioned in our preferred regions. CGH has high exposure in our favoured regions, namely Beijing-Tianjin-Hebei and surrounding areas. This allows them to be better positioned to capture opportunities from coal-to-gas conversions. As at the end of FY17, approximately 25% of its projects are located in Beijing-Tianjin-Hebei and surrounding areas. We believe Beijing, Tianjin, Hebei, Henan, Shandong, and Shanxi will be the largest markets for rural coal-to-gas conversions, underpinned by visible government policy support. Number of projects in Beijing-Tianjin-Hebei area China Gas ENN Towngas CR Gas Beijing Tianjin Hebei Henan Shandong Shanxi Total Source: Company, DBS Vickers Page 7

8 China /Hong Kong Company Guide The government shifted its focus to tackle the use of coal in rural areas starting in 2017 as rural residential coal consumption is believed to be one of the major contributors to air pollution. Beijing-Tianjin-Hebei will be the focus as rural household coal consumption in these regions accounted for >70% of the total residential coal consumption. In 2013, the Chinese government issued the Action Plan on Prevention and Control of Air pollution. A priority of the action plan is to reduce coal usage through the replacement coal-fired boilers and one of the key regions was Beijing-Tianjin-Hebei and surrounding areas. Household coal consumption Ton'000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Source: CEIC Beijing Tianjin Urban Hebei Largest LPG distributor. CGH is the largest vertically integrated LPG operator and distributor with 92 LPG distribution projects and 1,100 retail stores, serving more than 6m users. It has 8 LPG terminals located along coastal areas and 300,000 m3 of storage facilities. The demand for LPG in China has been strong in recent years due to the increasing use in deep processing of industrial chemicals. According to S&P Global Platts, LPG demand in China grew 26% y-o-y to 49.84m metric tonnes (mt) in 2016, though at a slower rate, it is expected to grow >10% in With strong distribution channels and an integrated value chain, we estimate the volume CAGR for LPG business to reach 13% between FY18 to FY20. After multiple years of falling ASP for LPG due to oil price decline and glut in supply growth, ASP for China s LNG has been relatively stable this year, and flat YTD. Assuming ASP declines slightly by 5% in each of the next three years, revenue for the segment is expected to increase 10% and 6% in FY18 and FY19 respectively. Shanxi Rural Shandong Henan LPG price Rmb/kg Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Source: Wind LPG supply and demand in China 10,000 ton % Supply (LHS) Demand (LHS) Import % (RHS) Source: Wind Page 8

9 China/Hong Kong Company Guide The right move at the right time First mover in rural coal-to-gas conversions. We believe the company s main earnings driver will be from rural coal-to-gas conversions and the market has not fully appreciated this growth potential. The government started to roll out supportive policies for rural coal-to-gas conversions this year and we believe the potential market size could exceed 40m households. CGH gained early mover advantage for being the first aggressive player to tap into this market. This would allow CGH to quickly expand its market share in rural coal-to-gas conversions. Accumulated number of rural coal-to-gas customers in China # household 6,000,000 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 The number of township coal-to-gas conversions for CGH only reached 34,432 by the end of FY17. As of March 2017, CGH had completed registration of 10 new companies and signed contracts to convert 500,000 village users from coal to natural gas, including 20,000 users from Xiongan New Area. As at the end of August, the number of contracted users has already reached 2.1m. We believe potential new connections from township conversion projects will exceed 1m in FY18, which will help to boost residential new connections for CHG. Our forecast for new connections for residential users is 3.7m, 4.8m, and 5m in FY18, FY19, and FY20 respectively. In addition, customers in rural regions will tend to use more natural gas than customers in urban areas as they do not have central heating, and this would help to boost gas sales volume on a recurring basis. To quantify this, assuming urban households use c.100 m3 p.a., gas usage in rural households will be higher, at above 1,000 m3 p.a. during winter especially for heating. Thus, 1m household connections is expected to consume >1,000m m3 of gas, which would account for 8% of gas sales volume based on FY17 financials. The connection fees per rural household is higher at Rmb3,000 4,000, due to the remote location and lower population density. However, we reckon stringent procurement process and increasing economies of scale will allow CGH to lower its procurement cost compared to industry peers. Therefore, we assume connection GPM to reach 40%. 0 FY17 FY18 FY19 FY20 Source: Wind Lower pipeline transmission tariff City gate price Upstream explant price Long distance pipeline transmission tariff Medium -short distance pipeline transmission tariff Distribution margin End selling price Source: DBS Vickers Page 9

10 China /Hong Kong Company Guide Lower price, higher demand. The National Development and Reform Commission (NDRC) issued a document in Oct 2016 proposing to limit the return for long-distance pipeline transmission. Under the new tariff structure, the investment return is capped at 8% for long distance gas transmission pipelines based on a minimum utilisation of 75%. As a result, the city-gate price was cut by Rmb0.1/m3 in Aug 2017 in response to the 15% cut in long distance transmission tariff and lower VAT. units of gas appliances will be installed for non-rural areas and 50% of the rural coal-to-gas customers will adopt CGH s gas heaters, we forecast revenue from value-added services will jump by 70% and 50% to Rmb1.4bn and Rmb2.1bn in FY18 and FY19 respectively. Gasbo products We are expecting more details relating to the return on intraprovincial transmission pipelines to be released in the coming months. We have seen tariff cuts in a few provinces such as Shandong and Jiangxi ranging from 7% to 34%, and we expect more provinces will follow. Assuming 15% cut in intraprovincial transmission tariff, the city-gate price and nonresidential selling price will reduce by Rmb /m3. Recent intra-provincial tariff cuts Date Province Old tariff New tariff Cut % Jul-17 Shandong % Apr-16 Zhejiang % Apr-16 Guangdong % Nov-16 Jiangxi % to 31% Oct-16 Shaanxi % Source: Company Source: NDRC, DBS Vickers We believe intra-provincial tariffs will be cut across multiple provinces amid government s intention to tighten the regulation for midstream. This will lower the city-gate price and effectively transfer to lower end- selling price without affecting a distributor s dollar margin. We have seen higher demand as gas distributors lowered distribution margin and selling price in the past months. Therefore, we are expecting the demand to continue to accelerate after lowering the intra-provincial tariffs, which does not affect the distribution margin. Room to increase penetration. We reckon the low penetration rate for CGH s existing gas projects provides plenty of room for organic growth. As at the end of FY17, the penetration rate reached 53.1%, which is far lower than the 80% threshold for an average mature project. Assuming the penetration rate increases by 5ppt p.a, organic growth will reach 9%, which would help to boost new connection revenue and gas sales growth. Strong growth in value-added services. CGH started to provide value-added services in FY16 in order to expand its operations, from a gas product provider to integrated operation services provider. Value-added services include e-commerce platform, supply of gas appliances (Gasbo), gas insurance, water purifiers, air purifiers, gas alarm systems, bottled water, gas corrugated pipes, and provision of maintenance and equipment conversion services. We believe the value-added services will achieve robust growth by leveraging on its existing >25m customer base and the strong growth from rural coal-to-gas conversions. The company sold 400,000 units of gas appliances in FY17. Assuming 400k Page 10

11 China/Hong Kong Company Guide Financials We expect CGH to deliver net profit CAGR of 27% from FY17 to FY20, higher than peers average of 15% growth. The stronger earnings growth is mainly driven by its more aggressive expansion in rural coal-to-gas conversions, which will drive up sales volume of piped gas, and new connection fees. We estimate revenue to increase 30% and 22% in FY18 and FY19 respectively. The revenue breakdown is expected to comprise of 45% piped gas sales, 21% connection fees, 31% LPG sales, and 3% from value-added services in FY18. For city gas projects, we forecast sales volume to increase 35% and 30% to 11.4bn and 14.9bn m3 in FY18 and FY19 respectively. For new connection fees, we expect revenues to increase by 53% and 32% in FY18 and FY19. We have assumed a flat average connection fee of Rmb2,540 for urban residential households and Rmb3,300 for rural residential households. As we are optimistic on CGH s rural coal-to-gas connection outlook, we expect residential new connections to reach 3.7m and 4.8m in FY18 and FY19 respectively vs 2.6m in FY17. We believe value-added services will achieve robust growth of 70% and 50% in FY18 and FY19, driven by gas appliance sales in rural regions. For LPG business, we expect sale volume growth to beat the industry average of 13%, reaching 16% in FY18. We conservatively assume 5% decline in LPG ASP based on the downtrend in recent years. Revenue breakdown HK$m 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY17 FY18 FY19 FY20 Piped gas Gas connection LPG Value-added services GPM for value-added services and LPG to be down 1.3ppts and 0.50ppts to 45% and 10.8% respectively in FY18. Gross margin 28% 26% 24% 22% 20% 18% 16% Source: Company FY17 FY18 FY19 FY20 The operating expenses to sales ratio is expected to gradually decline on increasing economies of scale. We expect selling and administrative expenses to sales ratio to drop 0.70ppts to 8.4% in FY18. Approximately HK$101m exchange losses were realised in other gains/loss as the Rmb has appreciated so far this year, we conservatively assume no exchange gains in FY18. The balance sheet of CGH is expected to continue to improve on strong cash inflow. The capital expenditure for the group is expected to reach HK$3.5bn in FY18, comprising of c.hk$500m of maintenance and HK$3bn for project expansion. The net gearing ratio is expected to decline to below 40% in FY19 from 79% in FY17. Thus, the dividend payout ratio may increase going forward. Source: Company We estimate the overall GPM will remain fairly stable. We are factoring in a slight gas sales dollar margin decline of Rmb0.02 / m3 in FY18 to take into consideration discounts offered to coalto-gas customers and competition from direct gas supply. The GPM for new connection fees is expected to go down from 73.5% in FY17 to 64% in FY18 from higher proportion of rural customers, which command lower margins of 40%. We assume Page 11

12 China /Hong Kong Company Guide Appendix Management profile Manager Age Appointment Previous experience Mr. Zhou Si 60 Chariman Mr. Zhou previously took up the role as ED in Graduated from Tsinghua University, he is experienced in urban management, economics and finance. He is also the vice chairman, ED, CEO of Beijing Enterprises Holding Ltd (392.hk) and vice chairman of Beijing Enterprises Group Company, both of which have interest in shares and underlying shares of the company. Prior to joining the company, he was chairman and ED of Beijing Properties (Holdings) Ltd (925.hk). Mr. Liu Ming Hui 54 Executive Chariman, Managing Director, President Mr. Liu is the founder of the company and a part of the executive committee, nomination committee and remuneration committee. He was previously the ED, MD and nonexecutive director of the company. His brother Mr. Liu Mingxing is the non-executive director. Mr. Huang Yong 54 Executive President Mr. Huang is the founder of the company and was elected as ED in He holds position as director for subsidiaries of the company and a member of the executive committee. He worked at Shenzhen Nanyou (Holdings) Ltd. and Asia Environmental Development Company Limited before joining the company. As a graduate from Wuhan University in Law, he is knowledgeable in legal issues and corporate management. Mr. Zhu Weiwei 44 VP Graduated with a Master s in finance from Zhongnan University of Finance and Economics, Mr. Zhu is experienced in financing and capital management and is also the CFO and director of subsidiaries of the company. He was previously elected as ED in Mr. Ma Jinlong 50 VP Mr. Ma has experience in human resources management and operations with a master s degree from University of International Business and Economics. He was previously appointed as ED in 2002 and is currently the director of subsidiaries of the company and member of each of the executive committee and nomination committee. Ms. Li Ching 59 ED Ms Li was appointed as ED in 2014 and was previously the ED of Fortune Oil Ltd which has interest in shares and underlying shares of the company. She graduated from School of Public Finance of Central University of Finance and Economics and is experienced in finance and corporate management. Source: Company Page 12

13 China/Hong Kong Company Guide A lucrative industry with bright prospect Natural gas is greatly supported by the Chinese government as a type of fossil fuel that burns cleaner than oil or coal. The government is currently reducing coal consumption and increasing clean energy consumption in an attempt to improve the environment. China targets to increase the energy consumption proportion for natural gas from 5.9% in 2015 to 10% in 2020 and 15% in By the end of 2016, the natural gas consumption increased 6.7% to 205.8bn, which accounted for 6.2% of the energy consumption in China. In order to reach the government s target, we expect the natural gas consumption to reach above 330bn m 3 by 2020, representing a CAGR of 13%. China natural gas consumption mix Industrial 64% Construction 0% Transport, Storage & Telecom 12% Residential 19% Wholesale, Retail and Catering Na 3% Other Consumption 2% China natural gas consumption m m 3 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Mar-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Feb-17 Jun-17 50% 40% 30% 20% 10% 0% -10% -20% -30% Source: CEIC Average operating heat rate Btu/ kwh 12,000 11,000 10,000 9,000 8,000 Source: CEIC Mid Price (m m3) (LHS) y-o-y % (RHS) 7,000 6, The natural gas consumption volume is highly dependent on industrial users, in turn which is correlated to underlying economic growth and the implementation of coal-to-gas conversion. Approximately 64% and 19% of the natural gas was consumed by industrial and residential users. For residential gas usage, it is mainly driven by the increasing penetration into existing residential buildings and construction of new residential buildings. Thanks to the improved economic growth in China, the natural gas consumption growth has rebounded in 1H17 reaching 15.2%. We expect the gas sales growth to continue as the governments tightens natural gas policy enforcements in order to reach the natural gas consumption target. Source: EIA Coal Petroleum Natural Gas Natural gas enjoys higher efficiency and lower carbon dioxide (CO2)/ nitrogen oxide (NO) / sulfur dioxide (SO2) emission compared to some of the traditional fossil fuels. Natural gas emits 50%/ 80%/99% less CO2/ NO/SO2 than coal, and 30%/80%/99% less than oil. Natural gas power plants operated at c.25% lower heat rate (more efficient) than coal and petroleum power plants Current city-gate pricing mechanism saids... The pricing mechanism for natural gas has seen several changes over the past years and it is heading towards the direction of market oriented pricing. Prior to 1993, the ex-factory gas price was set by the government. Since then, natural gas price has gradually adopted government-guided pricing, which implies greater Page 13

14 China /Hong Kong Company Guide price flexibility. At the current stage, the market netback pricing method is adopted, where a maximum city gate price is set by the NDRC, and the price is pegged to the alternative energy price. Natural gas price setting policies Date Policy Policy details Before 2011 Dec-11 J ul-13 Sep-14 Apr-15 Cost plus pricing method (Natural gas price set by government and facilitated by market. Price is determined at reasonable margin on top of production cost. ) Market net back pricing method. Link city gate market price with alternative fuels Market net back pricing method. Separate existing gas volume and incremental gas volume. Link incremental gas price with alternative fuels. Market net back pricing method. Narrow price down differences between existing and incremental gas. Market net back pricing method. Merge existing and incremental gas. Source: NDRC, DBS Vickers Trial in Guangdong and Guangxi Seeks to adjust price of incremental gas to a fair level comparable to alternative energy s price. For non-residential use, price will increase RMB 0.4/m³. Price for gas used to produce fertilizers will merge and increase by RMB 0.25/m³. Price for residential users will remain unchanged. Price for incremental gas remains unchanged. Non-residential users' existing gas price increase RMB 0.4/ m³. Price for gas used to produce fertilizers and residential users remain unchanged. Non-residential users incremental gas decrease by RMB 0.44/ m³. Existing gas increase RMB 0.04/ m³. Price for gas used to produce fertilizers increase by less than RMB 0.2/ m³ to a suitable level. Price for residential users will remain unchanged. Nov-15 Market net back pricing method. Price for non-residential users decrease RMB 0.7/ m³. No price floor is set while the ceiling price can increase by 20% starting from 20 Nov 2016 Aug-17 Market net back pricing method. Price for non-residential users decrease RMB 0.1/ m³ There is additional downside to the city-gate price even if we exclude potential transmission and distribution tariff cut factor. Firstly, based on the market net back pricing method, the city gate price falls into the range of Rmb /m3, which is below the Shanghai standard price of Rmb2.08/m3. Secondly, if we examine at the competitiveness of natural gas price to alternative fuel, there is more downside to the current level if the balance spread is restored to the 2014 level before the oil price crash. Alternative fuel price and natural gas price Rmb/mmbtu Jun-14 Jun-17 LPG Fuel Oil Crude Oil Steam Coal Shanghai city-gate price Source: DBS Vickers Page 14

15 China/Hong Kong Company Guide Average connection fee - residential (HK$) CRITICAL FACTORS TO WATCH 3,409 2, Critical Factors First mover into rural coal-to-gas. We believe the company s main earnings driver will be from rural coal-to-gas conversion and the market has not fully appreciate its growth potential. We estimate the earnings contribution from rural coal-to-gas contribution will amount to >10% and >20% in FY18 and FY19. The government started to roll out supportive policies for rural coal-to-gas conversion this year and we believe the potential market size exceeds 40m households. CGH gained early mover advantage for being the first aggressive player to tap into the market. 2,435 1,948 1, A 2017A 2018F 2019F 2020F New connections - residential (m households) The number of township coal-to-gas replacement only reached 34,432 by the end of FY17. By the end of March 2017, CGH completed registration of 10 new companies and signed contracts to convert 500,000 village users from coal to natural gas, including 20,000 users from Xiongan New Area. By the end of August, the contracted users already reached 2.1m. We believe the new connection from township conversion projects will exceed 1m in FY17, which can help to boost residential new connections. Our forecast for new connection of residential users amounts to 3.7m, 4.8m, and 5m in FY18, FY19, and FY20 respectively. Lower transmission tariff, higher demand. We believe the intraprovincial tariff will be cut further amid government s intention to intensify the regulation for midstream. This will lower end selling price without affecting distribution dollar margin, which will boost gas demand growth and is positive for share price. We believe details in regards to the return regulation of intraprovincial transmission tariff to be released in the coming months. We have seen tariff cuts in a few provinces such as Shandong and Jiangxi ranging from 7% to 34%, we expect more provinces will follow. Assuming 15% cut in intraprovincial transmission tariff, the city-gate price and nonresidential selling price is expected to be reduced by Rmb /m A 2017A 2018F 2019F 2020F Gas sales volume (m m3) 28,286 27, ,629 22, , ,972 12, ,314 9, , A 2017A 2018F 2019F 2020F Dollar margin (Rmb/m3) A 2016A 2017A 2018F 2019F Source: Company, DBS Vickers Page 15

16 China /Hong Kong Company Guide Share price chart China Gas rel to HSI (Rebased J an 10 = 100) Acceleration of rural coal-togas conversion Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Source: DBS Vickers Page 16

17 China/Hong Kong Company Guide Balance Sheet: Lower net gearing level. Strong earnings growth in the next few years is expected to lower net gearing ratio and support dividend payout. We forecast FY18 net gearing will decline to 58% from 79% in FY17, which supports CGH s intention to increase dividend payout ratio gradually Leverage & Asset Turnover (x) Share Price Drivers: Coal-to-gas conversion. The coal-to-gas conversion progress in China will determine the ramp up speed of gas consumption. The market share gained in rural coal-to-gas conversion will help to drive up the share price. Lower gas selling price. The cut in city-gate price will result in lowering of end selling price and boost in gas consumption. We are anticipating another round of pipeline transmission tariff cut to take place within the next few months A 2017A 2018F 2019F 2020F Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure HK$m 3, , , , , , , , , , , A 2017A 2018F 2019F 2020F 0.5 Key Risks: Sluggish economic growth in China. The natural gas sales volume is sensitive to the underlying economic growth. A slowdown in economic growth have negative impact to demand for gas demand from C&I customers. 25.0% 20.0% 15.0% Capital Expenditure (-) ROE Lack of government policy enforcement. Poor execution in supportive government policies can negatively affect the sentiment and performance for gas sector. For instance, a prolonged subsidy payment delay for rural customers can discourage new customers coming into the market Company Background: CGH is mainly involved in the in the construction and operation of city gas pipelines as well as the sale of natural gas and liquefied petroleum gas (LPG) in China. The company also invests in gas terminals, storage, transportation, logistics systems and vehicle refilling stations. CGH was listed in 2001 on the Hong Kong Stock Exchange. 10.0% 5.0% 0.0% 2016A 2017A 2018F 2019F 2020F Forward PE Band (x) sd: 21.6x sd: 18.1x Avg: 14.6x sd: 11.2x 8.9-2sd: 7.7x 6.9 Sep-13 Sep-14 Sep-15 Sep PB Band (x) Mar-14 Mar-15 Mar-16 Mar-17 Source: Company, DBS Vickers +2sd: 4.47x +1sd: 3.94x Avg: 3.4x -1sd: 2.86x -2sd: 2.33x Page 17

18 China /Hong Kong Company Guide Key Assumptions FY Mar 2016A 2017A 2018F 2019F 2020F Average connection fee - residential (HK$) New connections - residential (m households) Gas sales volume (m m3) 3, , , , , , , , , ,731.4 Dollar margin (Rmb/m3) Source: Company, DBS Vickers Segmental Breakdown (HK$ m) FY Mar 2016A 2017A 2018F 2019F 2020F Revenues (HK$ m) Piped gas 12,996 13,779 18,506 23,300 29,179 Connection fee 4,794 5,748 8,807 11,617 12,168 LPG 11,349 11,655 12,871 13,649 14,317 Value added services ,380 2,070 3,105 Total 29,497 31,993 41,564 50,636 58,768 GPM (HK$ m) Piped gas 2,391 2,508 3,184 4,082 5,031 Connection fee 3,293 4,225 5,645 6,686 6,814 LPG 1,379 1,313 1,390 1,433 1,475 Value added services ,397 Total 7,136 8,421 10,841 13,133 14,716 GPM Margins (%) Piped gas Connection fee LPG Value added services N/A N/A N/A N/A N/A Total Source: Company, DBS Vickers Page 18

19 China/Hong Kong Company Guide Income Statement (HK$ m) FY Mar 2016A 2017A 2018F 2019F 2020F Revenue 29,497 31,993 41,564 50,636 58,768 Cost of Goods Sold (22,283 (23,616 (30,723 (37,503 (44,052 Gross Profit 7,214 8,377 10,841 13,133 14,716 Other Opng (Exp)/Inc (2,649) (2,905) (3,509) (4,174) (4,668) Operating Profit 4,565 5,472 7,332 8,959 10,049 Other Non Opg (Exp)/Inc Associates & JV Inc ,247 1,519 1,763 Net Interest (Exp)/Inc (689) (636) (633) (537) (423) Dividend Income Exceptional Gain/(Loss) (1,443) (327) Pre-tax Profit 3,718 5,902 8,393 10,486 12,021 Tax (984) (1,208) (1,717) (2,202) (2,524) Minority Interest (460) (547) (711) (866) (1,005) Preference Dividend Net Profit 2,273 4,148 5,965 7,418 8,492 Net Profit before Except. 3,716 4,475 5,965 7,418 8,492 EBITDA 6,888 7,825 10,044 12,133 13,641 Growth Revenue Gth (%) (6.9) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) (32.6) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) N/A N/A N/A N/A N/A Net Interest Cover (x) Source: Company, DBS Vickers Page 19

20 China /Hong Kong Company Guide Balance Sheet (HK$ m) FY Mar 2016A 2017A 2018F 2019F 2020F Net Fixed Assets 22,850 25,783 28,357 30,840 32,733 Invts in Associates & JVs 8,903 9,578 9,578 9,578 9,578 Other LT Assets 8,134 9,263 9,926 10,550 11,102 Cash & ST Invts 5,508 4,752 5,001 4,377 5,451 Inventory 1,213 1,679 1,879 2,289 2,656 Debtors 5,094 6,067 7,250 8,832 10,251 Other Current Assets 1,831 2,865 3,325 3,798 4,408 Total Assets 53,533 59,987 65,316 70,263 76,178 ST Debt 10,324 10,873 8,873 8,873 5,873 Creditors 8,549 9,650 11,838 14,450 16,974 Other Current Liab 929 2,056 2,286 2,532 2,938 LT Debt 12,010 12,745 12,745 8,745 7,745 Other LT Liabilities Shareholder s Equity 17,853 20,550 24,751 29,975 35,954 Minority Interests 3,112 3,377 4,088 4,954 5,958 Total Cap. & Liab. 53,533 59,987 65,316 70,263 76,178 Non-Cash Wkg. Capital (1,340) (1,095) (1,671) (2,064) (2,598) Net Cash/(Debt) (16,826) (18,866) (16,617) (13,241) (8,168) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) NA NA NA NA NA Source: Company, DBS Vickers Page 20

21 China/Hong Kong Company Guide Cash Flow Statement (HK$ m) FY Mar 2016A 2017A 2018F 2019F 2020F Pre-Tax Profit 3,718 5,902 8,393 10,486 12,021 Dep. & Amort. 1, ,017 1,108 1,196 Tax Paid (992) (1,102) (1,717) (2,202) (2,524) Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. 1,193 (1,473) Other Operating CF 906 (170) (1,171) (1,338) (1,615) Net Operating CF 5,862 4,116 7,328 8,674 9,815 Capital Exp.(net) (3,154) (2,959) (3,500) (3,500) (3,000) Other Invts.(net) (362) (442) Invts in Assoc. & JV (414) (351) Div from Assoc & JV Other Investing CF (454) (411) (756) (716) (642) Net Investing CF (4,001) (4,112) (4,256) (4,216) (3,642) Div Paid (942) (954) (1,765) (2,194) (2,512) Chg in Gross Debt 1,693 1,430 (2,000) (4,000) (4,000) Capital Issues (947) (539) Other Financing CF (1,131) (458) 940 1,111 1,411 Net Financing CF (1,327) (520) (2,824) (5,083) (5,101) Currency Adjustments (265) (256) Chg in Cash 268 (772) 248 (626) 1,073 Opg CFPS (HK$) Free CFPS (HK$) Source: Company, DBS Vickers Page 21

22 China /Hong Kong Company Guide DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends Completed Date: 29 Sep :09:31 (HKT) Dissemination Date: 29 Sep :07:17 (HKT) Sources for all charts and tables are DBS Vickers unless otherwise specified. GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Vickers (Hong Kong) Limited ( DBSV HK ). This report is solely intended for the clients of DBS Bank Ltd., DBS Bank (Hong Kong) Limited (DBS HK), DBSV HK, and DBS Vickers Securities (Singapore) Pte Ltd. ( DBSVS ), its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSV HK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., DBS HK, DBSV HK, DBSVS, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the DBS Group ) have not conducted due diligence on any of the companies, verified any information or sources or taken into account any other factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we do not make any representation or warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group, may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may not contain all material information concerning the company (or companies) referred to in this report and the DBS Group is under no obligation to update the information in this report. This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) (b) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein. Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBSVUSA, a US-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making. Page 22

23 China/Hong Kong Company Guide ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s) primarily responsible for the content of this research report, in part or in whole, certifies that he or his associate 1 does not serve as an officer of the issuer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the management of the issuer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or his associate does not have financial interests 2 in relation to an issuer or a new listing applicant that the analyst reviews. DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately. There is no direct link of DBS Group's compensation to any specific investment banking function of the DBS Group. COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBS Bank Ltd, DBS HK, DBSVS, DBSV HK or their subsidiaries and/or other affiliates do not have a proprietary position in the securities recommended in this report as of 27 Sep Neither DBS Bank Ltd, DBS HK nor DBSV HK market makes in equity securities of the issuer(s) or company(ies) mentioned in this Research Report. 3. Compensation for investment banking services: DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively. 4. Disclosure of previous investment recommendation produced: DBS Bank Ltd, DBSVS, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA may have published other investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12 months. Please contact the primary analyst listed in the first page of this report to view previous investment recommendations published by DBS Bank Ltd, DBSVHK, their subsidiaries and/or other affiliates of DBSVUSA in the preceding 12 months. 1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst. 2 Financial interest is defined as interests that are commonly known financial interest, such as investment in the securities in respect of an issuer or a new listing applicant, or financial accommodation arrangement between the issuer or the new listing applicant and the firm or analysis. This term does not include commercial lending conducted at arm's length, or investments in any collective investment scheme other than an issuer or new listing applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new listing applicant. Page 23