China Gas Sector

Utilities / China 11 November 2013

Initiation: clearing the air on gas China Gas Sector tariffs Positive (initiation) • Despite city-gate tariff hikes, we believe some companies in the Neutral sector are in a position to expand their margins in 2014 Negative • Positive view driven by anti-pollution measures and NGV sales

• Gas utility BJCE and city-gas distributor ENN stand out on our PER-to-score ratio; our top pick is equipment maker CIMC Enric How do we justify our view?

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

Contents

Clearing the air on gas tariffs ...... 5 Investment thesis for 2014-15 ...... 5 Supply overview: more expensive imports before unconventional breakthrough ...... 8 Demand growth: natural gas vehicles and gas-fired utilities to mitigate air pollution ...... 13 Natural gas vehicles: three-fold rise in number by 2015 ...... 14 Gas-fired utilities: near-term growth from coal-replacement projects ...... 15 From gas shortage to gas surplus: potential upside for NGV and gas-fired utilities ...... 16 Margin: pass-through risks on further tariff hike ...... 17 M&A at the project level no longer attractive ...... 22 More takeovers of publicly listed city-gas operators? ...... 24 Connection fees not a near-term risk ...... 24 Quantifying the catalysts and risks with the valuation: the Daiwa PES ratio...... 25 Companies in the city-gas value chain: CIMC Enric the most leveraged play ...... 29

Company Section CIMC Enric ...... 33 Beijing Jingneng Clean Energy ...... 37 ENN Energy ...... 51 Towngas China ...... 61 China Gas ...... 71 China Suntien Green Energy ...... 81 Beijing Enterprises ...... 93 China Resources Gas ...... 109

Utilities / China 11 November 2013

• Gas utility BJCE and city-gas distributor ENN stand out on our PER-to-score ratio; our top pick is equipment maker CIMC Enric How do we justify our view?

As a result, we identify two • Newly announced overseas gas- investment themes, in terms of gas supply agreements. sales structure and favoured • geographical regions. Measures to cut air pollution extended to more regions. 1. NGV gas sales: we expect city- Dennis Ip, CFA gas operators with high sales- ■ Valuation (852) 2848 4068 [email protected] volume contributions from NGV The gas-distribution sector’s forward gas to maintain or expand their PER peaked at 22x in early 2010, Gary Zhou unit dollar margins, given NGV and was derated to 13x over 2H11- (852) 2773 8535 gas sales margins are 60% higher 1H12 following the tariff hike in June [email protected] than for C&I gas. NGV gas is the 2010. It was derated again in July-

most profitable and cost-pass- August 2013 amid cost-pass-through throughs are relatively easy. concerns and a further city-gate tariff ■ Investment case 2. Air-pollution measures: the rise. Going forward, we believe the We initiate coverage of the China sector will stabilise at 16-19x forward Gas Sector, comprising city-gas State Council has targeted a 25% cut in small particulates (PM2.5) PERs as the market recognises the operators (distributors), a gas utility, scope for margin expansion, and an equipment maker, with a in Beijing, Tianjin, and Hebei over 2012-17. We forecast gas-fired particularly for operators with large Positive rating, backed by a forecast exposure to NGV gas sales in highly EPS CAGR of 12-35% over 2012-15. power and heat cogeneration in the 3 cities to see gas sales-volume polluted or high-gas cost regions. Although further city-gate tariff hikes could lead to a margin squeeze growth of 250% over 2013-15, versus a rise of c.75% nationwide. ■ Risks for commercial and industrial (C&I) Risks include: 1) slower-than- gas, we believe gas operators with Our top sector pick is CIMC Enric expected natural-gas sales volume large exposure to natural-gas vehicle growth, and 2) a margin squeeze due (NGV) gas sales based in high gas- (3899 HK, HKD10.70, Buy [1]), which we see as a play on robust NGV to an ineffective cost pass-through of cost regions will be able to mitigate further city-gate tariff hikes. this risk and even expand their growth (with 45% potential upside to margins. our target). Gas utility Beijing Jingneng Clean Energy (BJCE) (579 HK, HKD3.30, Buy [1]) should Over the next few years, China plans Key stock calls to expedite the use of gas for benefit from a rise in gas-fired power and heating capacity as anti-pollution New Prev. vehicles, heating and power CIMC Enric (3899 HK) generation to reduce pollution. Sales measures are implemented. ENN Rating Buy Buy volume growth should be (2688 HK, HKD44.05, Buy [1]) is our Target 15.50 15.50 significant: Beijing aims to top pick among the distributors, Upside  49% quadruple its gas-fired power given its margin defensiveness due to Beijing Jingneng Clean Energy (579 HK) capacity over 2011-15, and we significant NGV gas sales. Rating Buy Target 3.90 forecast a three-fold rise in the Upside  13% number of NGVs in China. Natural ■ Catalysts ENN Energy (2688 HK) gas is also used by river vessels. We highlight the following as share- price drivers: Rating Buy Target 51.00 Upside  19.4% Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

Positive (initiation) How do we justify our view?

Neutral  Growth outlook

Negative  Valuation

 Earnings revisions

 China city-gas utilities: scorecard of catalysts and risks, and  Growth outlook PER-to-score ratio We introduce the Daiwa PER-to-score (PES) ratio, Total scores of which we have devised to assess the relative merits of five qualitative factors (0-35) 2014E PER (x) PER-to-score ratio (x) (a) (b) ('c) = (b) / (a) gas-distribution companies and utilities. In this system, BJCE 13 8.4 0.64 we assign scores (from 1-7, with 1 being the least ENN 25 16.4 0.66 positive) for different share-price catalysts and risk TCCL 21 14.2 0.68 factors we see for each company. We use the Daiwa PES CGHL 23 15.9 0.69 ratio to quantify these qualitative scores with the CSG 17 12.3 0.72 BEH 21 15.4 0.73 current valuations of the stocks to determine key CRG 21 16.7 0.79 investment picks – BJCE and ENN. Source: Daiwa Note: PERs are based on closing share prices as of 7 November 2013; FY15E PER for CGHL We forecast a robust CAGR in gas consumption for BJCE - Beijing Jingneng Clean Energy, CSG - China Suntien Green Energy, ENN - ENN Energy; TCCL - Towngas China; CGHL - China Gas; BEH - Beijing Enterprises Holdings; China over 2012-15, which should help support earnings CRG – China Resources Gas growth for the city-gas operators, even allowing for planned city-gate tariff hikes. Across the sector, we forecast EPS CAGRs of 12-35% for 2012-15.

 Valuation  China Gas Sector: 12-month forward PER history (x) In 2010, the China Gas Sector was derated from a forward June-2010: Wellhead hike by 23% PER of 22x to 13x, following a 23% increase in the July-13: City-gate hike by 15% 25 wellhead price of piped gas on 30 June that year. 2014-15: City-gate hike further by c.40% 22.1x Avg+2SD In July 2013, China announced gas-price reforms that will 20 19.0x Avg+1SD link the city-gate tariff price of piped gas for non- 16.0x Avg residential users to competing fuels. The sector was 15 derated from an 18x forward PER to 15x in July to August 12.9x Avg-1SD 2013, but rerated shortly after to 16x once most of the costs 10 9.9x Avg-2SD were passed through. However, we believe the sector will rerate again as investor concerns dissipate. 5 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Source: Bloomberg, Daiwa forecasts

 Earnings revisions  China Gas Sector: consensus 2013E EPS revisions The revisions to the Bloomberg-consensus EPS forecasts (Rebased to 100) for the companies in the sector have varied considerably 130 this year. Year-to-date, the 2013 EPS forecast has been 120 cut by 5% for ENN, because some analysts factor in the 110 CNY214m marked-to-market loss of its USD500m convertible bond (booked in 1H13). The 25% upward 100 revision to CGHL’s FY14E EPS forecast in June was 90 likely due to the strong results for the city-gas operation, and tax and finance-cost savings. 80 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13

ENN Towngas China Gas The 2013 consensus EPS forecasts for CRG, Beijing CR Gas Beijing Ent China Suntien Enterprises Holdings and BJCE and CSG have been Beijing Jingneng broadly unchanged over the past year. Source: Bloomberg Note: FY14E EPS for CGHL

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Executive summary

Clearing the air on gas tariffs

Although China gas operators face a c.40% city-gate tariff rise over 2014-15, we believe those with favourable gas-sales structures and geographical exposure will maintain or even expand their unit dollar margins.

 Investment thesis Identifying the We are positive on the prospects for the China Gas Sector despite the outperformers based on our perceived cost-pass-through risks. We favour the gas operators that are scorecard and PER-to-score best-positioned to protect, or even expand, their unit dollar margin due to rising NGV gas sales. We also like the city-gas operators that have high (PES) ratio exposure to regions that will see substantial coal-to-gas fuel conversions of power and heat cogeneration projects in a bid to reduce air pollution, or regions currently supplied mainly by expensive LNG, which will be replaced by piped gas (despite the planned c.40% city-gate tariff rise, piped gas should remain cheaper than LNG).

Stock selection will be vital in 2014-15 as focusing only on gas sales- volume growth is too simple a strategy, in our view. Based on our scorecard and the Daiwa PES ratio, our preferred stocks are BJCE and ENN.

 China gas utilities and distributors: stock picks based on the Daiwa PES ratio Total 2014E PER-to- Margin Volume scores PER score ratio New gas sources for NGV Exposure to high- Air-pollution provinces with low gas Trading exposure gas-cost regions theme penetration volume (f)= a+b (x) (x) (a) (b) ('c) (d) (e) +c+d+e (g) (h) = g / f BJCE 1 1 7 2 2 13 8.4 0.64 ENN 7 7 1 3 7 25 16.4 0.66 TCCL 2 6 3 7 3 21 14.2 0.68 CGHL 6 5 2 6 4 23 15.9 0.69 CSG 4 3 5 4 1 17 12.3 0.72 BEH 5 2 6 2 6 21 15.4 0.73 CRG 3 4 4 5 5 21 16.7 0.79 Source: Provincial DRCs, Daiwa; note: FY15E PER for CGHL

 Valuations The China-listed city-gas operators generated an aggregate net profit of CNY10bn for 2012, up 28% YoY, and higher than the national gas-volume Only city-gas operators that consumption rate of 16% YoY. With two more city-gate tariff hikes continue to outperform in planned over 2014-15, it is unlikely that all the gas operators will be able to pass through all the upstream cost increases to their end customers, terms of net profit deserve a resulting in them facing margin compression that would dilute their net- valuation premium, in our profit growth. We forecast net-profit growth for city-gas operators of 29% view YoY for 2013, 23% YoY for 2014 and 14% YoY for 2015, and a gas- consumption CAGR of 20% over the period.

However, some city-gas operators should be better-positioned to offset the margin risks through high-margin NGV gas sales, or by being in regions that have been consuming expensive LNG. Therefore, we forecast 2012-15 net-profit CAGRs for the gas operators to range from 17% to 23%. We expect only the city-gas operators whose net profit growth we forecast to continue to outperform peers to continue to maintain forward PERs of 16- 19x, which is the second quartile of the sector’s PER range since 2008.

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 Stock picks BJCE, ENN and CIMC Enric Beijing Jingneng Clean Energy (BJCE) (579 HK, Buy [1]) is our top pick are our preferred picks among the gas utilities. We forecast a 64% CAGR in its gas-fired power capacity and a 52% CAGR in its gas-fired heating capacity over 2012-15, driven by the Beijing Government’s aim to cut the use of coal for power and heat generation in Beijing city in a bid to reduce air pollution. We believe the government will continue to subsidise the company’s upstream gas cost that is passed through from BEH to BJCE. BJCE’s 8x 2014E PER is the lowest in this sector at current share prices. We forecast BJCE to record a 2012-15 EPS CAGR of 35%, the highest in the sector.

ENN Energy (ENN) (2688 HK, Buy [1]) is our top pick among the China gas distributors, given that we expect it to have the most organic gas-sales volume growth and see the least impact from further city-gate tariff hikes in 2014-15, and its 16x 2014E PER is at the higher end of that of its peers, whose 2014E PERs range from 14-17x. We forecast ENN to record an EPS CAGR of 21% over 2012-15.

Towngas China (TCCL) (1083 HK, Outperform [2]) is our No.2 choice TCCL has lagged peers in among the China gas distributors, given its 14x 2014E PER (peers: 14-17x). terms of share-price The company’s high-margin subsidiaries are mature, and should support its net-profit growth over 2013-15. In addition, its geographical focus on performance Liaoning should help to minimise the risk of a margin squeeze from city- gate tariff rises. We forecast TCCL to have an EPS CAGR of 23% over 2012-15.

China Gas Holdings (CGHL) (384 HK, Outperform [2]) ranks No.3 among CGHL also offers attractive the China gas distributors. We believe it offers a favourable risk-adjusted risk-adjusted reward reward as a recovery stock following corporate-governance issues over profiles 2011-12. The company’s alliance with Beijing Enterprises Group should enhance its near-term gas-sales growth, the pace of acquisitions, and also corporate governance. We have an 18% FY13-16E EPS CAGR for CGHL.

Equipment maker CIMC Enric (3899 HK, Buy [1]) is exposed to our bullish view on NGVs, LNG vessels, and gas-fired utilities in China. It is the most leveraged stock in our sector universe due to its heavy investments in refuelling and logistic infrastructure during the initial development stage of the NGV and peak-shaving LNG-storage markets. We forecast CIMC Enric to record an EPS CAGR of 23% over 2012-15.

Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Beijing Enterprises 392 HK 62.45 Outperform 70.00 3.244 4.064 Beijing Jingneng Clean Energy 579 HK 3.30 Buy 3.90 0.212 0.310 China Gas 384 HK 8.77 Outperform 10.00 0.507 0.552 China Resources Gas 1193 HK 19.82 Hold 20.50 0.975 1.188 China Suntien Green Energy 956 HK 2.82 Outperform 3.20 0.184 0.180 CIMC Enric 3899 HK 10.70 Buy Buy 15.50 15.50 0.0% 0.539 0.539 0.0% 0.636 0.636 0.0% ENN Energy 2688 HK 44.05 Buy 51.00 1.740 2.109 Towngas China 1083 HK 7.47 Outperform 8.60 0.424 0.525

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Further total 42% hike for non-residential gas (base volume) nationwide for 2013-15E Under this schedule for hikes in city-gate gas prices, we project a total additional 42% hike (nationwide) in the city-gate gas price for C&I customers from CNY1.95/m3 currently to CNY2.77/m3 by July 2015. As a result, Clearing the air on gas compared to its level of June 2013 (ie, before the increase in July), we forecast a total tariff hike for city- tariffs gate C&I customers of CNY1.08/m3 by 2015.

 China: average city-gate gas price for C&I customers (2013 Picking the best investment ideas in the and 2015E) sector involves balancing the margin (CNY/m3) risks and gas-sales volume growth, in our 3.00 2.77 view. 2.50 1.95 2.00 1.69 Investment thesis for 2014-15 1.50 1.00 We describe the latest developments in China’s natural 0.50 gas industry – centring on gas tariff reform – and discuss the two investment themes of NGV gas sales 0.00 Average city-gate price, Average city-gate price, Average city-gate price, and measures to reduce air-pollution that we have CNY/m³ (before July 2013) CNY/m³ (after July 2013) CNY/m³ (as of July 2015E) identified and that support our Positive rating on the Source: NDRC, Daiwa forecasts China Gas Sector. 1. Natural-gas vehicle (NGV) sales Background of recent gas tariff reform What is likely to happen in 2015 after the gas Launched in June 2013, China’s long-awaited gas price price reform is completed? reform targets to link the price of natural gas to prices Based on our analysis of 15 provinces, we believe city- of competing fuels at the city gate. This reform will take gas operators could see unit dollar margin compression place over two years, to mid-2015. With effect from from their gas sales to C&I customers, as by July 2015, July this year, the National Development and Reform natural gas for industrial customers could be priced at Commission (NDRC) has increased the gas price at the a premium to competing fuels, causing demand city gate for non-residential use, ie, commercial and destruction if the operators pass through fully to industrial (C&I), by 15%, to CNY1.95/m3 (from customers the additional CNY0.88/m3 (national CNY1.69/m3). average) hike we forecast by July 2015.

Under the reform plan, China will adopt a ladder-like We expect NGV gas to continue to be priced at a pricing mechanism for natural gas. This mechanism discount to competing fuels, and forecast an average will allow the upstream piped gas suppliers to discount in July 2015 of 28% (compared to 39% before implement substantial one-off price increases for the hike in June 2013). In addition, we would highlight incremental gas volume, which the NDRC projects will that NGV gas sales are more profitable for city-gas account for 9% of the country’s total piped gas supply operators than their gas sales for C&I customers. in 2013. For example, in 2012, ENN’s dollar margin for its NGV The NDRC will also give a grace period until 2015 for sales was CNY1.3/m3, which was about 60% higher gas prices for base volumes (91% of the country’s than CNY0.8/m3 for its C&I gas sales. To put the piped-gas supply for 2013) to be linked to regional potential for NGV gas sales into perspective, we competing fuels, such as heating oil and liquefied forecast a three-fold increase in the number of NGVs in petroleum gas (LPG), with a 15% discount to prevailing China from 1m in 2011 to 3m in 2015. prices of these competing fuels.

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 Natural gas price discount/premium to competing fuels in 2. Measures to reduce air pollution various provinces (2015E) 50% How will natural gas contribute to mitigating 40% air pollution? 30% On 10 September this year, the State Council published 20% an action plan to mitigate air pollution, with a concrete 10% target to reduce PM2.5 pollutant levels by 25% by 2017 0% from their 2012 levels in Beijing, Tianjin and Hebei, by (10%) shutting down a number of coal-fired boilers and (20%) power plants. (30%) Anhui Hebei Hubei

Hunan In Beijing, all coal-fired power plants and boilers Tianjin Gansu Beijing Jiangsu Sichuan Shanghai Shandong

Chongqing within the Sixth Ring Road will be replaced with new Shengyang Guangzhou Heilongjiang gas-fired power and heating cogeneration centres, with Natural gas discount for industrial usage Natural gas discount for NGV usage Source: Provincial DRCs, Daiwa gas-fired power capacity in the city targeted by the Beijing Government to increase four-fold from 2GW in Therefore, we see rising NGV sales as the first 2011 to 8GW in 2015. investment theme for the China Gas Sector. The higher their sales contribution from NGV gas, the more There are plans to expedite similar coal-to-gas fuel effectively the gas companies should be able to protect, conversion projects for utilities in Tianjin, Hebei and or even expand, their dollar margins. We forecast ENN, other northern metropolitan cities. The Beijing- BEH and CGHL (the three major city-gas operators) to Tianjin-Hebei region targets to reduce coal increase their NGV gas sales-volume contributions to consumption by about 65m tonnes by 2017 from its total sales volumes from 0-14% in 2012 to 6-21% in level in 2012. 2015, and thus to expand their total unit dollar margins 3 3  Coal consumption reduction target for Beijing-Tianjin-Hebei from CNY0.27-0.80/m in 2012 to CNY0.36-0.84/m regions in 2012-17E in 2015, even factoring in a 2-12% margin compression (m tonnes) 2012 2017E Reduction from their C&I gas sales volumes in 2015E. Beijing 23 10 57% Hebei 302 260 14%  Major city-gas operators: unit dollar margins and gas sales Tianjin 50 40 20% volume contributions from NGV gas Beijing-Tianjin-Hebei 375 310 17% (CNY/m3) Source: State Council 1.0 50% 0.8 40% Thus, our second investment theme for the sector is air 0.6 30% pollution mitigation in the Beijing-Tianjin-Hebei 0.4 20% region. BJCE, BEH and CSG are pure Beijing-Tianjin- Hebei regional plays on air pollution mitigation. Also, 0.2 10% CRG has formed a joint venture with Tianjin Gas to 0.0 0% 2012 2013E 2014E 2015E enjoy a targeted four-fold increase in gas volume sales ENN - unit dollar margin (LHS) from 1.6bcm in 2012 to 6.4bcm by 2017E. CGHL - unit dollar margin (LHS) BEH - unit dollar margin (LHS) ENN - NGV gas sales contribution (RHS) CGHL - NGV gas sales contribution (RHS) BEH - NGV gas sales contribution (RHS) Source: Companies, Daiwa forecasts

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 Gas companies: valuation comparison Daily trade Market vol Free EPS Bloomberg Share price Target price Upside cap (3M) Float PER (x) PBR (x) ROE (%) CAGR (%) Company name Code Rating (local curr.) (local curr.) (%) USDm USDm (%) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 12-15E China gas utilities and equipment Beijing Jingneng Clean Energy 579 HK Buy 3.30 3.9 18.2 2,733 3.8 30 12.2 8.4 7.1 1.6 1.4 1.2 13.5 17.9 18.2 35.0 Beijing Enterprises 392 HK Outperform 62.45 70.0 12.1 9,122 8.8 42 19.2 15.4 12.4 1.7 1.6 1.4 9.4 10.9 12.4 22.0 China Suntien Green Energy 956 HK Outperform 2.82 3.2 13.5 1,299 2.9 42 12.1 12.3 9.3 1.3 1.1 1.0 10.2 10.1 11.7 11.9 ENN Energy 2688 HK Buy 44.05 51.0 15.8 6,036 14.0 69 19.9 16.4 14.2 3.7 3.2 2.7 20.1 20.9 20.7 20.9 China Gas 384 HK Outperform 8.77 10.0 14.0 5,085 8.5 29 17.3 15.9 14.5 3.1 2.7 2.3 19.8 19.1 19.1 17.7 Towngas China 1083 HK Outperform 7.47 8.6 15.1 2,492 3.3 38 17.6 14.2 11.8 1.6 1.5 1.3 9.7 10.7 11.8 23.0 China Resources Gas 1193 HK Hold 19.82 20.5 3.4 5,675 8.7 30 20.3 16.7 14.9 3.3 2.8 2.5 17.2 18.2 17.6 17.4 CIMC Enric 3899 HK Buy 10.70 15.5 44.9 2,501 4.7 30 15.6 13.2 11.4 3.2 2.7 2.2 23.2 22.7 22.0 23.2 Simple average 4,368 6.8 16.8 14.1 12.0 2.5 2.2 1.9 15.4 16.3 16.6 24.1 Weighted average 18.1 14.9 12.8 2.6 2.3 2.0 15.4 16.4 16.6 24.4 Hong Kong and China gas utilities Kunlun Energy 135 HK NR 12.98 n.a. n.a. 13,417 42.0 37 14.3 12.6 10.9 2.1 1.8 1.6 15.5 15.8 16.0 9.4 Hong Kong and China Gas 3 HK NR 18.04 n.a. n.a. 22,110 23.7 57 23.1 21.5 20.2 3.5 3.3 3.0 15.3 15.0 14.8 4.6 China Oil & Gas 603 HK NR 1.33 n.a. n.a. 849 5.5 77 16.2 12.3 9.8 1.4 1.2 1.1 12.3 14.5 16.5 18.4 Tianlun Gas 1600 HK NR 6.96 n.a. n.a. 739 1.3 34 23.5 17.1 13.4 4.6 3.8 3.1 18.4 18.4 18.4 20.4 Tainjin Tianlian 1296 HK NR 2.09 n.a. n.a. 1,625 2.5 55 13.1 8.2 7.9 1.0 0.9 0.8 7.3 11.0 10.5 18.5 Simple average 7,748 15.0 18.0 14.3 12.4 2.5 2.2 1.9 13.7 14.9 15.2 14.3 Weighted average 19.5 17.6 16.1 2.9 2.6 2.4 15.0 15.1 15.1 7.5 Regional city-gas distributors PGAS PGAS IJ NR 5000.00 n.a. n.a. 10,630 12.2 43 12.5 11.9 11.0 4.3 3.7 3.2 35.3 32.4 30.2 4.6 Tokyo Gas 9531 JP Hold 511.00 560.0 9.6 13,024 39.6 93 11.8 13.8 12.4 1.3 1.3 1.2 11.4 9.2 n.a. 1.3 Osaka Gas 9532 JP Hold 403.00 420.0 4.2 8,525 22.3 94 13.2 13.5 12.2 1.1 1.0 1.0 8.3 7.8 n.a. 9.4 Simple average 10,726 24.7 12.5 13.0 11.8 2.2 2.0 1.8 18.3 16.5 30.2 5.1 Weighted average 12.4 13.1 11.8 2.2 2.0 1.8 18.5 16.5 10.0 4.5 Source: Daiwa forecasts, Bloomberg consensus estimates for non-covered stocks. Share price as of 7 November 2013 Note: CGHL’s year end is 31 March, and the data present is from FY14, FY15 and FY16 for the company

 Gas companies: valuation comparison Bloomberg EV/EBITDA (x) Net debt-to-equity (%) EBITDA margin (%) Net margin (%) Company name Code Rating 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E China gas utilities and equipment Beijing Jingneng Clean Energy 579 HK Buy 11.3 10.2 9.7 187% 231% 264% 49% 44% 40% 21% 21% 18% Beijing Enterprises 392 HK Outperform 12.9 10.9 9.5 45% 47% 47% 15% 13% 12% 9% 9% 8% China Suntien Green Energy 956 HK Outperform 9.2 8.3 7.6 136% 125% 129% 40% 36% 33% 13% 11% 11% ENN Energy 2688 HK Buy 8.8 7.5 6.4 44% 25% 2% 20% 18% 15% 8% 8% 7% China Gas 384 HK Outperform 10.8 9.6 8.7 61% 51% 40% 16% 13% 11% 9% 8% 6% Towngas China 1083 HK Outperform 12.3 10.0 8.1 18% 17% 15% 23% 22% 20% 17% 17% 17% China Resources Gas 1193 HK Hold 10.7 9.7 8.9 27% 28% 13% 21% 20% 18% 10% 10% 10% CIMC Enric 3899 HK Buy 10.2 8.4 6.9 net cash net cash net cash 14% 14% 14% 10% 10% 10% Simple average 10.8 9.3 8.2 74% 75% 73% 25% 23% 20% 12% 12% 11% Weighted average 11.0 9.5 8.4 53% 52% 47% 21% 19% 17% 11% 10% 10% Hong Kong and China gas utilities Kunlun Energy 135 HK NR 7.9 6.8 6.0 35% 33% 23% 42% 39% 36% 17% 16% 14% Hong Kong and China Gas 3 HK NR 21.6 20.1 19.0 38% 35% 30% 33% 33% 32% 27% 26% 26% China Oil & Gas 603 HK NR 7.7 6.1 5.0 n.a. n.a. n.a. 16% 16% 17% 6% 6% 6% Tianlun Gas 1600 HK NR 20.6 16.8 14.1 n.a. n.a. n.a. 24% 21% 17% 17% 15% 12% Tainjin Tianlian 1296 HK NR 11.4 8.7 8.0 115% 130% 131% 11% 12% 12% 3% 4% 4% Simple average 13.9 11.7 10.4 63% 66% 61% 25% 24% 23% 14% 13% 12% Weighted average 16.1 14.6 13.6 39% 37% 31% 35% 33% 32% 22% 21% 20% Regional city-gas distributors PGAS PGAS IJ NR 8.7 8.1 7.4 -23% -34% -53% 39% 38% 36% 26% 26% 25% Tokyo Gas 9531 JP Hold 6.3 6.6 6.2 66% 71% 73% 14% 14% 14% 5% 4% 5% Osaka Gas 9532 JP Hold 6.8 6.6 6.5 60% 52% 45% 13% 13% 13% 4% 4% 5% Simple average 7.3 7.1 6.7 34% 30% 22% 22% 21% 21% 12% 11% 11% Weighted average 7.3 7.1 6.7 35% 31% 24% 22% 21% 21% 12% 11% 11% Source: Daiwa forecasts, Bloomberg consensus estimates for non-covered stocks. Share price as of 7 November 2013 Note: CGHL’s year end is 31 March, and the data present is from FY14, FY15 and FY16 for the company

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 China: natural gas sources’ contributions Supply overview: more expensive 100% 4 - 11 48 60 1 imports before unconventional 80% 4 45 72 60% 12 97 breakthrough 16 36 40% 89 50 139 According to the NDRC, China’s natural gas supply is 20% 185 forecast to increase from 150bcm in 2012 to 260bcm in 0% 2015, representing a volume CAGR of 20%. According 2010 2015 NDRC target 2020E Daiwa forecast Domestic conventional gas to official estimates, the proportion of domestic gas will Domestic unconventional gas - CBM/shale gas fall from 86% in 2010 (82% conventional and 4% Domestic unconventional gas - coal-to-gas unconventional) to 64% (53% conventional and 11% Imported LNG Imported piped gas unconventional) by 2015. Imported piped gas from Russia Source: NDRC, Daiwa forecasts Coal-to-gas conversion will account for around 45% of the unconventional gas given that the scaled  China: CAGRs for natural gas sources production of coal bed methane (CBM) and shale gas is 70% unlikely to be a short-term goal due to insufficient 60% 50% technology to extract gas resources from the complex 40% geology. 30% 20%  China: natural gas supply forecasts 10% 0% 2015 2020E Daiwa 2010-15E 2015-20E 2010 NDRC target forecast CAGR CAGR 2010-15E CAGR 2015-20E CAGR bcm (%) bcm (%) bcm (%) (%) (%) Domestic conventional gas Domestic conventional gas 89 82% 139 53% 185 37% 9% 6% Domestic unconventional gas - CBM/shale gas Domestic unconventional gas - coal-to-gas Domestic unconventional gas- 4 4% 16 6% 50 10% 32% 2% Total domestic CBM/shale gas Total imported Domestic unconventional gas- - 0% 12 5% 36 7% NA 19% Total supply coal-to-gas Source: NDRC, Daiwa forecasts Total domestic 93 86% 167 64% 271 54% 12% 10% Imported LNG 11 10% 45 17% 97 19% 33% 17%  China: natural gas cost of different sources Imported piped gas 4 4% 48 18% 72 14% 64% 8% Imported piped gas from Russia - 0% - 0% 60 12% NA NA (CNY/m3) 6.0 Total imported 15 14% 93 36% 229 46% 44% 20% 5.0 Total supply 108 100% 260 100% 500 100% 19% 13% 4.0 City-gate tariff (wellhead + transmission) Primary energy consumption 4% 8% 12% 3.0 2015E: CNY2.77/m3 national average Source: NDRC, Daiwa forecasts 2.0 City-gate tariff (wellhead + transmission) 1.0  China: natural gas supply forecasts Current: CNY1.95/m3 national average 0.0 (bcm) 600 14% CAGR 2015-20E 500 Coal-to-gas (low range) (low (high range) (high range)

400 19% CAGR Imported LNG CBM/shale gas CBM/shale gas 2010-15E Russiafrom 300 Conventional gas Imported pipedImported gas pipedImported gas 200 100 Source: NDRC, Daiwa forecasts 0 2010 2015 NDRC target 2020E Daiwa forecast Domestic conventional gas Domestic unconventional gas - CBM/shale gas Domestic unconventional gas - coal-to-gas Imported LNG Imported piped gas Imported piped gas from Russia Source: NDRC, Daiwa forecasts

- 8 - China Gas Sector 11 November 2013

2010-15: more expensive imported gas  China: location of major planned coal-to-gas projects During the 12th Five-Year Plan (2010-15), the NDRC confirmed that imported gas would be the main growth driver (44% volume CAGR for 2010-15E), which would Xinjiang Fuyun raise the proportion of the country’s gas supply from Qinhua Guanghui Guodian Fuyun Datang Keqi Xinjiang Longyu 14% in 2010 to 36% in 2015E. Pingmei Yining Changjin Xinjiang Yumei Qitai Keqi Fuxin China Coal Inner Mongolia Liaoning Given that the cost of imported gas is 2-7x more Xinjiang Xinjiang Lijin Xinjiang Changji Datong Datang Fuxin expensive than that of domestic conventional gas, the Shengxin Xinjiang Ordos Honghua Zhungeer CNOOC Shanxi natural gas business of PetroChina (857 HK, HKD8.63, Shanxi CNOOC Inner Xintong Mongolia Outperform [2]), which imports most of its gas Inner Mongolia Huineng Hengyuan CNOOC Shanxi requirements and supplies 70% of the country’s natural Sichuan gas, posted a net loss of CNY7.3bn for 1H13 before the Luzhou China Coal Sichuan coal-to- Inner Mongolia tariff reforms were announced in July 2013 (as gas PetroChina could not offset costly imported gas with Yunan Mile Yunnan profitable domestic gas). Despite the high cost of Guoneng imported gas, we believe China will have to continue to Source: Datang, CNOOC, Sinopec, China Coal, Daiwa rely on imported gas supply to maintain consumption growth before there is a break-through in CBM/shale  China: coal-to-gas projects pipeline Annual gas production in China. capacity No. Project name Chinese name Province (bcm) Status For unconventional gas, we believe only coal-to-gas 1 Datang Keqi 大唐克旗 Inner 4.0 Commission in 2013-15 and CBM will have a significant volume contribution, Mongolia 2 Inner Mongolia 内蒙汇能 Inner 1.6 Under construction which we forecast at a combined 28bcm for 2010-15, Huineng Mongolia given large-scale production of shale looks unlikely due 3 Hengyuan 鄂托克前旗恒源 Inner 1.6 Under construction to the lack of technology to extract gas from China’s Mongolia 4 China Coal Inner 中煤能源内蒙 Inner 2.0 EA complex geology. Datang (991 HK, Not rated) should Mongolia Mongolia have 8bcm per year of projects commissioned in Inner 5 CNOOC Inner 中海油内蒙 Inner 4.0 EA Mongolia over 2013-14, and Xinjiang Guanghua (Not Mongolia Mongolia 6 Xintong 鄂尔多斯鑫通 Inner 4.0 EA rated) should have 5.5bcm per year of projects Mongolia commissioned in Xinjiang over the same period. 7 Xinjiang Qinhua 新疆庆华 Xinjiang 5.5 Commission in 2013 8 Fuyun Guanghui 新疆富蕴广汇 Xinjiang 12.0 EA The major drawbacks of coal-to-gas projects are that 9 Changji Shengxin 昌吉盛新 Xinjiang 1.6 EA these projects are water-intensive, which can have a 10 China Coal 中煤能源新疆 Xinjiang 4.0 EA severe negative environmental impact. Usually, coal- Xinjiang 11 Guodian Pingmei 国电平煤 Xinjiang 4.0 EA to-gas projects are located in coal-rich regions, such as 12 Xinjiang Lijin 新疆励晶 Xinjiang 6.0 EA Inner Mongolia and Xinjiang, where water resources 13 Xinjiang Longyu 新疆龙宇 Xinjiang 4.0 EA are lacking. Each 1bcm of gas production requires 5m 14 Xinjiang Yumei 新疆豫煤 Xinjiang 6.0 EA tonnes of coal and 15m tonnes of water. Therefore, 15 Xinjiang Honghua 新疆华宏 Xinjiang 2.0 EA about 60bcm of projects are still under environmental 16 Datang Fuxin 大唐阜新 Liaoning 4.0 Commission in 2014-16 assessment, and we estimate that only about 50% of 17 CNOOC Shanxi 中海油山西 Shanxi 4.0 EA these projects would be approved by 2020. 18 Yunnan Guoneng 云南国能 Yunnan 2.5 EA 19 Sichuan 四川煤气化 Sichuan 2.0 EA Total capacity 74.8 Daiwa's forecast by 2020 36.0 Source: Datang, CNOOC, Sinopec, China Coal, Daiwa Note: EA – Environmental assessment

- 9 - China Gas Sector 11 November 2013

2015-20: unconventional gas should start Therefore, the government plans to increase soon the to lead subsidy from the current CNY0.4/m3 to CNY1.0/m3. Together with the recent gas tariff reform, the break- For the 13th Five-Year Plan (2016-20), we believe the even cost of shale gas could therefore increase from government’s preliminary gas supply target of 400bcm CNY1.5/m3 to CNY3/m3. is over-conservative, considering the concrete 170bcm of imported gas contracts targeted by the big-3 oil majors, and the additional 24bcm of coal-to-gas Shale gas is a long-term theme projects located mainly in Xinjiang (2015E: 12bcm). We believe China’s CBM production outlook is more promising given that the country produced 12.6bcm The conventional gas supply should contribute 185bcm and consumed 5.2bcm of CBM in 2012. Therefore, we assuming a modest 6% 2015-20E volume CAGR (2010- have assumed a combined unconventional gas supply 15E CAGR: 9%), we conclude that 390bcm of gas of 50bcm (40bcm for CBM and only 10bcm for shale) supply from both conventional and imported gas is by 2020, lower than the 110-150bcm targeted by the highly visible. We project a total gas supply of 500bcm government. in 2020. The additional upside would come from imported gas from Russia and the shale ramp-up in According to our China Oil & Gas analyst, Adrian Loh, China. our shale gas production estimates are materially lower than those of the Chinese Government target of 110- Unlike the 12th Five-Year Plan, we forecast volume 150bcm for the following reasons: growth of imported gas to slow to a 20% CAGR over • China’s geology does not appear to be conducive to 2015-20E (from 44% for 2010-15E), contributing 46% producing shale gas given that it is heavily faulted to China’s total gas supply (2010-15E: 36%). Of the and is tectonically active (eg, Sichuan Province is th 230bcm of imported of gas during the 13 Five-Year prone to earthquakes). Plan, we estimate that 72bcm will be from piped gas originating from Central Asia and Myanmar (12th Five- • Unlike the US, China does not have a multitude of Year Plan: 45bcm), 60bcm from piped gas originating small and mid-sized independent E&P companies from Russia, and 97bcm from LNG receiving terminals that are willing to take on exploration risk; nor does (12th Five-Year Plan: 48bcm). it have a large and technologically advanced oil services industry. According to Caixin, the latest negotiations on ASPs for the gas supply from Russia to China have not been However, we would highlight that while some of the concluded yet, given Russia’s targeted CNY3-4/cm ASP recent drilling results from Sinopec appear positive, (the European price) is higher than China’s targeted nevertheless costs remain high. At the end of October CNY2-2.5/cm (Central Asian price). However, both 2013, Sinopec reported positive shale drilling results in countries have preliminary agreed to build CNY60bn in the Fuling area of the Sichuan Basin, with six pilot gas-pipeline projects and target to supply 38bcm of gas wells producing a combined 1.6mcm of gas per day, or to Northeast China by 2017 (stage 1). We believe LNG 37.4mmcfpd. According to Reuters, these wells have imports could slow unless the US can start to supply demonstrated the highest production rates of a total of China with LNG from its shale gas production. around 150 wells that the Chinese oil majors have drilled over the past three years. On unconventional gas, China is targeting a 50bcm CBM supply and 60-100bcm of shale gas by 2020. We We would note, however, that the unconventional-gas think this combined 110-150bcm target is aggressive, consultants Advanced Resources International and believe China needs more time to tackle its estimates that China’s all-in cost per well is still very complex geology, which requires high capex for high at USD30m versus USD9m in the US. drilling, surveying and exploration purposes. According to sina.com, some shale-gas mine owners plan to return the mining rights given that exploration has proven more difficult than expected, and the total exploration cost could reach CNY6/m3 for each mining right.

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 China: gas supply and demand trend and forecasts (Unit: bcm) 2009 2010 2011 2012 2013E 2014E 2015E 2020E Domestic conventional gas 79 89 97 110 120 131 139 185 YoY growth 13% 9% 13% 9% 9% 6% 6% Domestic unconventional gas 4 4 4 5 8 16 28 86 Yoy growth 0% 0% 25% 60% 100% 75% 25% CBM 4 4 4 5 8 11 14 40 Shale gas - - - - - 1 2 10 Coal-to-gas ----- 4 12 36 Total domestic gas supply 83 93 101 115 128 147 167 271 YoY growth 12% 9% 14% 11% 15% 13% 10% Imported piped gas - 4 16 20 28 39 48 132 Central Asia - 4 16 20 27 35 42 60 Myanmar - - - - 1 4 6 12 Russia ------60 Imported LNG 6 11 12 15 19 24 45 97 Shenzhen 5 6 7 8 9 9 9 9 Putian 1 3 3 3 4 5 6 7 Shanghai - 2 2 2 2 3 4 4 Nantong - - - 2 2 3 4 8 Dalian - - - 1 2 3 5 8 Ningbo - - - - - 1 3 3 Hainan ------2 3 Shantou Jieyang ------2 3 Shenzhen II ------2 3 Zhuhai ------2 3 Tangshan Caofeidian ------2 3 Beihai ------2 3 Qingdao ------2 3 Others ------37 Total imported gas supply 6 15 28 35 47 63 93 229 YoY growth 150% 87% 23% 36% 34% 48% 20% Total supply 89 108 129 150 175 210 260 500 YoY growth 21% 19% 16% 17% 20% 24% 14% as % of primary energy 4.3% 4.9% 5.4% 6.1% 7.0% 8.3% 12.7% Total demand 119 138 149 165 185 200 230 430 Residential 18 23 26 29 30 31 32 42 Commercial, industrial and chemical 50 55 67 79 80 85 90 124 Transportation 9 11 19 25 42 57 76 163 Power generation, heating and others 12 20 17 16 23 27 31 100 Other unfulfilled demand 30 30 20 15 10 - - - Total surplus / (deficit) (30) (30) (20) (15) (10) 10 30 70 Demand proportion Residential 15% 16% 18% 18% 16% 16% 14% 10% Commercial, industrial and chemical 42% 40% 45% 48% 43% 42% 39% 29% Transportation 8% 8% 13% 15% 23% 28% 33% 38% Power generation, heating and others 10% 14% 11% 10% 12% 14% 14% 23% Other unfulfilled demand 25% 22% 13% 9% 5% 0% 0% 0% Demand growth rate 16% 8% 10% 12% 8% 15% 13% Residential 28% 17% 11% 3% 3% 3% 6% Commercial, industrial and chemical 10% 21% 19% 0% 6% 6% 7% Transportation 17% 78% 32% 67% 36% 33% 17% Power generation, heating and others 59% -14% -8% 47% 18% 16% 26% Other unfulfilled demand 0% -33% -25% -33% -100% NR NR Source: CEIC, Company, Daiwa forecasts

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 China: map of gas sources

Eastern Siberia Western Siberia

Heilongjiang

Central Asia –China Pipeline (from Kazakhstan)

Xinjiang- Jilin Shandong coal gas pipeline (Sinoprec, to be approved by Liaoning NDRC) CNOOC Yingkou LNG

Xinjiang Beijing PetroChina Hebei Caofeidian LNG PetroChina Dalian LNG Xinjiang- Inner Mongolia Guangdong- Gansu Tianjin CNOOC Tianjin LNG Zhejiang coal Sinopec Tianjin LNG gas pipeline CNOOC Hebei Qinhuangdao LNG (Sinopec, to be approved by Shandong Sinopec Qingdao LNG NDRC) Ningxia Shanxi Hebei

Qinghai CNOOC Binhai LNG Jiangsu Shaanxi Henan PetroChina Rudong LNG LNG terminals (operating) Shanghai CNOOC Shanghai Yangshan LNG LNG terminals (to be Tibet commissioned by 2015) Anhui CNOOC Ning bo Zhejiang LNG Hubei LNG terminals (after 2015) Sichuan Chongqing Sinopec Wenzhou LNG Existing pipeline Jiangxi Zhejiang Planned pipeline CNOOC Ningde LNG Hunan Shaanxi-Beijing Pipeline I Guizhou CNOOC Putian LNG (PetroChina) West-East Pipeline III Fujian Shaanxi-Beijing Pipeline II (PetroChina) Taiwan CNOOC Longhai LNG (PetroChina) Burma-China Pipeline Guangdong CNOOC Yuedong LNG (PetroChina) Yunan CNOOC Shenzhen LNG PetroChina Shenzhen LNG Shaanxi-Beijing Pipeline III Guangxi (PetroChina) Hong Kong CNOOC Zhuhai LNG Yulin-Jinan Pipeline CNOOC Dapeng LNG Sinopec Beihai LNG Sinopec Macau LNG Shaanxi-Beijing Pipeline IV (Sinopec) Macau (PetroChina) Sichuan-East Pipeline CNOOC Yuexi LNG PetroChina Qinzhou LNG West-East Pipeline I (Sinopec) CNOOC Hainan LNG (PetroChina) Zhong-Wu Pipeline Hainan West-East Pipeline II (PetroChina) (PetroChina) Source: Companies, Daiwa

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Key measures include the closures of boilers, replacing Demand growth: natural gas coal-fired power plants and boilers for heating with vehicles and gas-fired utilities to gas-fired ones, mandating that 60% of new buses be fuelled by clean energy, and reducing coal consumption mitigate air pollution from the 2012 level, which would ensure significant gas demand in 12th Five-Year Plan and the 13th Five-Year Every winter, severe air pollution and gas shortages are Plan. two of the most frequent topics to hit the headlines in China. We believe the strong rise in imported gas in Under the air pollution mitigation policy, we expect prospect over 2010-15E will minimise the demand- NGVs and gas-fired power and heating utilities to be supply gap during peak seasons, and open more new the main sales-volume growth drivers, raising the markets, such as NGV, LNG vessels and gas-fired country’s gas sales volume contribution from 25% in power heating cogeneration plants, to reduce air 2012 to 47% in 2015E and 61% in 2020E. We forecast pollution. combined gas sales from NGVs and gas utilities to rise at a CAGR of 38% in 2012-15, higher than 12% for Latest natural gas and air pollution overall total gas demand over the same period. mitigation policies In 2012, in view of a greater gas supply as a result of  China: natural gas demand forecasts (I) the strong rise in imported gas, the NDRC released a (bcm) revised version of its ‘Natural Gas Usage Policy’, which 500 included upgraded groups of users, such as centralised 400 heating from ‘approved’ to ‘prioritised’ groups. In addition, it added new target users, such as natural gas 300 vessels, integrated energy projects, CBM-power 200 generation, etc., to the ‘prioritised’ list to mitigate air pollution. Before 2012, most of the gas supply was 100 focused on residential and selected industrial 0 customers given the insufficient supply. 2010 2011 2012 2013E 2014E 2015E 2020E Residential Commercial, industrial and chemical  Natural gas utilisation policy in China Transportation Power generation, heating and others Other unfulfilled demand Prioritised: Source: CEIC, Daiwa forecasts • City-gas use in residential and public services/commercial venues, • Natural gas vehicles • Centralized urban heating (upgraded from Approved category)  China: natural gas demand forecasts (II) • Air-conditioning (upgraded from Approved category) • Integrated energy projects (new addition) (bcm) • Natural gas vessels (new addition) 100% • CBM-power generation (new addition) • Combined-heat-power (CHP) generation • Certain industrial and chemical users whose gas supply can be halted (upgraded) 80%

60% Approved: • Space heating • Gas-fired power peaker, 40% • Gas-fired power based-load power plant except 13 provinces rich in coal resources (upgraded) certain industrial and chemical users 20%

Restricted: • New construction or expansion projects for existing ammonia or fertilizer production 0% facilities (unchanged) 2010 2011 2012 2013E 2014E 2015E 2020E Residential Commercial, industrial and chemical Prohibited: Transportation Power generation, heating and others • Gas-fired power base-load in 13 coal resources rich provinces (unchanged), new Other unfulfilled demand construction or expansion projects for gas-to-methanol projects (unchanged) Source: CEIC, Daiwa forecasts Source: NDRC, Daiwa

In September this year, the State Council released an air pollution mitigation action plan in three major polluted regions: the Beijing-Tianjin-Hebei, Yangtze Delta (Shanghai-Jiangsu-Zhejiang) and Pearl Delta (Guangdong) regions. The plan aims to reduce small particulates emissions by 15-25% from 2012 to 2017.

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BEH has just started a NGV gas refuelling business in Natural gas vehicles: three-fold Beijing, under a joint venture agreement with Sinopec rise in number by 2015 and a gas supply agreement with Beijing Public Transport (Not listed). Management targets to develop China targets to have 5% of vehicles fuelled by clean 10,000 new NGVs supported with 40 new CNG/LNG energies by 2020. If we assume NGVs take a 50% share vehicle refuelling stations in 2013, and further boost of the clean-fuel vehicles market, we forecast the gas sales to reach 3bcm (equivalent to around 150,000 number of NGVs on the road in China to rise three-fold NGVs based on our calculations) for the Beijing NGV from their level of 2011 to 3m in 2015, and by six-fold gas sales market, in the long term. to 6m in 2020. Management targets to garner a 60-70% market share For an NGV market analysis, please see our initiation of the NGV gas refuelling business in Beijing, but our report, CIMC Enric: a proxy for strong LNG growth in long-term forecast is more conservative at a 55% share, China, of 16 September 2013. We forecast as we believe other LNG suppliers, such as Kunlun and transportation gas demand (NGV and LNG vessels) to ENN, could enter this market freely. post higher-than-national demand growth of 68-33% YoY for 2012-15. We forecast its gas sales contribution LNG vessels: a longer-term theme, but to increase from 15% in 2012 to 41% in 2020. limited gas demand In our view, LNG vessels are likely to follow the NGV  Gas demand from transportation fuel: NGV and LNG vessels 2010 2011 2012 2013E 2014E 2015E 2020E growth with the recently launched technical standards Total no. of NG vehicles ('000) 700 1,000 1,365 1,817 2,360 3,011 6,025 on NG vessels’ fuel conversion and potential subsidies Gas consumed per NGV (mcm/year) 18.6 22.9 21.1 23.0 24.0 25.0 26.0 from the Ministry of Transportation. (For further Total NG vehicles gas consumption (bcm) 10.7 19.4 24.9 41.8 56.6 75.3 156.6 details, see our note CIMC Enric: more policies to Total no. of LNG vessels ('000) - - - - 1 3 36 Gas consumed per LNG vessels (mcm/year) 0.2 0.2 0.2 0.2 0.2 0.2 0.2 support LNG consumption, of 4 October 2013.) We Total LNG vessels gas consumption (bcm) - - - - 0.2 0.5 6.3 expect there to be 36,000 LNG vessels by 2020 along Transportation demand (bcm) 11 19 25 42 57 76 163 the major inland rivers, such as Yangtze and Grand Growth rate 17% 82% 28% 68% 36% 33% 17% Demand proportion 8% 13% 15% 23% 28% 33% 41% Canal, representing an 18% penetration rate. Source: Daiwa forecasts Even though the LNG vessels market looks set to ENN, CGHL and BEH have the highest expand, we believe the gas-equipment makers, rather exposure to NGV-refuelling gas sales than the LNG-fuelling operators, stand to benefit more given their limited gas sales volume, which we forecast Amongst our covered city-gas operators, ENN and at only 8% of total gas demand from transportation by CGHL have high exposure to NGV gas sales, with 2020. currently 9-14% gas sales volume contributed from

CNG/LNG refuelling stations. ENN targets to add 100 Therefore, we would keep expectations for the LNG LNG refuelling stations per year until 2015, and CGHL vessel refuelling operators– such as TCCL and CGHL – aims to add 200 CNG refuelling stations per year by in check. However, we would note that CGHL offers a 2015, to raise their gas sales volume contributions to 100% subsidy in exchange for fuel-cost savings, which 15-21%. Therefore, we conclude that ENN and CGHL would provide additional income for its LNG vessel should post higher organic gas sales growth, at 20-30% refuelling businesses. YoY for 2012-15E, than 12-16% YoY for its peers.

 LNG vessel gas demand in China  China city-gas operators: YoY organic gas volume growth Total vessels in China in 2012 a 160,000 vessels 35% Total vessels in China in 2020E b 200,000 vessels 30% % of vessels for conversion to LNG-diesel dual-fuelled c 18% Total LNG vessels in China in 2020E d = b x c 36,000 vessels 25% Annual gas consumption for each vessels e 175,500 cm 20% Total gas consumption for LNG vessels in China in 2020E f = d x e 6.3 bcm Total gas demand from transportation in 2020E g 84 bcm 15% Proportion of LNG vessel gas demand from transportation gas in h = f / g 8% 2020E 10% Total gas demand in China in 2020E i 375 bcm 5% Proportion of LNG vessel gas demand from total gas in 2020E j = f / i 2% Source: Daiwa forecasts 0% 2012 2013E 2014E 2015E ENN CGHL CRG TCCL Source: NDRC, Daiwa - 14 - China Gas Sector 11 November 2013

 Beijing: major four heating-power cogeneration centres Gas-fired utilities: near-term growth from coal-replacement projects

Given China’s long-standing natural-gas shortages, the country has never officially encouraged a substantial build-up of gas-fired power plants. However, with the North east North west cogeneration ramp-up of imported natural gas and the worsening air cogeneration centre centre quality, China has prioritised gas-fired power and heat cogeneration plants, and confirmed recently a total gas-fired power generation capacity target of 56GW South east (previously set target: 40GW) by 2015. South west cogeneration cogeneration centre centre In 2012, China had 38GW of gas-fired power capacity, and we forecast a 14% CAGR for 2012-15. We forecast utilities’ gas demand (power and heating) to post 2012 2013 2014E 2014E 2015E 2015E Plant owner Huaneng Jingneng Datang Jingneng Jingneng Huaneng higher-than-national demand growth at a 40% CAGR Shijingshan in 2012-15. Their gas sales-volume contribution should Plant location Gaobeidian Caoqiao Shijingshan Jingxi Gaoantuan Gaobeidian also rise from 10% in 2012 to 23% in 2020E. South east South west North west North west North east South east Plant area Beijing Beijing Beijing Beijing Beijing Beijing New  China: gas demand for power and heat generation commissioned (YoY) 2010 2011 2012 2013E 2014E 2015E 2020E capacity (MW) 923 838 1,380 1,308 845 923 Total installed gas-fired power Total capacity capacity (GW) 26 27 38 44 50 56 120 (MW) 2,891 3,729 5,109 6,417 7,262 8,185 Annual utilization hours 4,074 3,430 2,573 2,800 2,900 3,000 4,400 Additional gas Gas consumption rate for power sales (bcm) 0.50 1.22 1.35 1.10 generation (cm/kWh) 0.19 0.19 0.19 0.19 0.19 0.19 0.19 Total gas sales Gas consumption rate for heating (bcm) 2.26 3.49 4.83 5.94 (cm/GJ) 33 33 33 33 33 33 33 Source: Beijing DRC, Daiwa forecasts Gas-fired power and heating demand (bcm) 20 17 16 23 27 31 100  Beijing: coal-to-gas conversion of boilers for centralised Growth rate -14% -8% 47% 18% 16% 26% heating schedule Demand proportion 14% 11% 10% 12% 14% 14% 23% Source: Provincial DRCs, Daiwa forecasts

Beijing (BJCE and BEH) is the most leveraged to gas-fired utilities demand Beijing, the region in which air pollution mitigation is most focused, should see a 41% CAGR in the capital’s gas-fired power generation capacity from 2.9GW in 2012 to 8.2GW in 2015, according to forecasts from the Beijing Government. The capital targets to close all coal-fired boilers and power plants by 2015 and 2016, respectively, in order to reduce coal consumption from 23m tonnes in 2012 to 15m tonnes in 2015 and 10m tonnes in 2017.

We forecast BJCE, which is the state-owned clean- Year Coal-fired boilers to be converted (tonnes/yr) Region without coal-fired boilers power provider with a 40-50% share of the gas-fired 2013 2100 Fourth-ring road 2014 2200 Fifth-ring road power market in Beijing, to record a 64% installed 2015 600 Sixth-ring road capacity CAGR from 1.2GW in 2012 to 5.2GW in 2015. Source: Beijing DRC

- 15 - China Gas Sector 11 November 2013

 Gas-fired power capacity in China, Beijing and for BJCE  Coal consumption reduction target for BHT regions in 2012-17 (m tonnes) 2012 2017E Reduction (MW) BJCE: 64% CAGR 60,000 Beijing: 41% CAGR Beijing 23 1057% National: 14% CAGR Hebei 302 260 14% 50,000 Tianjin 50 40 20% Beijing-Tianjin-Hebei 375 310 17% 40,000 Source: State Council 30,000 20,000 From gas shortage to gas surplus: 10,000 potential upside for NGV and gas- 0 2012 2015E fired utilities BJCE Beijing China Source: State Council, Beijing DRC, BJCE, Daiwa forecasts Given the large supply of imported gas in China over 2012-15E, and unconventional gas (mainly coal-to-gas Apart from BJCE (the main gas-fired power and and CBM) post 2015E, we expect the current gas supply heating operator in Beijing), its gas supplier, BEH, deficit to continue to narrow, and turn into a surplus by should also benefit. We forecast BEH to post a 2014E. Our 2015 gas supply surplus forecast of 30bcm significant 23% CAGR in distribution gas sales volume could be enlarged to 70bcm in 2020E, which we believe for 2012-15, through a substantial 41% CAGR would provide China with more gas resources to clean expansion of gas-fired power plants as targeted by the up the air further by replacing polluting coal. Beijing Government.  China: natural gas supply and demand forecasts  BEH: natural gas distribution and transmission sales volume (bcm) forecasts 500 (bcm) 400 Gassupply from 40 30% shortage to surplus 300 30 20% 200

20 100 30 70 10 10% 0 10 (15) (10) (100) (30) (20) 0 0% 2010 2011 2012 2013E 2014E 2015E 2020E 2011 2012 2013E 2014E 2015E Natural gas supply Natural gas demand Natural gas distribution sales (Beijing) - LHS Natural gas surplus (shortage) Natural gas transmission sales - LHS YoY growth of natural gas distribution sales - RHS Source: CEIC, NDRC, Daiwa forecasts YoY growth of natural gas transmission sales - RHS Source: BEH, Daiwa forecasts Therefore, we see gas volume upside for NGVs and gas- fired utilities, of 28% in 2015E and 27% in 2020E. Our Hebei, Tianjin and Northern China to bullish case, which assumes gas consumption of follow Beijing to launch aggressive coal-to- 260bcm in 2015E and 500bcm in 2020E, only gas conversion projects for utilities translates into 8.3% of primary energy contributed Hebei Province and Tianjin city target to reduce their from natural gas in 2015E and 12.7% in 2020E, which coal consumption by 14% and 20%, respectively, over is still lower than the world average of 23.8% in 2012. 2011-17. BEH owns cross-provincial Shaanxi-Beijing pipelines and CSG owns city-gas and pipeline projects in Hebei. Even though CRG also owns a city-gas distributing joint venture in Tianjin, we believe it would take time for CRG’s profitability to turn around from a low-single-digit net-profit margin currently to 11-12%.

- 16 - China Gas Sector 11 November 2013

 Upside for gas demand from NGV and gas-fired utilities  China: cost of different sources of natural gas 2015 2020 (CNY/m3) base case bull case base case bull case 6.0 Transportation 5.0 Total number of NG vehicles ('000) 3,011 3,842 6,025 7,640 4.0 City-gate tariff (wellhead + transmission) Proportion of NGV to total vehicles 2.1% 2.6% 2.5% 3.2% 3.0 2015E: CNY2.77/m3 national average Gas consumed per NG vehicle (mcm/year) 25 25 26 26 2.0 City-gate tariff (wellhead + transmission) Total NG vehicles gas consumption (bcm) 75 96 157 199 1.0 Current: CNY1.95/m3 national average Total number of LNG vessels ('000) 3 4 36 46 0.0 Gas consumed per LNG vessels (mcm/year) 0.2 0.2 0.2 0.2 Total LNG vessels gas consumption (bcm) 1 1 6 8

Gas-fired utilities Coal-to-gas (low range) (low (high range) (high range) Imported Imported LNG

Total installed gas-fired power capacity (GW) 56 71 120 152 CBM/shale gas CBM/shale gas from Russiafrom

Proportion of gas-fired power plant to total 3.8% 4.8% 6.0% 7.6% Conventional gas Imported pipedgas Imported pipedgas Imported Annual utilization hours 3,000 3,000 4,450 4,450 Gas consumption rate for power generation (cm/kWh) 0.19 0.19 0.19 0.19 Source: NDRC, Daiwa forecasts Gas consumption rate for heating (cm/GJ) 33 33 33 33 Gas-fired power and heating demand (bcm) 31 40 100 127 Gas price reform Total transportation and utilities gas consumption 107 137 263 333 Total deficit/(surplus) 30 70 In order to minimise the loss from imported gas Additional upside 28% 27% because of its high cost and motivate upstream natural Source: Daiwa forecasts gas suppliers, China introduced gas tariff reform in June 2013 aiming to liberalise the city-gate tariffs through price linkage with competing fuels – LPG and Margin: pass-through risks on heating oil. further tariff hike On 28 June 2013, the NDRC increased the city-gate In the previous section (gas supply overview), we said price for non-residential natural gas by 15%, to 3 3 we believed expensive imported gas would be the main CNY1.95/m from CNY1.69/m , effective 10 July 2013. growth driver (forecasting a 44% 2010-15E volume Under the plan, China will adopt a ladder-like pricing CAGR) raising China’s gas supply proportion from 14% mechanism for natural gas, allowing one-off in 2010 to 36% in 2015. We expect imported gas to substantial price increases for incremental gas supplies, contribute 50-60% of new gas supply in China over which the NDRC estimates to account for 9% of the 2010-15. piped gas supply for 2013. Moreover, the NDRC will give a grace period until 2015 for the price of existing  China: new gas supply sources base volumes (91% of piped-gas supply for 2013) to be 2010 2011 2012 2013E 2014E 2015E linked to regional competing fuels, such as heating oil New gas supply 19 21 21 26 35 50 and LPG, with a 15% discount. Domestic conventional gas 10 8 13 10 11 8 Domestic unconventional gas - - 1 3 8 12  Average city-gate price for non-residential gas in 2013-15E Imported 9 13 7 13 16 30 (CNY/m3) Proportion from unconventional gas 0% 0% 5% 12% 23% 24% 2.77 Proportion from imported gas 47% 62% 32% 49% 46% 61% 3.00 Source: CEIC, NDRC, Company, Daiwa forecasts 2.50 1.95 Given that the cost of imported gas is 2-7x more 2.00 1.69 expensive than that of domestic conventional gas, 1.50 PetroChina’s natural gas business has been running at a loss, recording a peak net loss of CNY7.3bn for 1H13. 1.00 0.50

0.00 Average city-gate price, Average city-gate price, Average city-gate price, CNY/m³ (before July 2013) CNY/m³ (after July 2013) CNY/m³ (as of July 2015E) Source: NDRC, Daiwa

- 17 - China Gas Sector 11 November 2013

Margin risks on C&I gas higher than that  Natural-gas discount to competing fuels for industrial and vehicle use (as of September 2013) for NGV gas 60% Under this gas tariff scheme, we understand there 50% would be an additional CNY0.88/cm hike on base gas 40% volume (CNY0.58/cm for Guangdong and Guangxi) for 30% non-residential gas over 2014-15. Our stress test shows 20% that city-gas operators in some provinces (five of the 15 10% 0% in our database) might not be able to fully pass through (10%) the planned city-gate price hikes to industrial (20%) customers by the end of 2015. Anhui Hubei Hebei Gansu Hunan Tianjin Beijing Jiangsu

Sichuan Shanghai Shandong Chongqing Shengyang Guangzhou

However, natural gas should still be competitive in all Heilongjiang provinces, with price discounts of 10-45% to other fuels, Natural gas discount for industrial usage Natural gas discount for vehicular usage even taking into account the gas-processing fee of CNY0.8/m3 needed for converting piped gas to Natural gas discount for Natural gas discount for NGV CNG/LNG. Therefore, we believe city-gas operators industrial usage usage Beijing 28% 31% will focus more on developing their LNG-vehicle Tianjin 27% 40% refuelling businesses to protect their gross margins in Hebei 33% 47% the future. Shenyang 13% 45% Heilongjiang 15% 36% Shanghai 21% 36% In addition, NGV gas sales are also more profitable for Jiangsu 26% 38% city-gas operators. For example, in 2012, ENN’s dollar Anhui 19% 44% Shandong 7% 33% margin of NGV gas sales were CNY1.3/cm, around 60% Hubei 8% 36% higher than CNY0.8/cm for C&I gas. Therefore, higher Hunan 22% 35% growth of high-margin NGV gas sales could offset the Guangzhou -9% 18% Chongqing 38% 49% margin squeeze from C&I gas. As such, ENN, BEH and Sichuan 36% 45% CGHL have aggressive expansion plans for their Gansu 36% 56% refuelling station businesses to boost vehicle gas sales. Simple average 21% 39% Source: Provincial DRCs, Daiwa forecasts  China: city-gate hikes in all provinces Note: Highlighted cell represents a premium in the price of natural gas to competing fuels

(CNYb/m3) 4 80%

3 60%

2 40%

1 20%

0 0% g xi in j g hai Jilin g don g Henan Hunan Gansu Tian Jian Jiangsu Yunnan Xinjiang Shaanxi Sichuan Liaoning Shan Chongqing Guan City-gate for base volume (LHS) City-gate for incremental volume (LHS) Further city-gate hike for base volume in 2013-15E (RHS) Source: NDRC, Company Daiwa

- 18 - China Gas Sector 11 November 2013

 Natural-gas discount to competing fuels for industrial and Margin risks for Guangdong, Guangxi, vehicle use (end-2015E) assuming full cost pass-through of city- gate tariff Fujian and Liaoning should be smaller 50% Before the commissioning of the W-E pipeline II at the 40% end of 2011, Guangdong used more expensive LNG, 30% priced at CNY4-5/cm. In 2012, W-E piped gas started 20% to supply Guangdong at CNY2.74/m3, a 30-45% 10% discount to LNG. 0% (10%) 3 (20%) In our view, a further hike in piped gas to CNY3.32/m (30%) would not lead to demand destruction from industrial customers in Guangdong, given that the inflated piped Anhui Hebei Hubei Hunan Tianjin Gansu Beijing Jiangsu

Sichuan gas would still be 15-35% cheaper than LNG in this Shanghai Shandong Chongqing Shengyang Guangzhou

Heilongjiang province. Guangdong will also see a lower absolute hike Natural gas discount for industrial usage Natural gas discount for NGV usage at CNY0.58/cm on base gas volume (compared with an average of CNY0.88/cm for other provinces). Natural gas discount for Natural gas discount for NGV industrial usage usage Some 24% of ENN’s connectable population is located Beijing 10% 20% Tianjin 9% 29% in Guangdong, so we believe the company’s margins Hebei 15% 36% will be less impacted. Shenyang -5% 33% Heilongjiang -3% 25% Natural gas prices in Guangdong Province Shanghai 4% 26% (CNY/m3) Jiangsu 8% 26% 5.00 4.5 Anhui 1% 32% Shandong -11% 22% 4.00 Hubei -10% 25% 3.32 Hunan 4% 24% 3.00 2.74 Guangzhou -21% 10% Chongqing 20% 38% 2.00 Sichuan 18% 34% Gansu 18% 45% Simple average 4% 28% 1.00 Source: Provincial DRCs, Daiwa forecasts 0.00 Note: Highlighted cells represent a premium in the price of natural gas to competing fuels Non-residential city-gate Non-residential city-gate LNG tariff (before July 2013) tariff (end of July 2015E) Gas-fired utilities should continue to gain Source: NDRC, Daiwa support In our view, natural gas for power and heating in the Guangxi, Fujian and Liaoning have also historically regions focused on controlling air pollution should be been mainly supplied by expensive LNG. And in this continuously subsidised by government. However, region, TCCL stands to benefit, as it has around a 30% based on the NDRC announcement on 28 June 2013, total investment in Liaoning. we estimate city-gas operators would need to provide preferential gas tariffs to gas-fired power-heating cogeneration plants.

As such, BEH and CRG could suffer a margin squeeze in future, even though they could fully pass on the recent city-gate hike for utilities gas. However, BEH’s margin squeeze could be offset by forthcoming NGV gas sales in Beijing.

 

- 19 - China Gas Sector 11 November 2013

 Geographical footprint of TCCL in terms of total investments

Source: Company, Daiwa

- 20 - China Gas Sector 11 November 2013

 China: provincial city-gate hike details for non-residential gas, and exposure of city-gas operators CGHL ENN connectable connectable Premium for TCCL residential residential Base Tariff Incremental Tariff incremental Premium for investment household household volume discount to volume discount to volume (unit incremental proportion proportion proportion Major gas (Unit: CNY per m3) tariff Guangdong tariff Guangdong CNY/cm) volume (%) (2012) (2012) (2012) operators Guangdong 2.74 3.32 0.58 21% 5% 1% 24% ENN, HKCG Guangxi 2.57 7% 3.15 5% 0.58 23% 1% 9% 2% CRG, CGHL Shanghai 2.44 12% 3.32 0% 0.88 36% 0% 0% 0% NA Zhejiang 2.43 13% 3.31 0% 0.88 36% 5% 1% 7% ENN, HKCG Jiangsu 2.42 13% 3.30 1% 0.88 36% 0% 6% 10% ENN, HKCG, CRG Anhui 2.35 17% 3.23 3% 0.88 37% 8% 8% 5% TCCL, CGHL Henan 2.27 21% 3.15 5% 0.88 39% 0% 8% 9% ENN, CRG, CGHL Beijing 2.26 21% 3.14 6% 0.88 39% 0% 0% 0% BEHL Tianjin 2.26 21% 3.14 6% 0.88 39% 0% 0% 0% CR Gas Hebei 2.24 22% 3.12 6% 0.88 39% 0% 2% 8% ENN, CSG Liaoning 2.24 22% 3.12 6% 0.88 39% 25% 6% 1% TCCL Shandong 2.24 22% 3.12 6% 0.88 39% 21% 11% 11% ENN, TCCL, CGHL Jiangxi 2.22 23% 3.10 7% 0.88 40% 6% 0% 0% TCCL Hubei 2.22 23% 3.10 7% 0.88 40% 0% 6% 0% HKCG Hunan 2.22 23% 3.10 7% 0.88 40% 2% 1% 14% ENN Shanxi 2.17 26% 3.05 9% 0.88 41% 0% 0% 0% NA Jilin 2.02 36% 2.90 14% 0.88 44% 9% 0% 0% TCCL Heilongjiang 2.02 36% 2.90 14% 0.88 44% 2% 18% 0% CGHL Sichuan 1.93 42% 2.79 19% 0.86 45% 16% 0% 0% CRG, TCCL Guizhou 1.97 39% 2.85 16% 0.88 45% 0% 0% 0% NA Yunnan 1.97 39% 2.85 16% 0.88 45% 0% 0% 1% Kunlun, COG Hainan 1.92 43% 2.78 19% 0.86 45% 0% 0% 0% NA Chongqing 1.92 43% 2.78 19% 0.86 45% 1% 1% 0% CRG Ningxia 1.77 55% 2.65 25% 0.88 50% 0% 0% 0% NA Gansu 1.69 62% 2.57 29% 0.88 52% 0% 0% 0% NA Inner Mongolia 1.60 71% 2.48 34% 0.88 55% 0% 10% 1% CGHL Shaanxi 1.60 71% 2.48 34% 0.88 55% 0% 4% 0% HKCG Qinghai 1.53 79% 2.41 38% 0.88 58% 0% 0% 0% Kunlun, COG Xinjiang 1.41 94% 2.29 45% 0.88 62% 0% 0% 0% NA Weight average (as of 2011) 2.06 2.89 0.83 40% 39% 38% 32% National average Hike Average city-gate price, CNY/m3 (before July 2013) 1.69 Average city-gate price, CNY/m3 (after July 2013) 1.95 15% Average city-gate price, CNY/m3 (as of July 2015E) 2.77 42% Source: NDRC, Daiwa Note: Cells highlighted in yellow show the narrowing of the tariff discount to Guangdong; cells in light blue show the provinces with higher-than-national-average city-gate tariff hike percentage over 2014-15

Narrowing the provincial tariff gap could incentivise the CNPC to supply gas to the Beijing- encourage gas supply to northern China Tianjin-Hebei region in the future.

Before the latest tariff hike in June 2013, the CNPC was more willing to supply natural gas to Guangdong than Significant demand destruction or margin to the northern regions through the W-E Pipeline #2 squeeze could occur in the northwest due to the significant 40% or so tariff premium of Given the northwest has been enjoying cheap natural Guangdong over the Beijing-Tianjin-Hebei region. This gas, we see that region facing a higher 50-60% increase led to flat (+0.7% YoY) growth in BEH’s gas in city-gate tariffs for non-residential gas (compared transmission volume of its Shaanxi-Beijing pipelines in with the national average of 40%). Either a demand 1H13, compared with a 24% YoY rise for 1H12, given its destruction or margin squeeze could occur if end cross-province pipelines in the Beijing, Tianjin and customers, such as factories, have difficulty passing on Hebei areas. We forecast the discount of city-gate the higher fuel costs. China Oil & Gas (603 HK, Not tariffs in the Beijing-Tianjin-Hebei region to narrow rated) and Kunlun Energy (135 HK, Not rated) are from 21% in 2013 to 6% in 2015, which should major city-gas operators in Qinghai.

- 21 - China Gas Sector 11 November 2013

 HKCG and TCCL: total acquisitions from 2001-11 M&A at the project level no longer (CNYm) HKCG and TCCL spent HKCG and TCCL have spent CNY2.7bn on average from only CNY1bn on average attractive 6,000 2001 to end-2007 acquiring since 2008 without acquiring six provincial capital projects. any provincial capital projects. 5,000

From 2000-12, city-gas operators acquired a large 4,000 number of city-gas projects to boost earnings. However, we observe that the city-gas operators, even 3,000 big spenders like CR Gas, have slowed down their M&A 2,000 activity as the provincial governments and project 1,000 owners have realised the value of the city-gas projects, 0 after the failed hostile takeover of CGHL by ENN/ 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sinopec in 2012. HKCG TCCL

Source: Company, Daiwa Slowdown in pace of acquisitions In 2001-06, HKCG dominated the city-gas M&A arena  China gas distributors: number of city-gas projects with various provincial capital projects in Nanjing, 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 ENN 29 41 52 59 64 69 72 79 90 104 117 Wuhan, Shenzhen, Jinan, Changchun, Chengdu and CR Gas n.a. n.a. n.a. n.a. n.a. n.a. 7 27 48 73 151 Xi’an, etc. CRG then took over the leadership in the Towngas Chinan.a. n.a. n.a. 25 35 39 43 49 63 68 78 M&A market by adding Chongqing, Zhengzhou, China Gas n.a. 21 43 50 60 68 110 123 148 160 179 Fuzhou, Nanchang and Tianjin, from 2008-12. Yoy growth ENN 41% 27% 13% 8% 8% 4% 10% 14% 16% 13% CR Gas n.a. n.a. n.a. n.a. n.a. n.a. 286% 78% 52% 107% By contrast, ENN and CGHL have focused on third-tier Towngas China n.a. n.a. n.a. 40% 11% 10% 14% 29% 8% 15% cities and recently slowed their pace of acquisition of China Gas n.a. 105% 16% 20% 13% 62% 12% 20% 8% 12% big city-gas projects. Source: Companies Note: Highlighted cells show that ENN, TCCL and CGHL have slowed down their acquisition pace since 2005  China: provincial capital acquisition history Acquisition Total cost for Year of Stake cost 100% stake Small green-field projects are loss-making Province City Operator completion (%) (CNYm) (CNYm) in the early stage Hubei Wuhan HKCG 2002 50% 1,200 2,400 Hebei Shijiazhuang ENN 2002 55% 120 218 Most city-gas operators are currently targeting to Guangdong Shenzhen HKCG 2003 27% 2,316 8,642 acquire 10-20 new green-field projects focusing on new Jiangsu Nanjing HKCG 2003 50% 1,200 2,400 towns and industrial zones. According to TCCL, these Shandong Jinan East HKCG 2003 50% 610 1,220 projects could take 3-5 years to develop and break Hunan Changsha ENN 2003 65% 300 462 even. Therefore, we think the acquisition of small Shandong Jinan West TCCL 2005 48% 405 844 Jilin Changchun TCCL 2005 48% 800 1,667 projects would only contribute to the city-gas Sichuan Chengdu TCCL 2005 13% 800 6,154 operators’ bottom lines after five years. Shaanxi Xian HKCG 2006 49% 1,668 3,404  Inner Mongolia Hohhot CGHL 2006 51% 400 784 New big projects take time and money to Harbin Heilongjiang CGHL 2007 48% 477 994 Sichuan Chengdu CRG 2008 36% 1,900 5,278 conclude Chongqing Chongqing CRG 2010 25% 1,200 4,800 Unlike the previous big city-gas deals before 2010, we Henan Zhengzhou CRG 2010-12 100% 1,450 1,450 note that recent deals, such as those completed by CRG Fujian Fuzhou CRG 2012 49% 1,000 2,041 in Tianjin and Ningbo (see following chart), have taken Jiangxi Nanchang CRG 2012 49% 1,000 2,041 Tianjin Tianjin CRG 2013 49% 2,500 5,102 over two years to complete at a high price tag of CNY2- Source: Companies 2.5bn. We believe big project acquisitions in the future Note: Highlighted cells show all big city-gas projects that have been acquired by CRG since will be completed in a more timely manner and be 2008 more expensive.

Therefore, we do not think M&A would be a share-price catalyst for the city-gas operators due to the less attractive opportunities going forward.

- 22 - China Gas Sector 11 November 2013

 CRG: number of green-field projects to total projects

Source: Company, Daiwa

- 23 - China Gas Sector 11 November 2013

gas distribution market, which explains in part the More takeovers of publicly listed rationale for ENN/Sinopec’s hostile takeover attempt city-gas operators? of CGHL, and the stake accumulation in CGHL by BEH. As future M&A is likely to be time-consuming and not value-accretive, we think there is the possibility that Although ENN’s recent USD500m convertible-bond some privately owned city-gas operators could be near- issuance could reduce the 31% stake held by the term acquisition targets for SOEs or big operators, as chairman of ENN, Wang Yusuo, to about 28%, we was the case in the failed hostile takeover of CGHL by understand that ENN has a cash-settlement option that ENN/Sinopec in 2012. would avoid such a reduction, and management has not given guidance on its intention to sell the company. The following table shows the companies we see as Therefore, we believe a general offer for ENN is potential acquirers and targets. We believe that given unlikely in the near future. the clear natural-gas strategies of the oil majors, some small- and mid-sized city-gas operators could be acquisition targets in the future. Connection fees not a near-term risk  Possible M&A city-gas players Possible acquirers Possible targets Connection-fee income is an essential part of the city- Kunlun Energy (135 HK)/PetroChina (857 HK) China Tianlun Gas (1600 HK) Sinopec (386 HK) China Oil & Gas (603 HK) gas business model, providing most of the cash flow in CNOOC (883 HK) China Gas (384 HK)* the early stages of a new city-gas project. Gas Beijing Enterprises (392 HK) ENN Energy (2688 HK) companies usually charge such one-off income to a new China Resources Gas (1193 HK) customer upon connection. For the city-gas operators Hong Kong and China Gas (3 HK)/Towngas China (1083 HK) we cover, connection fees account for 40-60% of our ENN Energy (2688 HK) China Gas (384 HK) 2013 total gross-profit forecasts, excluding BEH, which Source: Daiwa forecasts barely charges connection fees in Beijing anymore. Note: *Beijing Enterprises Group, the parent of BEH, has succeeded in having its chairman placed on the board of CGHL (384 HK)  China gas distributors: gas connection fees as a proportion of gross profit The failed takeover bid by the ENN/Sinopec 70% consortium was the focus for the sector in 2012. In response to the bid, Beijing Enterprises Group (BEG) 60% (the parent of BEH) and a former managing director of CGHL accumulated CGHL’s shares in the open market, 50% in a price range of HKD3-8/share. This resulted in them holding a combined stake of about 40% and led 40% to the attempted takeover failing. 30% BEG, currently the largest shareholder in CGHL, has appointed Zhou Si, the CEO of BEH, as the chairman of 20% CGHL’s board. Following the signing of a co-operation 2008 2009 2010 2011 2012 2013E 2014E 2015E agreement between BEG and CGHL in August 2013, we ENN CGHL CRG TCCL Source: Company, Daiwa forecasts believe BEG has succeeded in making CGHL its city- gas platform outside Beijing. Given that connection fees account for a high proportion of gross profit contribution, we think China Tianlun (Not rated) and ENN are the only investors could be concerned that the potential privately owned gas distributors (aside from HKCG cancellation of connection fees or a slowdown in the and TCCL, which are considered foreign companies) property market could jeopardise the earnings growth classified as potential targets in our list. One question of the city-gas operators. we think investors are asking now is: “Could ENN be a takeover target?” However, we do not see such risks as being imminent, as: 1) the China Government uses the connection-fee Our view is that natural gas will play an important role policy to encourage city-gas infrastructure investment, in national energy security, given that we forecast its 2) city-gas operators have a high number of existing contribution to primary energy to rise from 4% for households waiting to be connected, in the event of a 2010 to 8% for 2015, and to 13% for 2020. Therefore, slowdown in new-build properties. ENN has said that it SOEs should be keen to hold interests in the natural- - 24 - China Gas Sector 11 November 2013

has more than 2m households waiting to be connected,  Major city-gas operators: unit dollar margin and % of gas representing a two-year backlog. sales contributed from vehicle refuelling (CNY/m3) Ultimately, cities could start cancelling connection fees 1.0 50% once the level of natural-gas usage is high, as is the case 0.8 40% in cities such as Beijing, Shanghai, and Hong Kong. In 0.6 30% our model, we assume the city-gas operators will not be 0.4 20% able to collect connection fees when residential 0.2 10% penetration rates are above 65% (they range currently 0.0 0% from 35-45%), which we expect only between 2018 and 2012 2013E 2014E 2015E ENN - unit dollar margin (LHS) 2020. CGHL - unit dollar margin (LHS) BEH - unit dollar margin (LHS) ENN - NGV gas sales contribution (RHS) CGHL - NGV gas sales contribution (RHS) Quantifying the catalysts and BEH - NGV gas sales contribution (RHS) Source: Companies, Daiwa forecasts risks with the valuation: the Daiwa PES ratio Factor 2 – Exposure to high-gas-cost regions In view of the gross margin uncertainty associated with We believe some provinces will be less affected by the gas sales created by the current gas-tariff reform, we planned tariff hikes. For example, in Guangdong and believe that picking stocks based purely on gas sales- Guangxi, the city-gate tariff rises over 2014-15 will be volume growth potential is too simple a strategy. We CNY0.58/m3 on base gas volume (compared with the therefore introduce the Daiwa PES ratio, which nationwide average of CNY0.88/cm). quantifies five qualitative factors – ranging from share- price catalysts to risk factors – with the current The general lack of piped gas supply in Guangdong, valuations of each stock. This allows us to identify the Fujian, and Liaoning provinces means they have been best risk-adjusted investment names. using more expensive LNG, priced at CNY4-5/m3. However, the piped gas after the CNY0.58/m3 hike, at Our five-factor scorecard CNY3.1-3.3/m3, would still be at a discount of 20-60% We first decide on the five major qualitative factors to current LNG prices. Therefore, we do not expect the that are likely to drive the share prices of our covered planned city-gate tariff rises to lead to demand gas stocks. We then assign scores (from 1-7, with 1 destruction among industrial customers in these being the least positive) for each factor. To determine a provinces. stock’s Daiwa PES ratio, we then divide the forward PER into the quantitative scores of each stock, in order Meanwhile, in other provinces, such as Qinghai and to obtain the most risk-adjusted undervalued gas stock. Xinjiang, where the cost of natural gas is only CNY1.4/m3, there are downside risks to either gas Factor 1 – NGV exposure demand or the dollar margin for the city-gas operators, as the planned CNY0.88/m3 price rise will represent an We favour gas companies with significant NGV gas increase of about 60% in the city-gate gas cost sales, as they are less likely to see a margin squeeze (Guangdong: 20%; national average: 40%). than those with high exposure to C&I gas. NGV gas sales are also more profitable for city-gas operators. Both ENN and TCCL have significant exposure to For example, in 2012, ENN’s dollar margin from NGV Guangdong and Liaoning provinces, respectively. 3 gas sales was CNY1.3/m , which was about 60% higher than the CNY0.8/m3 for C&I gas.

We expect some of the gas companies, such as ENN, CGHL, and BEH to be able to expand their total gas dollar margins on the back of a rise in the sales volume of high-margin NGV gas.

- 25 - China Gas Sector 11 November 2013

 Provinces currently mainly supplied by LNG receiving terminal and we expect the capital to continue to support the consumption of clean energies to reduce air pollution.

In Beijing, BJCE has the highest gas-fired power capacity growth target, a 64% CAGR over 2012-15. Therefore, BJCE is the most leveraged play to the air- pollution reduction theme in China, followed by BEH (a city-gas operator in Beijing with cross-province pipelines in the Beijing, Tianjin and Hebei areas), CSG (a city-gas and provincial pipeline operator in Hebei), and CRG (which owns a 49% stake in a joint venture with Tianjin Gas).

 Coal consumption-reduction targets for Beijing, Tianjin, and Hebei over 2012-17 (m tonnes) 2012 2017E Reduction Beijing 23 1057% Source: NDRC, Daiwa Hebei 302 260 14% Tianjin 50 40 20%  China: city-gate gas tariff hike for all provinces Beijing-Tianjin-Hebei 375 310 17% (CNYb/m3) Source: State Council 4 80% 3 60%  Gas-fired power capacity in China, Beijing, and for BJCE (MW) 2 40% 60,000 BJCE: 64% cAGR 1 20% Beijing: 41% CAGR 50,000 National: 14% CAGR 0 0% 40,000 Jilin Hunan Gansu Henan Tianjin Jiangxi Yunnan Jiangsu Xinjiang Sichuan Shaanxi Liaoning 30,000 Shanghai Chongqing Guangdong City-gate for base volume (LHS) 20,000 City-gate for incremental volume (LHS) 10,000 Further city-gate hike for base volume in 2013-15E (RHS) Source: NDRC 0 2012 2015E Factor 3 – Air pollution BJCE Beijing China The State Council has announced detailed air-pollution Source: State Council, Beijing DRC, BJCE, Daiwa forecasts measures and targets for three major areas: Beijing,  Beijing: government subsidies of public services Tianjin and Hebei, the Yangtze Delta (comprising Subsidy (CNYm) 2012 % of total government spending Shanghai, Jiangsu and Zhejiang), and the Pearl River Taxi (fuel subsidy) 670 0.2% Delta (Guangdong). Subway 3,690 1.1% Gas-fired utilities 1,553 0.5% Among these, Beijing, Tianjin and Hebei have the Gas-fired utilities in 2015E 8,493 2.5% Bus 13,820 4.1% highest PM2.5 reduction target of 25% (according to Total government spending 338,980 the State Council target document) from 2012 to 2017, Source: MOF, Beijing Municipal Commission of Transport compared with a PM2.5 reduction target of 20% for the Yangtze Delta and 15% for the Pearl River Delta. Factor 4 – New gas sources for provinces with low penetration rates Among the areas of Beijing, Tianjin and Hebei, Beijing has the most ambitious coal-reduction target, at 57% Gas supply is always the key driver of the earnings for compared with 14% and 20%, respectively, for Hebei the city-gas operators. We expect the following gas and Tianjin. Beijing city aims to close all coal-fired sources to see major increases in volume over 2014-15 power plants, and boilers for urban heating by 2016. – Shaanxi-Beijing Pipeline III and IV, West-to-East Pipeline II and III, Sino-Myanmar Pipeline, coal-to-gas Unlike in the other regions, the municipal government plants (Beijing and Liaoning), Putian LNG (Fujian), in Beijing has been subsidising tariffs and natural-gas Nantong LNG (Jiangsu), Dalian LNG (Liaoning), costs for gas-fired power plants and heating centres, Ningbo LNG (Zhejiang), Tianjin LNG, and Qingdao LNG (Shandong).

- 26 - China Gas Sector 11 November 2013

However, we believe that picking stocks based solely on  China gas utilities: market capitalisation and free float gas sources is too simple a strategy. There are gas (USDm) surpluses in some places where the natural-gas 9,000 80 penetration is high (in terms of gas consumption per 8,000 70 capita), such as Sichuan, Chongqing, and Nanjing, 7,000 60 6,000 which only saw low single-digit YoY gas-volume 50 5,000 40 consumption growth over 1H13. 4,000 30 3,000 Meanwhile, we believe that regions that have low 2,000 20 penetration rates, such as the southwest, northeast, 1,000 10 Fujian and Jiangxi, will see significant natural-gas 0 0 BEHL BJCE CGHL CRG CSG ENN TCCL consumption growth as a result of new supplies from the Sino-Myanmar Pipeline and coal-to-gas/LNG Market cap (LHS) Free Float (RHS) projects. TCCL, CGHL, and CRG have significant Source: Bloomberg exposure to these regions.  China gas utilities: three-month average daily trading volume (USDm)  China: gas consumption rate and new gas sources for each 25 province 2011 gas 20 consumption Major gas Province per capita operators New gas sources by 2015 15 Guangxi 5 CRG, CGHL Sino-Myanmar Pipeline, W-E Pipeline II, III Yunnan 9 Kunlun , COG Sino-Myanmar Pipeline, W-E Pipeline II, III 10 Guizhou 14 NA Sino-Myanmar Pipeline, W-E Pipeline II, III Jiangxi 14 TCCL Sichuan-East, W-E Pipeline II, III 5 Hunan 23 ENN W-E Pipeline II, III Anhui 34 TCCL, CGHL W-E Pipeline II, III 0 Hubei 43 HKCG W-E Pipeline II, III Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Shandong 55 ENN, TCCL, China Sinopec and CNPC pipelines, Qingdao LNG Gas CGHL CSG BJCE BEH Henan 59 ENN, CRG, CGHL W-E Pipeline II, III CRG ENN TCCL Gansu 62 NA Domestic, W-E Pipeline III Source: Bloomberg Jilin 70 TCCL Domestic Zhejiang 80 ENN, HKCG W-E Pipeline II, III, Ningbo LNG Daiwa PES ratio – linking the qualitative Heilongjiang 81 China Gas Domestic Shanxi 89 NA W-E Pipeline II, III, CBM, Shaanxi-Beijing Pipeline scores to the valuation III, IV We add up the scores of five qualitative factors to obtain Liaoning 89 TCCL Fuxin coal-to-gas, Shaanxi-Beijing Pipeline IV China average 97 NA total scores for each stock. ENN has the highest score, Fujian 102 NA Putian LNG, W-E Pipeline III with 25 points, followed by CGHL, BEH, TCCL, CRG, Hebei 106 ENN, CSG Sinopec's pipeline, Tangshan LNG CSG and BJCE. We therefore see ENN as the most Guangdong 109 ENN, HKCG W-E Pipeline Ii, III, Shenzhen LNG Jiangsu 119 ENN, HKCG, CRG W-E Pipeline II, III, Nantong LNG defensive city-gas operator, able to maintain its gross- Inner Mongolia 165 CGHL Fuxin coal-to-gas, Shaanxi-Beijing Pipeline IV profit margin despite the tariff hikes over 2014-15. Shaanxi 167 HKCG Shaanxi-Beijing Pipeline III, IV Sichuan 194 CRG, TCCL Domestic Chongqing 212 CR Gas Domestic Meanwhile, compared with their peers, CGHL should Shanghai 236 NA W-E Pipeline II, III, Nantong LNG see greater growth in low-penetrated projects and BEH Tianjin 239 CR Gas Shaanxi-Beijing Pipeline IV, Tianjin LNG, Sinopec's pipeline should see higher gas-volume growth for coal-to-gas Ningxia 291 NA Domestic, W-E Pipeline III utility projects in Beijing and Hebei due to air- Beijing 423 BEHL Shaanxi-Beijing III, IV, Tangshan LNG, Keqi coal- pollution reduction targets. Small-cap stocks such as to-gas TCCL, CSG and BJCE have lower scores due to their Source: CEIC, Daiwa forecasts liquidity.

Factor 5 – Stock liquidity We also consider stock liquidity in our score card, given that a low trading volume could lead to share-price volatility. ENN’s current three-month average daily trading volume is the highest, at USD15m, followed by BEH, CRG and CGHL each at around USD10m. TCCL, BJCE and CSG have daily trading volumes currently of USD3-4m, making them relatively illiquid.

- 27 - China Gas Sector 11 November 2013

 China gas utilities: scorecard results PER with the total scores of our five qualitative factors, Total scores to derive the Daiwa PES ratio. A low Daiwa PES ratio NGV exposure ENN: 25 indicates that the stock is cheap after taking into 8 CGHL: 23 6 BEH: 21 account its margin defensiveness, gas sales-volume TCCL: 21 4 Exposure to high- growth potential, and liquidity risks. Trading volume CRG: 21 2 gas-cost regions CSG: 17 0 BJCE: 13 We like gas utility BJCE due to its cheap valuation and significant 64% CAGR of gas-fired power and heat New gas sources cogeneration expansion over 2012-15E. for low penetrated Air pollution theme provinces Among the China gas distributors, we see ENN as being BJCE CSG ENN TCCL attractive given its margin defensiveness and NGV gas CGHL BEH CRG exposure. Source: Daiwa

To determine our preferred stocks, we take the valuation into consideration by dividing the forward   China gas utilities: Daiwa PES ratio Margin Volume Risks 2014E PER PES ratio NGV exposure Exposure to high-gas-cost regions Air-pollution theme New gas sources for low penetrated provinces Trading volume Total scores (x) (x) (a) (b) (c) (d) (e) (f)= a + b + c + d + e (g) (h) = g / f BJCE 1 1 7 2 2 13 8.4 0.64 ENN 7 7 1 3 7 25 16.4 0.66 TCCL 2 6 3 7 3 21 14.2 0.68 CGHL 6 5 2 6 4 23 15.9 0.69 CSG 4 3 5 4 1 17 12.3 0.72 BEH 5 2 6 2 6 21 15.4 0.73 CRG 3 4 4 5 5 21 16.7 0.79 Source: Bloomberg, Daiwa

- 28 - China Gas Sector 11 November 2013

Companies in the city-gas value Gas-pipe makers Chu Kong Petroleum and Natural Gas Steel Pipe (Chu chain: CIMC Enric the most Kong) (Not rated) and Shengli Oil & Gas Pipe (Shengli) leveraged play (Not rated) are two of the largest oil and gas pipeline manufacturers in China. Besides the upstream oil and gas producers, city-gas suppliers and gas-fired power and heating co- Shengli’s main products, spiral submerged arc weld generators, the following companies’ business models (SSAW) pipes, are mainly used in long-distance are also linked with the natural-gas market in China. national transmission pipelines in rural areas, while Chu Kong’s main products, longitudinal submerged arc CNG/LNG equipment makers weld (LSAW) pipes, are used mainly in provincial, city- gas high-pressure pipeline projects located in more CIMC Enric has about a 50% share of the CNG/LNG densely populated areas. Chu Kong’s LSAW pipes can equipment market in China. The CNG/LNG equipment also be used for deep-sea oil and gas projects due to its is used mainly for NGV refuelling, the refuelling of strength. China Liansu (Not rated) makes polyethylene LNG vessels, and peak-shaving LNG storage tanks for (PE) pipes for low-pressure, city-gas pipeline projects. city-gas. It mainly comprises five major types: 1) LNG liquefaction and CNG compressors, 2) LNG/CNG  Natural gas pipeline system trailers for fuel distribution, 3) LNG storage tanks and CNG storage tubes, 4) NGV refuelling equipment, and 5) CNG/LNG fuel cylinders for vehicles.

Based on our forecasts, the market for LNG trailers, storage tanks and refuelling equipment in China will be worth some CNY310bn over 2013-20. We assume CIMC Enric accounts for about a 40% share of this CNY310bn market, which should be driven mainly by our forecast of a six-fold increase in the number of NGVs, coal-to-gas utilities conversion projects, and emerging LNG vessels market.

Given the heavy investments in refuelling and logistical infrastructure during the initial growth stages of the Source: Daiwa three above-mentioned markets, CIMC Enric is the most leveraged play on the volume growth over the Pipeline or trailer, which to choose? near term. Other major CNG/LNG equipment Trailers and pipelines are the two major means of providers include Chart Industries (Not rated) and transporting natural gas from upstream to downstream. Furuise (Not rated). Please refer to CIMC Enric Given the significant initial capex required for a pipeline initiation: a proxy for strong LNG growth in China. project – eg, CNY14bn for the about 800km cross- provincial Shaanxi-Beijing pipeline, or about CNY3bn  NGV supply chain for a provincial pipeline of about 550km in Hebei – we believe trailers are the most economical way to transport gas for low-consumption customers, such as NGV refuelling stations, or low-demand industrial customers.

Pipelines are built mainly for city-gas, industrial parks and high-demand industrial customers. According to an industry expert from CUCBM (Not listed), the consumption threshold at which a gas pipeline is economically justified is 500m m3/year.

Source: Daiwa Note: Dotted red boxes indicate the CNG/LNG equipment supplied by CIMC Enric

- 29 - China Gas Sector 11 November 2013

Gas-fired turbine makers dominant local manufacturers of gas-fired turbines for In China, the big-3 power-equipment makers, power and heating plants. Most of the businesses are Shanghai Electric (Not rated), Dongfang Electric (Not conducted through joint ventures with foreign partners rated) and Harbin Electric (Not rated) are the such as Siemens, Mitsubishi Heavy Industries, and GE.   Major city-gas distributors in Daiwa’s coverage: comparison of operating data (I) 2008 2009 2010 2011 2012 2013E 2014E 2015E Number of city gas projects Beijing Enterprises Holdings 6 6 6 6 10 10 10 10 ENN Energy 72 79 90 104 117 130 145 160 Towngas China 43 49 63 68 78 93 108 123 China Gas 110 123 148 160 179 200 215 230 China Resources Gas 7 27 48 73 151 170 190 210 China Suntien Green Energy NA 3 5 14 18 22 26 30 New household connection ('000) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 710 788 876 1,030 1,122 1,222 1,322 1,422 Towngas China (consolidated) 147 140 190 235 260 266 297 331 China Gas 419 658 902 1,105 1,226 1,306 1,366 1,426 China Resources Gas 361 595 926 1,005 1,129 1,215 1,234 1,256 China Suntien Green Energy NA NA NA NA NA NA NA NA Connectable households (m) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 14 15 16 18 19 19 20 21 Towngas China 13 14 15 15 16 17 17 18 China Gas 17 19 20 21 22 23 25 26 China Resources Gas 6 11 24 26 30 34 39 43 China Suntien Green Energy NA NA NA NA NA NA NA NA Residential penetration rate (%) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 26% 31% 35% 38% 42% 46% 51% 55% Towngas China 36% 37% 40% 42% 45% 47% 50% 53% China Gas 25% 30% 33% 37% 42% 45% 49% 53% China Resources Gas 36% 30% 36% 40% 47% 50% 53% 56% China Suntien Green Energy NA NA NA NA NA NA NA NA Connection fee per household (CNY) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 2,662 2,682 2,854 2,796 2,810 2,813 2,816 2,818 Towngas China 2,962 3,161 3,209 3,607 3,787 4,010 4,246 4,495 China Gas 2,437 2,368 2,454 2,473 2,550 2,611 2,659 2,697 China Resources Gas 2,821 2,150 2,640 2,874 2,875 2,784 2,784 2,784 China Suntien Green Energy NA NA NA NA NA NA NA NA Connection fee gross-profit margin Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 60% 57% 53% 62% 62% 62% 63% 63% Towngas China (segment margin) 40% 41% 40% 44% 46% 49% 51% 52% China Gas 67% 71% 68% 65% 69% 71% 73% 75% China Resources Gas 46% 51% 61% 59% 62% 62% 62% 62% China Suntien Green Energy NA NA NA NA NA NA NA NA Connection fee as a % of revenue (%) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 29% 30% 27% 23% 20% 20% 18% 16% Towngas China 27% 24% 23% 24% 23% 21% 20% 19% China Gas 18% 14% 15% 15% 16% 13% 10% 8% China Resources Gas 25% 25% 23% 21% 21% 19% 17% 14% China Suntien Green Energy NA NA NA NA NA NA NA NA Connection fee as a % of gross profit / segment profit (%) Beijing Enterprises Holdings NA NA NA NA NA NA NA NA ENN Energy 63% 57% 54% 55% 47% 46% 45% 45% Towngas China 56% 61% 66% 66% 64% 61% 62% 65% China Gas 53% 49% 55% 51% 52% 44% 39% 36% China Resources Gas 29% 41% 48% 42% 42% 37% 34% 31% China Suntien Green Energy NA NA NA NA NA NA NA NA Source: Companies, Daiwa forecasts

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 Major city-gas distributors in Daiwa’s coverage: comparison of operating data (II) 2008 2009 2010 2011 2012 2013E 2014E 2015E City-gas distributed sales volume (m m3) Beijing Enterprises Holdings 4,890 5,690 6,460 6,470 7,940 9,528 11,529 14,065 ENN Energy 2,200 2,632 3,808 5,011 6,225 7,703 9,512 11,375 Towngas China (consolidated) 582 760 987 1,200 1,310 1,520 1,748 1,992 China Gas 2,130 3,380 4,452 5,563 6,825 8,850 11,476 14,306 China Resources Gas 1,415 2,214 5,574 7,216 9,268 13,547 16,194 18,773 China Suntien Green Energy 183 239 249 426 492 640 828 1,066 City-gas distributed sales YoY volume growth (%) Beijing Enterprises Holdings 33% 16% 14% 0% 23% 20% 21% 22% ENN Energy 25% 20% 45% 32% 24% 24% 23% 20% Towngas China NA 31% 30% 22% 9% 16% 15% 14% China Gas 104% 59% 32% 25% 23% 30% 30% 25% China Resources Gas NA 57% 152% 29% 28% 46% 20% 16% China Suntien Green Energy NA 31% 4% 71% 15% 30% 29% 29% Gas sales proportion to residential (%) Beijing Enterprises Holdings 8% 9% 11% 10% 9% 8% 7% 6% ENN Energy 16% 18% 15% 15% 14% 13% 12% 11% Towngas China 29% 28% 27% 26% 25% 25% 25% 25% China Gas 13% 12% 13% 13% 12% 11% 10% 10% China Resources Gas 23% 17% 20% 20% 21% 21% 19% 18% China Suntien Green Energy NA NA 9% 6% 6% 6% 5% 5% Gas sales proportion to commercial and industrial (%) Beijing Enterprises Holdings 11% 12% 13% 12% 11% 9% 8% 7% ENN Energy 71% 69% 71% 67% 67% 67% 67% 66% Towngas China 71% 72% 73% 74% 75% 75% 75% 76% China Gas 79% 81% 79% 78% 79% 78% 76% 76% China Resources Gas 60% 67% 61% 58% 60% 60% 59% 59% China Suntien Green Energy NA NA 18% 29% 33% 39% 45% 50% Gas sales proportion to vehicles refuelling (%) Beijing Enterprises Holdings NA NA NA NA NA NA 2% 6% ENN Energy 13% 13% 13% 13% 14% 16% 18% 21% Towngas China NA NA NA NA NA NA NA NA China Gas 8% 7% 9% 9% 9% 11% 14% 15% China Resources Gas 2% 3% 7% 8% 12% 13% 13% 14% China Suntien Green Energy NA NA 5% 4% 5% 4% 4% 4% City gas ASP (CNY/ m3) Beijing Enterprises Holdings 2.02 1.89 1.92 2.09 2.06 2.31 2.71 3.11 ENN Energy 2.87 2.84 3.04 3.37 3.42 3.55 3.86 4.21 Towngas China 2.02 1.82 2.03 2.26 2.46 2.62 2.94 3.25 China Gas 1.97 2.08 2.32 2.37 2.44 2.65 3.02 3.39 China Resources Gas 1.99 1.94 2.24 2.24 2.49 2.77 2.96 3.19 China Suntien Green Energy 1.61 1.63 1.79 1.93 1.97 2.16 2.54 2.91 City gas average cost (CNY/ m3) Beijing Enterprises Holdings 1.73 1.61 1.64 1.82 1.80 2.01 2.37 2.75 ENN Energy 2.21 2.23 2.52 2.63 2.62 2.74 3.04 3.37 Towngas China (segment) 1.89 1.68 1.90 2.10 2.27 2.40 2.72 3.04 China Gas 1.46 1.55 1.84 1.86 1.96 2.16 2.51 2.89 China Resources Gas 1.51 1.46 1.79 1.76 1.93 2.02 2.29 2.62 China Suntien Green Energy 1.26 1.30 1.47 1.61 1.57 1.74 2.10 2.45 City gas dollar margin (CNY/ m3) Beijing Enterprises Holdings 0.29 0.28 0.28 0.26 0.27 0.30 0.34 0.36 ENN Energy 0.66 0.62 0.53 0.74 0.80 0.81 0.83 0.84 Towngas China (segment) 0.13 0.13 0.13 0.16 0.19 0.22 0.22 0.21 China Gas 0.51 0.53 0.47 0.51 0.49 0.50 0.51 0.50 China Resources Gas 0.48 0.47 0.45 0.48 0.56 0.74 0.66 0.57 China Suntien Green Energy 0.35 0.34 0.32 0.33 0.40 0.42 0.45 0.46 City gas dollar margin YoY growth (%) Beijing Enterprises Holdings NA -1% -3% -6% 2% 13% 12% 6% ENN Energy NA -6% -14% 40% 8% 1% 2% 1% Towngas China (segment) NA -2% -3% 25% 19% 16% 1% -4% China Gas NA 4% -11% 7% -4% 2% 3% -2% China Resources Gas NA -1% -5% 6% 17% 32% -10% -14% China Suntien Green Energy NA -4% -5% 1% 22% 6% 6% 4% Source: Companies, Daiwa forecasts

- 31 - China Gas Sector 11 November 2013

- 32 -

Industrials / China 3899 HK Industrials / China 11 November 2013

CIMC Enric

CIMC Enric Target (HKD): 15.50  15.50 Upside: 44.9% 3899 HK 7 Nov price (HKD): 10.70

Likely to benefit the most from positive sector outlook 1 Buy (unchanged) 2 Outperform • We see CIMC Enric as the best play on our bullish view on NGVs 3 Hold and gas-fired utilities in China 4 Underperform • Recent concerns over piped-gas tariff hike seem overdone, as 5 Sell vehicle gas sales should be most profitable for gas operators • Reiterating our Buy (1) rating: our top pick in the sector

How do we justify our view?

CIMC Enric: a proxy for strong Risks to our view would be either a LNG growth in China. slowdown in the LNG market due to a city-gate tariff hike in China or a More policies to support LNG margin squeeze on LNG equipment.

consumption. China has published Forecast revisions (%) Dennis Ip, CFA its first technical standards for LNG Year to 31 Dec 13E 14E 15E (852) 2848 4068 vessels, and subsidies to begin the fuel Revenue change --- [email protected] conversion of the first 1,000 vessels Net profit change --- Core EPS (FD) change - - - could follow. We expect the market for Gary Zhou LNG vessels to expand significantly Source: Daiwa forecasts (852) 2773 8535 over the near term (see CIMC Enric: [email protected] Share price performance More policies to support LNG consumption, 4 October 2013). (HKD) (%) 13 230 ■ What's new 11 193 ■ What we recommend We understand from the president of 9 155 Chart China, a subsidiary of Chart Although the company’s share price 7 118 Industries, a competitor of CIMC has appreciated by 38% since 1 5 80 Enric in the LNG-equipment market, September this year, the stock is Nov-12 Feb-13 May-13 Aug-13 Nov-13 that Chart China’s LNG-equipment trading at a 2014E PER of 13x, which CIMC Enric (LHS) Relative to HSI (RHS) sales remain robust, with 9M13 remains attractive compared with its revenue rising by 100% YoY. We peers, Chart China and Furuise, which 12-month range 5.75-12.78 believe this supports our positive view are trading at respective PERs of 25x Market cap (USDbn) 2.60 on CIMC Enric and the 80% YoY rise and 29x based on the Bloomberg- 3m avg daily turnover (USDm) 4.75 consensus forecasts. We reaffirm our Shares outstanding (m) 1,882 we forecast for its 2013 LNG Major shareholder CIMC Group (70.4%) equipment sales. In 1H13, LNG Buy (1) rating and six-month target equipment sales for CIMC Enric grew price of HKD15.50, based on peers’ Financial summary (CNY) by 78% YoY. multiple with a 30% discount. Year to 31 Dec 13E 14E 15E Revenue (m) 10,359 12,455 14,804 ■ What's the impact ■ How we differ Operating profit (m) 1,294 1,534 1,797 Our 2013-15E EPS are 1-5% above Net profit (m) 1,037 1,224 1,426 A proxy for NGV and storage Core EPS (fully-diluted) 0.539 0.636 0.741 infrastructure for gas utilities those of the consensus as we expect EPS change (%) 34.4 18.1 16.4 in China. We expect CIMC Enric to higher LNG-equipment sales growth, Daiwa vs Cons. EPS (%) 4.8 0.8 3.1 have about a 40% share of the with a 47% CAGR (1H13: up 57% YoY) PER (x) 15.6 13.2 11.4 CNY310bn gas-equipment market over 2012-15, supported by a three- Dividend yield (%) 1.2 1.4 1.7 fold rise in NGVs, rising demand for DPS 0.097 0.117 0.140 by 2020, driven by rising demand PBR (x) 3.2 2.7 2.2 for NGVs, peak-shaving LNG peak-shaving LNG tanks for EV/EBITDA (x) 10.2 8.4 6.9 storage tanks, and LNG vessels. See centralised urban heating, and the ROE (%) 23.2 22.7 22.0 our initiation-of-coverage report, coming demand from LNG vessels. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy (unchanged) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CIMC Enric: gross-profit outlook for each business segment We forecast CIMC Enric’s gross profit to rise at a CAGR of 24% for 2012-15, driven by an attractive 29% gross- 2015E profit CAGR for the energy equipment segment. We forecast the chemical equipment business to see an 8% 2014E gross-profit CAGR for 2012-15, while the liquid-food equipment business should see a strong turnaround in 2013E volume and margin from the acquisition in August 2012 of Germany’s Ziemann, a major competitor in brewery 2012 equipment. 0 500 1,000 1,500 2,000 2,500 (CNYm) Liquid food equipment Chemical equipment Energy equipment Source: Company, Daiwa forecasts

 Valuation  CIMC Enric: one-year forward PER Our target price of HKD15.50 is based on a peer PER (x) comparison. This translates into a 2014E PER of 19x, 40 which is 0.7SD above the stock’s mean since 2009. 35

30 29.5x Avg+2SD Given the government’s plans to continue to promote 25 Rerated power equipment PER range (3Q10-1Q11) the NGV market, and with the conversion of centralised 21.5x Avg+1SD 20 urban heating systems and power plants from being 15 fuelled by coal to clean gas in order to reduce air 13.5x Avg pollution, CIMC Enric looks likely to go through a 10 similar rerating to the power-equipment makers in 5 5.4x Avg-1SD 2H10 (their forward PERs rose from 10-15x to 20-25x 0 over 3Q10-1Q11, when the government announced its Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 80GW nuclear-power capacity target by 2020E [2010: Source: Companies, Daiwa forecasts 11GW]).

 Earnings revisions  CIMC Enric: consensus earnings-forecast revisions

The Bloomberg-consensus 2013 and 2014 earnings (HKD) forecasts started to be raised in April and August 2012, 0.65 due to the strong expansion of LNG vehicle-refuelling 0.60 stations announced by Kunlun Energy and ENN Energy 0.55 at the 2011/1H12 results announcements. 0.50 In 2015, we see a number of LNG product growth 0.45 drivers for CIMC Enric, such as LNG liquefaction and 0.40 storage tanks for city-urban heating projects and LNG 0.35 vessels. Jul-12 Jul-13 Apr-12 Apr-13 Oct-12 Oct-13 Jan-12 Jun-12 Jan-13 Jun-13 Mar-12 Mar-13 Feb-12 Feb-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 Nov-13 May-12 May-13 2013E EPS 2014E EPS Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E CNG equipment revenue (CNY m) n.a. 1,139 1,417 1,614 1,914 2,010 2,131 2,237 LNG equipment revenue (CNY m) n.a. 619 745 1,518 1,860 2,787 4,144 5,887 Energy consultancy revenue (CNY m) n.a. 0 0 0 181 243 314 399 CNG equipment gross profit margin n.a. 31 27 28 27 28 28 28 LNG equipment gross profit margin n.a. 9.9 13.9 19.6 18.1 19.6 20.0 20.1

 Profit and loss (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Energy n.a. 1,812 2,392 3,381 4,268 5,772 7,460 9,551 Chemical n.a. 652 1,198 2,875 2,846 2,988 3,138 3,295 Other Revenue n.a. 591 408 573 968 1,598 1,858 1,958 Total Revenue n.a. 3,054 3,999 6,829 8,083 10,359 12,455 14,804 Other income n.a. 134 118 130 182 195 195 195 COGS n.a. (2,512) (3,250) (5,550) (6,505) (8,219) (9,884) (11,759) SG&A n.a. (405) (490) (670) (824) (1,041) (1,233) (1,443) Other op.expenses n.a. (99) (107) (115) (136) (146) (185) (241) Operating profit n.a. 272 378 739 936 1,294 1,534 1,797 Net-interest inc./(exp.) n.a. (40) (12) (12) (9) (17) (14) (13) Assoc/forex/extraord./othersn.a.0000000 Pre-tax profit n.a. 232 366 726 927 1,277 1,520 1,784 Tax n.a. (34) (84) (147) (162) (233) (288) (350) Min. int./pref. div./others n.a. (1) (6) (8) (6) (7) (8) (9) Net profit (reported) n.a. 197 277 572 760 1,037 1,224 1,426 Net profit (adjusted) n.a. 197 277 572 760 1,037 1,224 1,426 EPS (reported)(CNY) n.a. 0.105 0.148 0.305 0.405 0.551 0.651 0.758 EPS (adjusted)(CNY) n.a. 0.105 0.148 0.305 0.405 0.551 0.651 0.758 EPS (adjusted fully-diluted)(CNY) n.a. 0.105 0.148 0.305 0.401 0.539 0.636 0.741 DPS (CNY) n.a. 0.000 0.000 0.060 0.070 0.097 0.117 0.140 EBIT n.a. 272 378 739 936 1,294 1,534 1,797 EBITDA n.a. 371 485 854 1,072 1,440 1,718 2,038

 Cash flow (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax n.a. 232 366 726 927 1,277 1,520 1,784 Depreciation and amortisation n.a. 99 107 115 136 146 185 241 Tax paid n.a. (34) (84) (147) (162) (233) (288) (350) Change in working capital n.a. 682 (67) (481) (185) (291) (283) (315) Other operational CF items n.a. (189) (17) 140 141 20 20 20 Cash flow from operations n.a. 788 306 353 857 920 1,154 1,380 Capex n.a. (257) (139) (446) (376) (300) (700) (700) Net (acquisitions)/disposals n.a. (25) 0 0 (380) 0 0 0 Other investing CF itemsn.a.84(3)(58)29000 Cash flow from investing n.a. (198) (142) (504) (726) (300) (700) (700) Change in debt n.a. (52) (78) 373 (113) 13 0 0 Net share issues/(repurchases) n.a. 0000000 Dividends paid n.a. 0 0 0 (112) (133) (186) (226) Other financing CF itemsn.a.(36)(12)(11)14000 Cash flow from financing n.a. (88) (90) 362 (211) (120) (186) (226) Forex effect/others n.a.0000000 Change in cash n.a. 502 73 211 (81) 500 267 454 Free cash flow n.a. 531 167 (93) 481 620 454 680 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment n.a. 873 941 1,082 1,010 1,510 1,778 2,232 Inventory n.a. 906 1,325 2,078 1,974 2,440 2,776 3,270 Accounts receivable n.a. 902 879 1,356 1,842 2,035 2,412 2,827 Other current assets n.a. 255 343 456 498 567 665 770 Total current assets n.a. 2,936 3,488 4,971 5,324 6,552 7,630 9,098 Fixed assets n.a. 1,020 1,027 1,295 1,763 1,939 2,478 2,960 Goodwill & intangibles n.a. 99 85 76 263 246 229 212 Other non-current assets n.a. 242 249 435 377 370 364 358 Total assets n.a. 4,297 4,848 6,777 7,727 9,108 10,702 12,629 Short-term debt n.a. 154 100 321 263 194 194 194 Accounts payable n.a. 652 872 1,312 1,351 1,674 2,004 2,384 Other current liabilities n.a. 646 821 1,250 1,501 1,718 1,917 2,235 Total current liabilities n.a. 1,451 1,793 2,883 3,115 3,587 4,115 4,813 Long-term debt n.a. 40 22 195 137 150 150 150 Other non-current liabilities n.a. 230 219 269 397 435 495 559 Total liabilities n.a. 1,721 2,034 3,346 3,649 4,172 4,759 5,522 Share capital n.a.17171717171717 Reserves/R.E./others n.a. 2,549 2,783 3,393 4,035 4,885 5,884 7,039 Shareholders' equity n.a. 2,566 2,800 3,411 4,052 4,903 5,901 7,056 Minority interests n.a. 9 15 20 26 33 41 50 Total equity & liabilities n.a. 4,297 4,848 6,777 7,727 9,108 10,702 12,629 EV n.a. 15,153 15,018 15,277 15,239 14,690 14,430 13,985 Net debt/(cash) n.a. (679) (819) (566) (610) (1,166) (1,434) (1,888) BVPS (CNY) n.a. 1.370 1.495 1.821 2.162 2.605 3.136 3.749

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) n.a. n.a. 30.9 70.8 18.4 28.2 20.2 18.9 EBITDA (YoY) n.a. n.a. 30.8 76.1 25.5 34.4 19.3 18.6 Operating profit (YoY) n.a. n.a. 38.9 95.6 26.7 38.2 18.5 17.2 Net profit (YoY) n.a. n.a. 40.8 106.4 33.0 36.5 18.1 16.4 Core EPS (fully-diluted) (YoY) n.a. n.a. 40.8 106.4 31.4 34.4 18.1 16.4 Gross-profit margin n.a. 17.8 18.7 18.7 19.5 20.7 20.6 20.6 EBITDA margin n.a. 12.1 12.1 12.5 13.3 13.9 13.8 13.8 Operating-profit margin n.a. 8.9 9.4 10.8 11.6 12.5 12.3 12.1 Net profit margin n.a. 6.4 6.9 8.4 9.4 10.0 9.8 9.6 ROAE n.a. 15.3 10.3 18.4 20.4 23.2 22.7 22.0 ROAA n.a. 9.2 6.1 9.8 10.5 12.3 12.4 12.2 ROCE n.a. 19.6 13.2 21.5 22.2 26.5 26.5 26.2 ROIC n.a. 12.2 15.0 24.2 24.4 29.2 30.0 29.7 Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cash Effective tax rate n.a. 14.7 22.8 20.3 17.4 18.2 18.9 19.6 Accounts receivable (days) n.a. 53.9 81.3 59.7 72.2 68.3 65.2 64.6 Current ratio (x) n.a. 2.0 1.9 1.7 1.7 1.8 1.9 1.9 Net interest cover (x) n.a. 6.8 32.3 59.3 105.2 77.3 112.0 138.2 Net dividend payout n.a. 0.0 0.0 19.7 17.3 17.6 18.0 18.5 Free cash flow yield n.a. 3.4 1.1 n.a. 3.0 3.9 2.9 4.3 Source: FactSet, Daiwa forecasts

 Company profile CIMC Enric has a c.50% share of the CNG/LNG equipment market in China. In our view, it is well positioned for strong volume growth of the natural gas vehicles (NGV) market and city-gas peak shaving infrastructure in China. The company also has chemical container tank and liquid food equipment businesses serving the overseas market.

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Utilities / China 579 HK Utilities / China 11 November 2013

Beijing Jingneng Clean Energy

Beijing Jingneng Clean Energy Target (HKD): 3.90 Upside: 18.2% 579 HK 7 Nov price (HKD): 3.30

Initiation: mitigating air pollution in the capital 1 Buy (initiation) 2 Outperform • We forecast BJCE to post a 50%+ CAGR in gas-fired power and 3 Hold heating capacity over 2012-15E 4 Underperform • We believe the government will continue to subsidise the pass- 5 Sell through of upstream gas costs • BJCE is the most leveraged investment on Beijing’s coal-free campaign to mitigate air pollution in the city; initiating with Buy

How do we justify our view?

capacity in Beijing city and rural natural gas costs, as we assume 30% Beijing combined in 2015. Boosted of BJCE’s gas cost hike would not be by the targeted capacity increase, we able to be passed on through forecast BJCE’s gas-fired power and government subsidies. heating business to post a net-profit Dennis Ip, CFA CAGR of 46% over 2012-15. (852) 2848 4068 [email protected] Subsidies may not offset higher gas costs. We believe the Beijing Gary Zhou Government will continue to (852) 2773 8535 support clean energy, and forecast [email protected] Share price performance its subsidies for gas-fired utilities to rise sharply from CNY1.6bn in 2012 (HKD) (%) to CNY8.5bn in 2015. We take a 3.4 205 ■ Investment case 2.9 174 We believe Beijing Jingneng Clean more conservative stance by 2.4 143 Energy (BJCE) will benefit from the assuming that BJCE will not be able 1.9 111 Beijing Government’s aggressive to pass on 30% of the increase in its 1.4 80 gas-fired power and heating capacity natural gas costs over 2013-16. Nov-12 Feb-13 May-13 Aug-13 Nov-13 expansion in the city to mitigate air Bj J Clean (LHS) Relative to HSI (RHS) pollution, and initiate coverage with ■ Catalysts a Buy (1) rating. We expect BJCE to expand capacity 12-month range 1.44-3.36 for both gas-fired and wind-power Market cap (USDbn) 2.76 Ramp-up of gas-fired power projects in the next four years, which 3m avg daily turnover (USDm) 3.84 would support its earnings growth. Shares outstanding (m) 6,477 and heating cogeneration Major shareholder Beijing Energy Investment (69.7%) plants in Beijing. We forecast a ■ Valuation 37% net-profit CAGR for BJCE for Financial summary (CNY) 2012-15, driven mainly by a 64% Our SOTP-based six-month target Year to 31 Dec 13E 14E 15E CAGR in its gas-fired cogeneration price of HKD3.90 implies a 10x Revenue (m) 6,265 9,381 13,292 power capacity, from 1.2GW in 2012 2014E PER, at a c.30% premium to Operating profit (m) 2,166 3,005 3,747 BJCE’s coal-fired IPP peers and a Net profit (m) 1,313 2,010 2,358 to 5.2GW in 2015E. In order to Core EPS (fully-diluted) 0.212 0.310 0.364 reduce air pollution in the city, c.25% discount to its wind IPP peers. EPS change (%) 43.1 46.4 17.3 Beijing targets a four-fold increase BJCE’s 1.4x 2014E PBR is Daiwa vs Cons. EPS (%) 5.5 5.9 3.4 in the city’s gas-fired power capacity, undemanding, in our view, as we PER (x) 12.2 8.4 7.1 from 2GW in 2010 to 8GW in 2015, forecast a high 17.9% ROE for 2014. Dividend yield (%) 1.6 2.4 2.8 DPS 0.042 0.062 0.073 and plans to retire all coal-fired PBR (x) 1.6 1.4 1.2 ■ boilers for centralised urban heating Risks EV/EBITDA (x) 11.3 10.2 9.7 by end-2015. We project BJCE to The key risk would be insufficient ROE (%) 13.5 17.9 18.2 own 51% of the total gas-fired government subsidies to offset rising Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 BJCE: total consolidated installed year-end power-generation  Growth outlook capacity (2008-15E) We forecast BJCE’s total consolidated installed year-end (MW) capacity for gas-fired power, wind power and hydro 10,000 2012-15E CAGR: 43% power to increase from 1.2GW, 1.3GW and 369MW in 2012 to 5.2GW, 2.5GW and 547MW in 2015, 8,000 respectively. This implies a 43% CAGR in its total year- 6,000 end power generation capacity over 2012-15E. 4,000 2,000

0 2010 2011 2012 2013E 2014E 2015E Gas-fired power capacity Wind power capacity Hydropower capacity Solar power capacity Source: Company, Daiwa forecasts

 Valuation  BJCE and China peers: PER comparison (2014E)

BJCE operates a mixed portfolio of clean energy: gas- 13.5x fired power and wind power. In the absence of a directly 14.0x comparable listed company, we use the major China 12.0x wind IPPs and coal-fired IPPs as a proxy for its peers. 10.0x 8.4x 7.6x Based on our 2014 EPS forecast, the BJCE stock is 8.0x trading currently at a PER of 8.4x, which is at about a 6.0x 40% discount to the average multiple of its wind IPP 4.0x peers and about a 10% premium to the average multiple of its coal-fired IPP peers (based on our and the 2.0x Bloomberg 2014 EPS forecasts). We believe the stock 0.0x merits a rerating, as we forecast a superior 17.9% 2014 BJCE Wind IPP average Coal IPP average ROE (coal IPPs: 13%, wind IPPs: 10% on average) and Source: Bloomberg, Daiwa forecasts power capacity growth. Note: based on closing share prices of 7 November 2013

 Earnings revisions  BJCE: Bloomberg-consensus EPS-forecast revisions

We believe that, early this year, some analysts had (CNY) thought that the commissioning of BJCE’s new gas-fired 0.31 cogeneration power capacity could be delayed, which led 0.29 to cuts in the Bloomberg consensus EPS forecasts for 0.27 2013 and 2014 (down 35% for 2014). The consensus 0.25 2013-14 EPS forecasts have been revised up relative to 0.23 their levels at the start of the year since March 2013, as 0.21 0.19 the company’s new gas-fired cogeneration capacity 0.17 expansion schedule appears on track. 0.15 Jul-12 Jul-13 Apr-12 Apr-13 Oct-12 Jan-12 Jun-12 Jan-13 Jun-13 Mar-12 Mar-13 Feb-12 Feb-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 May-12 May-13 2013E EPS 2014E EPS Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Consolidated installed gas-fired 1,190 1,190 1,190 1,190 1,190 2,028 4,421 5,201 power capacity at year end (MW) Gas-fired power utilization hours 3,244 3,240 4,237 4,141 3,750 3,850 3,900 3,950 Natural gas purchase price, excl VAT 1.61 1.65 1.74 1.90 1.80 1.96 2.28 2.54 (CNY/m3) Gas-fired tariff subsidy, excl VAT 76 76 38 38 48 68 84 93 (CNY/MWh) Consolidated installed wind power 165 811 1,059 1,059 1,303 1,700 2,100 2,500 capacity at year end (MW)

 Profit and loss (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Gas-fired power and heat energy gene 1,164 1,893 2,554 2,700 2,539 4,389 6,907 10,206 Wind power 115 368 1,032 1,177 1,318 1,575 2,080 2,603 Other Revenue 59 149 57 174 294 300 395 484 Total Revenue 1,339 2,410 3,643 4,051 4,152 6,265 9,381 13,292 Other income 502 580 609 963 733 1,096 2,266 3,840 COGS (1,008) (1,459) (1,970) (2,110) (1,841) (3,457) (6,371) (10,463) SG&A (148) (218) (289) (317) (400) (500) (658) (810) Other op.expenses (440) (836) (984) (1,024) (1,094) (1,238) (1,613) (2,113) Operating profit 244 477 1,009 1,562 1,549 2,166 3,005 3,747 Net-interest inc./(exp.) (192) (281) (488) (575) (681) (844) (1,013) (1,409) Assoc/forex/extraord./others 18 21 56 147 244 318 460 518 Pre-tax profit 69 217 577 1,134 1,112 1,640 2,452 2,856 Tax (20) (18) (56) (197) (124) (236) (350) (406) Min. int./pref. div./others (4) (19) (32) (92) (78) (92) (92) (92) Net profit (reported) 45 180 489 846 910 1,313 2,010 2,358 Net profit (adjusted) 45 180 489 846 910 1,313 2,010 2,358 EPS (reported)(CNY) 0.018 0.049 0.102 0.168 0.148 0.212 0.310 0.364 EPS (adjusted)(CNY) 0.018 0.049 0.102 0.168 0.148 0.212 0.310 0.364 EPS (adjusted fully-diluted)(CNY) 0.018 0.049 0.102 0.168 0.148 0.212 0.310 0.364 DPS (CNY) 0.000 0.000 0.000 0.011 0.038 0.042 0.062 0.073 EBIT 244 477 1,009 1,562 1,549 2,166 3,005 3,747 EBITDA 498 974 1,767 2,364 2,403 3,074 4,163 5,280

 Cash flow (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 69 217 577 1,134 1,112 1,640 2,452 2,856 Depreciation and amortisation 254 496 758 802 854 908 1,158 1,533 Tax paid (20) (18) (56) (197) (124) (236) (350) (406) Change in working capital 0 (359) (187) (335) 1,223 622 (671) (3,443) Other operational CF items 83 (66) 446 778 (1,499) (346) (488) (546) Cash flow from operations 386 270 1,538 2,182 1,567 2,587 2,101 (6) Capex (3,891) (6,609) (1,575) (3,752) (4,993) (6,095) (8,906) (7,120) Net (acquisitions)/disposals00000000 Other investing CF items 248 475 (357) 254 1,546000 Cash flow from investing (3,643) (6,134) (1,932) (3,498) (3,447) (6,095) (8,906) (7,120) Change in debt 2,749 5,644 (292) 2,627 3,975 3,540 8,249 9,035 Net share issues/(repurchases) 0 0 0 1,541 176 924 0 0 Dividends paid 0 0 (187) (105) (672) (263) (402) (472) Other financing CF items 707 404 760 (637) (2,168) (871) (1,041) (1,437) Cash flow from financing 3,456 6,048 281 3,427 1,311 3,329 6,806 7,126 Forex effect/others 00000000 Change in cash 199 184 (112) 2,111 (569) (178) 0 0 Free cash flow (3,505) (6,339) (37) (1,569) (3,426) (3,507) (6,806) (7,126) Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 570 768 639 2,747 2,386 2,208 2,208 2,208 Inventory 86 35 35 60 70 100 128 186 Accounts receivable 302 850 1,157 1,440 1,475 2,104 2,796 3,662 Other current assets 165 366 409 734 896 919 1,213 1,570 Total current assets 1,122 2,018 2,241 4,981 4,827 5,331 6,345 7,626 Fixed assets 8,163 11,104 11,813 14,866 17,405 22,750 30,651 36,384 Goodwill & intangibles 1,770 3,996 3,806 4,920 4,780 4,623 4,470 4,323 Other non-current assets 1,346 2,256 2,990 3,320 4,096 4,951 6,143 7,476 Total assets 12,401 19,375 20,849 28,087 31,109 37,654 47,609 55,810 Short-term debt 2,718 3,599 2,731 6,127 4,267 4,267 4,267 4,267 Accounts payable 1,317 1,563 1,644 1,579 1,915 3,047 3,048 1,494 Other current liabilities 268 135 468 500 1,422 1,693 1,783 845 Total current liabilities 4,304 5,297 4,843 8,206 7,604 9,007 9,097 6,605 Long-term debt 3,795 8,461 8,883 8,365 13,889 17,428 25,677 34,712 Other non-current liabilities 147 51 49 68 294 428 343 23 Total liabilities 8,246 13,809 13,776 16,639 21,787 26,863 35,118 41,341 Share capital 500 1,006 5,000 6,032 6,150 6,477 6,477 6,477 Reserves/R.E./others 3,215 4,270 1,764 5,038 2,897 3,947 5,555 7,442 Shareholders' equity 3,715 5,277 6,764 11,070 9,047 10,424 12,032 13,919 Minority interests 440 289 309 378 276 367 459 550 Total equity & liabilities 12,401 19,375 20,849 28,087 31,109 37,654 47,609 55,810 EV 22,695 26,821 26,650 27,314 31,156 34,647 42,528 51,136 Net debt/(cash) 5,943 11,292 10,976 11,745 15,770 19,488 27,737 36,772 BVPS (CNY) 1.447 1.434 1.764 2.214 1.471 1.609 1.858 2.149

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) n.a. 80.0 51.2 11.2 2.5 50.9 49.7 41.7 EBITDA (YoY) n.a. 95.7 81.5 33.8 1.7 27.9 35.5 26.8 Operating profit (YoY) n.a. 95.6 111.4 54.8 (0.9) 39.8 38.7 24.7 Net profit (YoY) n.a. 299.7 172.2 73.0 7.6 44.2 53.1 17.3 Core EPS (fully-diluted) (YoY) n.a. 178.9 109.6 64.4 (11.9) 43.1 46.4 17.3 Gross-profit margin 24.7 39.5 45.9 47.9 55.6 44.8 32.1 21.3 EBITDA margin 37.2 40.4 48.5 58.4 57.9 49.1 44.4 39.7 Operating-profit margin 18.2 19.8 27.7 38.6 37.3 34.6 32.0 28.2 Net profit margin 3.4 7.5 13.4 20.9 21.9 21.0 21.4 17.7 ROAE 2.4 4.0 8.1 9.5 9.0 13.5 17.9 18.2 ROAA 0.7 1.1 2.4 3.5 3.1 3.8 4.7 4.6 ROCE 4.6 3.4 5.6 7.0 5.8 7.2 8.0 7.8 ROIC 1.7 3.3 5.2 6.3 5.7 6.7 7.3 7.0 Net debt to equity 160.0 214.0 162.3 106.1 174.3 187.0 230.5 264.2 Effective tax rate 28.9 8.2 9.8 17.4 11.1 14.4 14.3 14.2 Accounts receivable (days) 41.1 87.2 100.6 117.0 128.1 104.3 95.3 88.7 Current ratio (x) 0.3 0.4 0.5 0.6 0.6 0.6 0.7 1.2 Net interest cover (x) 1.3 1.7 2.1 2.7 2.3 2.6 3.0 2.7 Net dividend payout 0.0 0.0 0.0 6.4 25.3 20.0 20.0 20.0 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile Beijing Jingneng Clean Energy Co, Ltd (BJCE) provides clean energy in China. The company operates gas-fired power, heat energy, wind power, small to medium sized hydropower, and other clean energy projects.

- 40 - China Gas Sector 11 November 2013

Strong capacity expansion of other clean energies In addition to gas-fired power and heating, BJCE also focuses on other clean energies, namely wind power for the northern grid, small-to-medium scale hydro power Mitigating air pollution in Sichuan and Yunnan, and solar farms in China. We forecast the company’s year-end installed capacity for in the capital wind power, hydro power and solar power to rise at CAGRs of 24%, 21% and 123%, respectively, over 2012-15. Company background

BJCE is the largest gas-fired power provider in Beijing Gas-fired power and heating: free and China’s ninth-largest wind-power operator, in of coal on power and heating terms of consolidated installed capacity (as at the end utilities in Beijing by 2016E of 2011). BJCE’s largest shareholder is Beijing Energy Investment Holding (BEIH), which is directly With respect to the government’s target to cut coal controlled by the Beijing State Assets Management and consumption in Beijing by 13m tonnes by 2017 Administrative Centre. compared to its level in 2012, we expect 85% (10.8m tonnes) of the reduction to come from its aggressive Investment exposure to major air coal-to-gas fuel conversion plan for power and heat generation. The Beijing Development and Reform pollution mitigation in the capital Commission (DRC) (which is under the NDRC), projects total gas-fired power capacity in Beijing city to We believe BJCE is on the right track to expand its gas- increase from 2GW in 2011 to around 8GW in 2015. fired power generation and heating capacity over the This projection excludes rural Beijing. We forecast next 3-4 years. This is to support the planned closure of BJCE to own 51% of the gas-fired power capacity in all coal-fired boilers and power plants in Beijing by Beijing city and rural Beijing combined in 2015. 2015 and 2016, respectively, and the government’s target to reduce coal consumption from 23m tonnes in Power: 8.4m tonnes of coal targeted to be 2012 to 15m tonnes by 2015, and to 10m tonnes by replaced with 5.0bcm of gas by 2016 2017. We forecast BJCE’s power generation and According to the Beijing DRC, by 2016, Beijing targets heating capacity to rise at CAGRs of 64% and 52%, to convert all coal-fired power plants to gas-fired respectively, over 2012-15. cogeneration power plants in order to reduce coal

 BJCE: total consolidated gas-fired power capacity at year-end consumption by 8.4m tonnes from its level of 2012. Beijing DRC plans a total capacity in Beijing city of (MW) Gas-fired power capacity: 64% CAGR 6,000 Gas-fired heating capacity: 52% CAGR 120% 8GW (up from 2GW for 2010) of gas-fired cogeneration power plants located at the four heating- 100% power centres in Beijing. We forecast BJCE to have 4,000 80% gas-fired capacity in Beijing city and rural Beijing of 60% 5.3GW in 2015, and thus to own 51% of the total gas- 2,000 40% fired power generation capacity in Beijing city and 20% rural Beijing combined that year. 0 0% 2012 2013E 2014E 2015E Total consolidated gas-fired power capacity at year-end - LHS Total consolidated gas-fired heating capacity at year-end - LHS YoY growth of total consolidated gas-fired power capacity at year-end - RHS YoY growth of total consolidated gas-fired heating capacity at year-end - RHS Source: Company, Daiwa forecasts

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 Beijing city: major four heating-power cogeneration centres  Beijing city: major operators of gas-fired power generation (2015E)

BJCE 4181MW 51.1% Beijing Zhengdong Electronic Power Group 120MW 1.5% Huadian Group 508MW North east Datang Power North west cogeneration 1380MW 6.2% cogeneration centre 16.9% centre CR Power 150MW Huaneng Power 1.8% 1846MW 22.6% South east South west cogeneration Source: Beijing DRC, Daiwa forecasts cogeneration centre centre  Beijing city: gas-fired power generation capacity (2012-15E) (MW) 2012 2013 2014E 2014E 2015E 2015E Plant owner Huaneng Jingneng Datang Jingneng Jingneng Huaneng 10,000 100% Plant location Gaobeidian Caoqiao Shijingshan Shijingshan Gaoantuan Gaobeidian 80% Jingxi 7,500 Plant area South east South west North west North west North east South east 60% Beijing Beijing Beijing Beijing Beijing Beijing 5,000 Newly 923 838 1,380 1,308 845 923 40% commissioned 2,500 capacity (MW) 20% Total capacity 2,891 3,729 5,109 6,417 7,262 8,185 0 0% (MW) 2012 2013E 2014E 2015E Additional gas 0.50 1.22 1.35 1.10 sales (bcm) Total BJCE's consolidated installed power capacity in Beijing City (year-end) - LHS Total consolidated installed power capacity in Beijing City (year-end) - LHS Total gas sales 2.26 3.49 4.83 5.94 BJCE's proportion for total consolidated installed capacity in Beijing City (year-end) (bcm) Source: Beijing DRC, Daiwa forecasts Source: Beijing DRC, Daiwa forecasts

 Beijing: gas-fired power capacity Heating : 2.4m tonne of coal targeted to be Capacity Operational replaced by 1.4bcm of gas by 2015 Plant (MW) date Operator Note Beijing City One of the major reasons for the severe PM2.5 air Jingfeng co-gen 410 May-06 BJCE Taiyanggong co-gen 780 May-08 BJCE pollution during the winter in Beijing is the use of coal- Dianzicheng co-gen 120 Apr-11 Beijing fired boilers for centralised urban heating. Unlike Zhengdong Electronic power plants, which can be built in rural areas, boilers Power Group for urban heating need to be built near town centres to Huadian Zhengchangzhuang co-gen 508 May-11 Huadian Group CRP Xiexin co-gen 150 Jun-11 CR Power minimise the heat loss. In 2012, Beijing converted 60% Huaneng Thermal Expansion Project 923 Dec-11 Huaneng Southeast Thermal Phase II Power Power Centre of its coal-fired boilers to gas-fired ones, with all coal- Huaneng Thermal Expansion Project 923 Expected in Huaneng Southeast Thermal fired boilers within the third-ring road retired. Phase III 2014 Power Power Centre Jingqiao Caoqiao co-gen 838 Mar-12 BJCE Southwest Thermal Power Centre According to the Beijing DRC, by 2015E, Beijing also Gaoantun co-gen 845 Expected in BJCE Northeast Thermal Mar-Jun Power Centre targets to convert all coal-fired boilers for centralised 2014 Jingxi Gaojing co-gen 1,308 Expected in BJCE Northwest Thermal urban heating to gas-fired, in order to reduce coal Mar 2014 Power Centre consumption by 2.4m tonnes compared to its level in Datang Gaojin co-gen 1,380 Expected in Datang Power Northwest Thermal 2013/14 Power Centre 2012. We estimate that about 40% of Beijing city’s BJCE's total 4,181 boilers, equivalent to 4,900t of steam (137 boilers), Total 8,185 BJCE's share 51% have yet to be converted. Rural Beijing Changping Future Hitech City gas- 240 2014 BJCE fired cooling-heating-power co-gen Moreover, there is a further 4,000t of small coal-fired Shougang Industrial Area gas-fired 240 2015 BJCE cooling-heating-power co-gen boilers (<20t/hr) in rural Beijing to be converted to Yizhuang southward expansion 120 2014 BJCE gas-fired ones from 2014-17E, representing an project Changping TBD project 180 2015 BJCE additional reduction in coal consumption of 2m tonnes. Tongzhou Taihu project 120 2015 BJCE Northern Haidian New Region 240 2014 BJCE BJCE's total 1,140 Source: Beijing DRC Note: Highlighted plants are owned by BJCE

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 Beijing city: coal-to-gas conversion of boilers for centralised  Beijing: benchmark on-grid tariff for gas-fired and coal-fired heating schedule power, VAT inclusive (2008-13) (CNY/KWh) 0.7 0.617 Subsidy 0.6 0.573 paid by 0.538 0.6 0.528 0.5 0.472 0.5 0.452 Tariff paid 0.400 0.387 by grid 0.4 0.361 0.381 0.4 0.350 0.345 0.3 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Gas-fired on-grid tariff Coal-fired on-grid tariff Gas-fired total settlement tariff

Source: Beijing government

 BJCE: calculation of electricity price subsidy for gas-fired power Year Coal-fired boilers to be converted (t/yr) Region without coal-fired boilers Allowed power Tariff gap 2013E 2100 Fourth Ring Road output 2014E 2200 Fifth Ring Road 2015E 600 Sixth Ring Road Settlement tariff incl. VAT Source: Beijing DRC - On-grid tariff incl. VAT Total electricity Lower of: = x = price subsidy We forecast BJCE’s gas-fired heating capacity to rise at Tariff gap incl. VAT 1) Approved power output; a CAGR of 52% over 2012-15, driven mainly by the x 2) Actual power output Beijing Government’s gas-fired power cogeneration (1-VAT) expansion plan. = Subsidy per output Source: Company

Government subsidies for gas- We believe the BMFB will continue offering the on-grid fired power and heat generation tariff subsidy, as we see a trend emerging whereby the grid companies further increase the on-grid tariff to Gas-fired power is more expensive than coal-fired narrow the subsidy gap in the future. power, and as such local governments usually support gas-fired power via providing subsidies. The Beijing Natural gas price subsidy Government subsidises gas-fired power plants in two BJCE’s increases in natural gas costs, if not passed on ways: 1) via a tariff subsidy, and 2) by passing on the via rises in on-grid power tariffs, are fully subsidised by cost of natural gas to end users. the BMFB, based on the allowed electricity-generation amount of BJCE’s gas-fired co-generation plants. On-grid tariff subsidy  BJCE: calculation of natural gas price subsidy for gas-fired The following chart shows the tariff structure, which power comprises two parts: 1) an on-grid tariff, and 2) the government’s tariff subsidy – via the Beijing Municipal Finance Bureau (BMFB). The BMFB provides a subsidy to gas-fired power enterprises based on the gap between each enterprise’s on-grid tariff (excluding tax) and the settlement tariffs approved by the Beijing DRC.

Currently, BJCE’s major gas-fired power plants receive CNY0.617/kWh for electricity sales, of which CNY0.573/kWh is paid by the State Grid and the rest is subsidised by the Beijing Government.

Source: Company

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BJCE’s natural gas is supplied by Beijing Gas (Not Margin squeeze for BEH or BJCE? listed), a wholly owned subsidiary of Beijing Based on the NDRC’s announcement in June on gas Enterprises Holdings (BEHL) (392 HK, HKD62.1, tariffs, it stated that either preferential gas tariffs or Outperform [2]), the sole city-gas operator in Beijing. local government subsidies would be provided to gas- fired power plants and heating centres. If the  BJCE: supplier and customers government adopts a preferential gas tariff, city-gas operator BEH might not able to pass through the entire cost hike from the city gate, which we estimate at CNY0.74/m3, and would therefore see margin compression.

Source: Daiwa However, we do not rule out the government also possibly reducing the natural gas subsidy on gas-fired power and heating, given we forecast the total subsidy Cost pass-through risks on rising to increase rise sharply from CNY1.6bn in 2012 to natural gas price CNY8.5bn in 2015, following Beijing’s expansion of the city’s gas-fired power capacity four-fold from 2GW to On 28 June this year, the NDRC increased the city-gate 8GW, with natural gas costs likely to increase further natural gas price for non-residential use in Beijing by from CNY2.67/m3 currently to CNY3.41/m3 by 2015, about 17% (or CNY0.35/m3), to CNY2.40/m3, effective assuming BEH to pass through fully the city-gate hike from 10 July 2013. to customers by the end of 2015.

Under China’s gas price reform (discussed in our  Beijing: natural-gas city-gate price and natural-gas price for gas-fired co-generation plant (incl. VAT) (2005-15E) industry analysis in this sector report), the country will 3 adopt a ladder-like pricing mechanism for natural gas. (CNY/m ) 3.5 Under this mechanism it will allow substantial price 3.14 increases one at a time for incremental gas supplies, 3.0 2.67 2.77 which we estimate will account for 17% of the piped gas supply for 2013 in Beijing, while giving a grace period 2.5 2.28 2.40 1.95* until 2015 for the price of existing volumes (83% of the 2.0 2.01 piped gas supply for 2013 in Beijing on our estimate) to 1.55 be linked to regional competing fuels, such as heating 1.5 1.4 1.68 1.13 oil and LPG, with a 15% discount. 1.28 1.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 CNY0.74/m3 hike for non-residential gas City gate price Heat-electricity co-generation end-user price (base volume) for Beijing in 2013-15E Source: NDRC, Daiwa estimates Note: We assume there would be two more rounds of natural gas tariff hikes at city-gate in Under this schedule for increases in city-gate tariffs, we 2014 and 2015E, to reach CNY3.14/cm by the end of 2015E estimate that there will be an additional 39% price rise in Beijing at the city gate to CNY3.14/m3 by 2015. As a result,  Beijing: total subsidy for gas-fired power and heating the total tariff hike for city-gate non-residential customers (CNYm) would be CNY1.09/m3 from its level of June 2013. 10,000 250%

8,000 200%  Average city-gate gas price for non-residential gas for Beijing (2013-15E) 6,000 150% (CNY/cm) 4,000 100% 3.50 3.14

3.00 2,000 50% 2.40 2.50 2.05 0 0% 2.00 2011 2012 2013E 2014E 2015E 1.50 Total subsidy of gas-fired power and heating in Beijing - LHS 1.00 Yoy growth of total subsidy of gas-fired power and heating in Beijing - RHS 0.50 Source: BMFB (Beijing), Daiwa forecasts

0.00 Average city-gate price, Average city-gate price, Average city-gate price, CNY/cm (before July-2013) CNY/cm (after July-2013) CNY/cm (as of July-2015E) Source: NDRC, Daiwa

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However, we believe the government would still  BJCE: sensitivity of NAV, net profit and ROE to different levels support gas-fired power and heating for environmental of natural gas hike pass-through in 2016E % of natural gas cost 2016E net concerns, given the PM2.5 pollution mist has been in hike unable to be passed profit 2016E 2016E gas subsidy unable the headlines every winter since 2011. Our total subsidy on via subsidies NAV (CNYm) ROE to be passed on (CNYm) forecast for gas-fired utilities in 2015 (power and Base case 3.90 2,284 15.4% 1,118 heating) is only 61% of the fare subsidies for buses, or -5% 3.30 2,126 14.5% 1,386 -10% 2.71 1,968 13.6% 1,584 2.5% of the budgeted government spending in 2012. -15% 2.11 1,809 12.7% 1,782 Source: Daiwa forecasts  Beijing: government subsidies for public services Subsidy (CNYm) 2012 % of total government spending  BJCE: degree of sensitivity of NAV, net profit, ROE to different Taxis (fuel subsidy) 670 0.2% levels of natural gas subsidy pass-through relative to base case Subway 3,690 1.1% NAV 2016E net profit 2016E ROE 2016E gas subsidy unable to be passed on (CNY m) Gas-fired utilities 1,553 0.5% -15.2% -6.9% -0.87pp 16.7% Gas-fired utilities in 2015E 8,493 2.5% -30.5% -13.9% -1.76pp 33.3% Buses 13,820 4.1% -45.9% -20.8% -2.68pp 50.0% Total government spending 338,980 Source: Daiwa forecasts Source: MoF, Beijing Municipal Commission of Transport, BMFB Note: rows assume the respective 5%, 10% and 15% hike inability pass-through percentages shown in the first table Sensitivity analysis of a lower natural gas subsidy for gas-fired power and heating In our model, we already assume that the Beijing Government will cut natural gas subsidies, of which Though we believe the government will continue to BJCE needs to be responsible for 30% of the increase support clean energy, we do not rule out it possibly in natural gas costs in 2013-16E. reducing natural gas subsidies. As such, we have conducted an analysis to gauge the sensitivity of Based on our discussion with BJCE’s management, a BJCE’s NAV, 2016E net profit and 2016E ROE to lower revised subsidy to offset the recent gas price hike natural gas subsidies for its gas-fired power and (CNY0.35/m3), effective from July 2013, has not been heating units, in terms of the percentage of the natural concluded yet. gas cost hike not offset by government subsidies.

  BJCE: natural gas cost and our subsidy assumptions 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas price - VAT included 1.88 1.94 2.04 2.23 2.11 2.30 2.66 2.97 Natural gas price - VAT excluded 1.61 1.65 1.74 1.90 1.80 1.96 2.28 2.54 Increment - VAT excluded 0.16 0.47 0.73 Percentage BJCE would not be able to pass-through as subsidy 30% 30% 30% Amount BJCE would not be able to pass-through as subsidy (CNY/m3) 0.05 0.14 0.22 Total amount not able to pass-through as subsidy (CNY m) 84 397 908 Total subsidy by government assuming part of natural gas not pass-through 523 551 851 639 987 2,132 3,680 Total subsidy by government assuming full pass-through of natural gas 523 551 851 639 1,071 2,529 4,588 Percentage not subsidised by government 8% 16% 20% Capacity share from BJCE 100% 60% 41% 54% 87% 54% Total subsidy by government in Beijing 551 1,406 1,553 1,970 2,922 8,493 YoY change 155% 10% 27% 48% 191% Source: Company, Daiwa forecasts

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 BJCE: consolidated installed wind power capacity at year-end Other clean energy business (MW) Wind: 24% 2012-15E CAGR 3,000 400% 2,500 BJCE was the ninth-largest wind-power operator in 300% China at the end of 2011 in terms of total installed 2,000 capacity, with 1,686MW, according to the Chinese 1,500 200% 1,000 Wind Energy Association (CWEA). Its wind farms in 100% 500 operation and under construction are located in Inner 0 0% Mongolia, Beijing, Liaoning and Ningxia. 2009 2010 2011 2012 2013E 2014E 2015E Inner Mongolia BJCE also focuses on small-to-medium hydro power Beijing Liaoning projects in Sichuan and Yunnan, with total Ningxia Other consolidated capacity of 369MW as of 1H13. In Yoy growth of total wind power capacity addition, in 2012 the company started to expand its Source: Company, Daiwa forecasts clean energies portfolio to solar energy by commissioning 40MW of capacity as of 1H13, followed Hike in renewable-energy surcharge could by 202MW of approved projects in the pipeline. improve its cash position On 30 August 2013, the NDRC announced an increase  BJCE: year-end capacity growth in clean energies [DTP in the renewable-energy surcharge for non-residential amend left axis to (MW) and non-agricultural users from CNY0.008/kWh to (MW) CNY0.015/kWh, effective from 25 September 2013. We 10,000 80% believe this increase will effectively support China’s 8,000 60% renewable-energy development fund (the funding 6,000 40% source for the renewable on-grid tariff premium), 4,000 which had a shortfall of CNY20bn in 1H13, and could 2,000 20% widen to CNY33bn by 2015, based on previous 0 0% surcharges (CNY0.008/kWh), according to the NDRC’s 2010 2011 2012 2013E 2014E 2015E forecasts. Gas-fired power capacity - LHS Wind power capacity - LHS Based on our industry research, most wind IPPs are Hydropower capacity - LHS Solar power capacity - LHS confident of collecting their tariff-premium receivables Yoy growth of total power generation capacity - RHS before the end of 2013. For BJCE, tariff-premium Source: Company, Daiwa forecasts receivables amounted to CNY980m in 1H13, representing 60% of its total trade and bills receivables Aggressive wind-power capacity expansion (CNY1,634m). We forecast such receivables to be plan reduced to CNY800m by the end of 2013, which would BJCE targets to almost double its consolidated further improve the company’s cash position. installed capacity from 1,303MW in 2012 to 2,500MW in 2015E. Management guides for 400MW of new capacity in 2013, representing a further 400MW of new CDM income should bottom out capacity for both 2014 and 2015. In order to diversify its geographical risk, BJCE aims to expand its wind BJCE’s pre-tax profit contribution from the clean power projects outside the Inner Mongolia, Beijing and development mechanism (CDM) declined from 14% in Liaoning regions. 1H12 to 4% in 1H13 (22% in 2012), while its certified emission reduction (CER) declined by 98% YoY for 1H13. Regarding CDM income, 70% of BJCE’s contracts are on a floating basis, driven by the spot prices of CER and voluntary emission reductions (VER).

We are cautious on the company’s CDM income in the near term as we believe a turnaround in CER/VER spot prices is unlikely. However, further downside for BJCE’s earnings from the CDM seems limited to us given that its pre-tax profit contribution from the CDM was only 4% for 1H13, compared with 20-30% in 2010-12.

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 Carbon credit spot price (EUR/CO2t) Risks 40 35 In addition to the risk of natural-gas cost pass-through 30 due to insufficient government subsidies, which 25 constitutes the main investment risk we see for BJCE, 20 the company faces risks specific to Beijing, given its 15 exposure there. 10 5 All of BJCE’s gas-fired power and heat energy 0 generation fleets are located in Beijing, and are subject Apr-08 Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Apr-12 Dec-12 Aug-13 to risks specific to the Beijing region, such as changes CER EUA in the temperature (warmer weather means less Source: Bloomberg demand for heating) and a change in overall governmental policies.  China clean energy peers: CDM income over PBT

60% In addition, the price administrative authority of 50% Beijing determines the amount of the subsidy provided to BJCE, based on the annual approved quantity of on- 40% grid electricity generation entitled to subsidies. As no 30% subsidy is provided for the electricity generated in excess of the approved amount, additional electricity 20% generation would be a risk for the company, and we see 10% the likelihood of this happening as high.

0% 2009 2010 2011 2012 1H13 China Longyuan China Suntien Green Energy Beijing Jingneng Source: Companies

Valuation

Since BJCE’s natural gas, wind and hydro power businesses have different risk profiles, we adopt the SOTP methodology to value the company. Within our model, we value each business segment with a DCF analysis, and assume WACCs ranging from 7.1-7.7% to reflect the different risk profiles we see for the segments (see following table). Our SOTP-based valuation produces a fair value per share of HKD3.90, which we set as our six-month target price, and which implies a 2014E PER of 10x.

 BJCE: SOTP valuation % of Business Segment Valuation Ownership HKD/share value Natural gas power generation and heating WACC of 7.3% 100.0% 6.83 83% Wind power WACC of 7.7% 100.0% 0.90 11% Hydropower WACC of 7.1% 100.0% 0.45 5% Other - solar power WACC of 7.5% 100.0% 0.03 0% Corporate value 8.21 100% Net cash / (debt) [2014E] (4.31) Target price 3.90 Source: Daiwa forecasts

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 BJCE: key operating assumptions and financials for gas-fired co-generation business 2009 2010 2011 2012 2013E 2014E 2015E Financial forecasts (CNY m) Sales of electricity 1,546 2,185 2,309 2,148 3,724 5,998 9,063 Sales of heat 346 369 350 387 665 909 1,143 Others 1 - 41 4 - - - Revenue 1,893 2,554 2,700 2,539 4,389 6,907 10,206 Adjusted revenue 2,320 2,962 3,307 2,967 5,339 8,983 13,806 Other income 523 551 851 639 987 2,132 3,680 '- Government subsidies 427 409 607 428 950 2,076 3,600 ' - CERs and VERs income 88 124 198 203 30 48 72 '- Others 8 18 45 8 8 8 8 Gas consumption cost (1,459) (1,970) (2,110) (1,841) (3,457) (6,371) (10,463) EBITDA 750 904 860 960 1,242 986 362 Adjusted EBITDA 1,177 1,312 1,467 1,388 2,191 3,062 3,962 Adjsuted EBITDA margin 51% 44% 44% 47% 41% 34% 29% Depreciation & amortization (315) (320) (270) (262) (310) (451) (619) Operating profit 434 583 590 698 932 536 (257) Adjsuted operating profit 861 992 1,197 1,126 1,882 2,612 3,343 Adjusted operating profit margin 37% 33% 36% 38% 35% 29% 24% Gas subsidies as % of adjusted operating profit 50% 41% 51% 38% 50% 79% 108% CDM income from gas-fired utilities as % of adjusted operating profit 10% 13% 17% 18% 2% 2% 2% Operation assumptions Consolidated power capacity at year end (MW) 1,190 1,190 1,190 1,190 2,028 4,421 5,201 Consolidated power capacity, weighted average (MW) 1,190 1,190 1,190 1,190 2,028 3,225 4,811 Consolidated heat energy capacity at year end (MW) 1,045 1,045 1,045 1,045 1,637 3,107 3,653 Consolidated heat energy capacity, weighted average (MW) 1,045 1,045 1,045 1,045 1,637 2,372 3,013 Weighted average utilization hours 3,240 4,237 4,141 3,750 3,850 3,900 3,950 Gross electricity generation (GWh) 3,855 5,042 4,928 4,463 7,809 12,576 19,004 Net electricity generation (GWh) 3,797 4,907 4,798 4,345 7,604 12,246 18,506 Heat energy generation (kGJ) 5,115 5,625 5,625 5,625 9,161 13,696 17,484 Weighted average gas-fired power on-grid tariff (incl. VAT) (CNY/kWh) 0.53 0.53 0.57 0.57 0.57 0.57 0.57 Weighted average heat tariff (incl. VAT) (CNY/GJ) 76 74 74 80 85 78 76 Weighted average natural gas price (incl. VAT) (CNY/m3) 1.94 2.04 2.23 2.11 2.30 2.66 2.97 Note: Adjusted revenue is revenue plus government subsidies on clean energy; adjusted operating profit is derived from adjusted revenue minus operating expenses; adjusted EBITDA is adjusted operating profit plus depreciation and amortisation Source: Company, Daiwa forecasts

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 BJCE: key operating assumptions and financials for wind power business 2009 2010 2011 2012 2013E 2014E 2015E Financial forecasts (CNY m) Sales of electricity 364 1,032 1,146 1,318 1,575 2,080 2,603 Others 4 - 31 - - - - Revenue 368 1,032 1,177 1,318 1,575 2,080 2,603 Adjusted revenue 375 1,044 1,199 1,341 1,605 2,119 2,652 Other income 47 47 109 60 75 95 116 '- Government subsidies 8 12 23 22 30 39 49 ' - CERs and VERs income 26 32 82 25 33 43 54 '- Others 13 3 5 12 12 12 12 EBITDA 315 954 1,058 1,193 1,224 1,621 2,036 Adjusted EBITDA 322 966 1,080 1,215 1,254 1,660 2,085 Adjsuted EBITDA margin 86% 92% 90% 91% 78% 78% 79% Depreciation & amortization (174) (422) (493) (537) (545) (630) (789) Operating profit 140 531 564 656 679 992 1,248 Adjsuted operating profit 148 543 587 678 709 1,031 1,297 Adjusted operating profit margin 39% 52% 49% 51% 44% 49% 49% Gas subsidies as % of adjusted operating profit 5% 2% 4% 3% 4% 4% 4% CDM income from gas-fired utilities as % of adjusted operating profit 17% 6% 14% 4% 5% 4% 4% Operation assumptions Consolidated power capacity at year end (MW) 811 1,059 1,059 1,303 1,700 2,100 2,500 Consolidated power capacity, weighted average (MW) 357 982 982 1,181 1,501 1,900 2,300 Weighted average utilization hours 2,243 2,369 2,224 1,860 1,945 2,024 2,090 Gross electricity generation (GWh) 787 2,288 2,147 2,160 2,872 3,781 4,729 Net electricity generation (GWh) 802 2,326 2,183 2,196 2,920 3,845 4,808 Weighted average wind power on-grid tariff (incl. VAT) (CNY/kWh) 0.55 0.53 0.53 0.55 0.55 0.55 0.55 Note: Adjusted revenue is revenue plus government subsidies on clean energy; adjusted operating profit is derived from adjusted revenue minus operating expenses; adjusted EBITDA is adjusted operating profit plus depreciation and amortisation Source: Company, Daiwa forecasts

 BJCE: key operating assumptions and financials for hydropower business 2011 2012 2013E 2014E 2015E Financial forecasts (CNY m) Revenue 154 284 270 350 420 Adjusted revenue 154 284 270 350 420 Other income (270) (241) (290) (425) (589) '- Government subsidies - - - - - ' - CERs and VERs income - 21 20 25 30 '- Others (270) (262) (310) (451) (619) EBITDA 382 474 521 724 948 EBITDA margin 32% 35% 32% 34% 36% Depreciation & amortisation (35) (51) (47) (64) (96) Operating profit 347 423 474 660 852 Operating profit margin 29% 32% 30% 31% 32% CDM income from gas-fired utilities as % of adjusted operating profit 0% 5% 4% 4% 4% Operation assumptions Consolidated power capacity at year end (MW) 13 369 447 547 647 Consolidated power capacity, weighted average (MW) 7 363 385 497 597 Weighted average utilization hours 3,000 3,500 3,200 3,200 3,200 Gross electricity generation (GWh) 38 1,291 1,231 1,591 1,911 Net electricity generation (GWh) 37 1,252 1,194 1,544 1,854 Weighted average wind power on-grid tariff (incl. VAT) (CNY/kWh) 0.23 0.23 0.23 0.23 0.23 Source: Company, Daiwa forecasts

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Appendix

 BJCE: organisational and shareholder structure

Source: Company

- 50 -

Utilities / China 2688 HK Utilities / China 11 November 2013

ENN Energy

ENN Energy Target (HKD): 51.00 Upside: 15.8% 2688 HK 7 Nov price (HKD): 44.05

Initiation: risk resilience plus growth from vehicle LNG sales 1 Buy (initiation) 2 Outperform • Likely to see the least impact among peers from the proposed 3 Hold non-residential city-gate tariff hike in 2015 4 Underperform • Should post the highest organic gas sales volume growth in 5 Sell 2013-15E due to project locations and vehicular LNG investment • Initiate with an Buy (1) and target price of HKD51.0

How do we justify our view?

adopted expensive LNG, at an ASP ■ Risks CNY4-5/cm. We believe piped gas, Key downside risks include slower- at CNY3.32/cm after the 21% hike, than-expect gas sales volume growth would still be attractive to end users. and residential gas connections, Therefore, demand destruction higher-than-expected margin Dennis Ip, CFA looks unlikely in Guangdong. squeeze from C&I gas customers and (852) 2848 4068 less-than-expected vehicular gas [email protected] Ramping up vehicle LNG sales sales growth. to protect margins. In addition, Gary Zhou ENN plans to ramp up LNG gas (852) 2773 8535 sales by targeting to have a total of [email protected] Share price performance 500 LNG vehicle refuelling stations by 2015 (1H13: 123). We believe a (HKD) (%) higher contribution from NGV gas 48 145 ■ Investment case 44 131 sales, from 14% in 1H13 to 21% by We forecast ENN’s organic gas sales 40 118 volume to rise at a CAGR of 23% for 2015E, the highest in the sector, 36 104 2012-15, the highest growth among could hedge the risk of a potential 32 90 its peers. However, market concerns margin squeeze on commercial & Nov-12 Feb-13 May-13 Aug-13 Nov-13 as to whether it would be able to industrial (C&I) gas sales. ENN Energy (LHS) Relative to HSI (RHS) pass on the higher city-gate tariffs over the next two years could cloud ■ Catalysts 12-month range 32.50-47.35 its outlook, even though ENN would We believe ENN could exceed its Market cap (USDbn) 6.15 likely be less affected due to its 2013 guidance for gas sales growth 3m avg daily turnover (USDm) 13.75 (25% YoY) and residential gas Shares outstanding (m) 1,083 favourable geographical focus and Major shareholder ENN Group (31.2%) high contribution from vehicular connection (1.2m), based on its track LNG sales. record of beating its own guidance. Financial summary (CNY) Year to 31 Dec 13E 14E 15E Minimal impact from tariff ■ Valuation Revenue (m) 22,271 28,659 36,733 hike. Given ENN’s significant We initiate coverage of ENN with a Operating profit (m) 3,823 4,334 4,730 Buy (1) rating and DCF-based six- Net profit (m) 1,885 2,284 2,640 exposure to Guangdong, where Core EPS (fully-diluted) 1.740 2.109 2.438 tariffs for piped gas are due to be month target price of HKD53.0. The EPS change (%) 26.2 21.2 15.6 hiked by a 21% over 2014-15 (much stock is trading at a 16x 2014E PER, Daiwa vs Cons. EPS (%) 4.9 3.9 3.5 lower than the 36-62% hikes for at the higher end of peers’ 14-17x. PER (x) 19.9 16.4 14.2 other provinces), we believe it will But we think ENN’s gas sales volume Dividend yield (%) 1.3 1.5 1.8 and gross margin are more defensive DPS 0.435 0.527 0.609 be less impacted by the tariff hike PBR (x) 3.7 3.2 2.7 than its peers. Before piped gas than peers, which justify its higher EV/EBITDA (x) 9.1 7.7 6.6 reached Guangdong via the W-E valuation. ROE (%) 20.1 20.9 20.7 Pipeline II in 2H12, Guangdong had Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  ENN: gas sales volume forecasts

We forecast ENN to record a gas-sales volume CAGR of (mcm) 23% for 2012-15, most of which should be organic 12,000 50% growth. Vehicular gas sales should be the major gas 9,000 40% 30% 6,000 sales volume growth contributor, rising at a CAGR of 20% 37% for 2012-15E. By 2015, we forecast ENN will have 3,000 10% 21% of its gas sales contributed by vehicular LNG/CNG, 0 0% higher than peers’ 10-15%. 2009 2010 2011 2012 2013E 2014E 2015E Residential gas sales - LHS C&I gas sales - LHS NGV gas sales - LHS YoY growth of total gas sales - RHS YoY growth of residential gas sales - RHS YoY growth of C&I gas sales - RHS YoY growth of NGV gas sales - RHS Source: Company, Daiwa forecasts

 Valuation  ENN: one-year forward PER

ENN is trading currently at a 16x 2014E PER based on (x) our recurring EPS forecast, on a par with its past-7-year 26 average 12-month-forward PER of 15.8x. We see this 24 level as fair given that we forecast ENN to deliver the 22 22.7x Avg+2SD 20 strongest organic gas sales growth among its peers, with 19.2x Avg+1SD minimal margin shrinkage risks due to its significant 18 vehicular gas sales. 16 15.8x Avg 14 12 12.4x Avg-1SD 10 9.0x Avg-2SD 8 6 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Company, Daiwa forecasts

 Earnings revisions  ENN: consensus earnings-forecast revisions

The Bloomberg consensus 2013-14 EPS forecasts for (HKD) ENN had been rising before the 1H13 results 2.15 announcement at the end August 2013. 2.05 1.95 However, we believe the downward revisions since then 1.85 have been due to some analysts taking into account the 1.75 CNY214m mark-to-market (MTM) loss of its USD500m 1.65 CB (booked in 1H13). We do not think this is a concern 1.55 given it is non-cash, non-recurring, and the loss could 1.45 be revised subject to the price of the CB by the end of Jul-13 Jul-12 Oct-13 Oct-12 Apr-13 Apr-12 Jun-13 Jun-12 Jan-13 Jan-12 Mar-13 Mar-12 Feb-13 Feb-12 Aug-13 Sep-13 Aug-12 Sep-12 Nov-12 Dec-12 May-13 the reporting period. May-12 2013E EPS 2014E EPS Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas sales volume (m3) 2,200 2,632 3,808 5,011 6,225 7,703 9,512 11,375 Gas ASP, incl tax (CNY/m3) 2.87 2.84 3.04 3.37 3.42 3.55 3.86 4.21 Gas purchase cost, incl tax (CNY/m3) 2.21 2.23 2.52 2.63 2.62 2.74 3.04 3.37 Residential gas connection ('000 710 788 876 1,030 1,122 1,222 1,322 1,422 houesholds) Gross profit contribution - connection 63 57 54 55 47 46 45 45 fee

 Profit and loss (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Gas connection 2,422 2,554 3,049 3,415 3,633 4,388 5,108 5,946 Sales of gas 3,095 4,078 6,633 7,980 10,516 13,120 17,137 22,004 Other Revenue 2,749 1,782 1,534 3,673 3,878 4,763 6,414 8,783 Total Revenue 8,266 8,413 11,215 15,068 18,027 22,271 28,659 36,733 Other income 214 105 189 167 171 171 171 171 COGS (5,973) (5,873) (8,203) (11,166) (13,183) (16,246) (21,523) (28,467) SG&A (1,160) (1,016) (1,382) (1,663) (1,971) (2,373) (2,973) (3,708) Other op.expenses (234) (435) (323) (374) (482) (688) (788) (888) Operating profit 1,357 1,496 1,840 2,420 3,057 3,823 4,334 4,730 Net-interest inc./(exp.) (381) (328) (311) (460) (621) (714) (749) (749) Assoc/forex/extraord./others 200 216 282 367 416 517 613 710 Pre-tax profit 1,177 1,383 1,811 2,327 2,852 3,627 4,198 4,690 Tax (260) (304) (410) (660) (859) (1,092) (1,159) (1,178) Min. int./pref. div./others (240) (276) (388) (414) (511) (650) (755) (872) Net profit (reported) 677 803 1,013 1,253 1,482 1,885 2,284 2,640 Net profit (adjusted) 677 803 1,013 1,253 1,482 1,885 2,284 2,640 EPS (reported)(CNY) 0.670 0.777 0.965 1.193 1.388 1.740 2.109 2.438 EPS (adjusted)(CNY) 0.670 0.777 0.965 1.193 1.388 1.740 2.109 2.438 EPS (adjusted fully-diluted)(CNY) 0.659 0.774 0.954 1.180 1.379 1.740 2.109 2.438 DPS (CNY) 0.154 0.193 0.286 0.295 0.345 0.435 0.527 0.609 EBIT 1,357 1,496 1,840 2,420 3,057 3,823 4,334 4,730 EBITDA 1,602 1,798 2,184 2,808 3,552 4,512 5,122 5,618

 Cash flow (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 1,177 1,383 1,811 2,327 2,852 3,627 4,198 4,690 Depreciation and amortisation 304 378 440 519 620 688 788 888 Tax paid (260) (304) (410) (660) (859) (1,092) (1,159) (1,178) Change in working capital 168 563 725 525 941 671 1,370 2,107 Other operational CF items (124) 164 149 (154) 394 293 197 100 Cash flow from operations 1,265 2,185 2,715 2,557 3,948 4,186 5,394 6,606 Capex (1,217) (1,609) (2,189) (2,739) (3,150) (3,150) (3,150) (3,150) Net (acquisitions)/disposals (151) (20) (100) (179) (179) (179) (179) (179) Other investing CF items (48) 249 (116) (2,731) 2,388 157 185 215 Cash flow from investing (1,415) (1,379) (2,404) (5,649) (941) (3,172) (3,144) (3,114) Change in debt 404 498 402 4,370 270 529 0 0 Net share issues/(repurchases) 0 237 0 130000 Dividends paid (247) (309) (418) (527) (315) (471) (571) (660) Other financing CF items 26 (244) (156) (260) (155) 3,202 (155) (155) Cash flow from financing 182 182 (172) 3,596 (200) 3,260 (726) (815) Forex effect/others 00000000 Change in cash 32 987 139 504 2,807 4,273 1,524 2,677 Free cash flow 48 576 526 (182) 798 1,036 2,244 3,456 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 1,805 2,831 2,916 6,024 6,472 10,746 12,270 14,947 Inventory 254 286 249 272 311 339 366 394 Accounts receivable 1,431 1,208 1,356 1,837 2,062 2,408 3,099 3,972 Other current assets 864 429 557 811 842 667 722 796 Total current assets 4,354 4,754 5,079 8,944 9,687 14,159 16,458 20,109 Fixed assets 7,855 9,028 10,800 13,073 15,099 18,491 21,069 23,547 Goodwill & intangibles 634 622 894 1,247 1,434 1,173 1,136 1,099 Other non-current assets 1,731 2,231 2,867 3,624 4,673 5,098 5,961 6,987 Total assets 14,574 16,635 19,640 26,888 30,893 38,922 44,624 51,743 Short-term debt 1,869 1,484 2,379 3,213 3,945 3,974 3,974 3,974 Accounts payable 2,752 2,772 3,573 4,172 4,894 6,106 7,837 10,372 Other current liabilities 807 1,108 1,536 2,135 2,775 3,343 4,211 5,423 Total current liabilities 5,428 5,364 7,488 9,520 11,614 13,423 16,022 19,769 Long-term debt 3,534 4,400 3,884 7,459 7,297 11,183 11,183 11,183 Other non-current liabilities 171 444 728 1,069 1,312 1,583 2,219 2,738 Total liabilities 9,133 10,208 12,100 18,048 20,223 26,189 29,424 33,690 Share capital 106 110 110 110 113 113 113 113 Reserves/R.E./others 4,149 5,007 5,922 6,936 8,540 9,953 11,666 13,646 Shareholders' equity 4,256 5,117 6,031 7,046 8,653 10,066 11,779 13,759 Minority interests 1,186 1,310 1,508 1,794 2,017 2,667 3,421 4,294 Total equity & liabilities 14,574 16,635 19,640 26,888 30,893 38,922 44,624 51,743 EV 41,219 40,509 40,491 41,500 41,203 40,977 39,594 37,079 Net debt/(cash) 3,598 3,054 3,347 4,648 4,770 4,411 2,887 210 BVPS (CNY) 4.214 4.955 5.743 6.708 8.104 9.295 10.876 12.705

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) n.a. 1.8 33.3 34.4 19.6 23.5 28.7 28.2 EBITDA (YoY) n.a. 12.2 21.4 28.6 26.5 27.0 13.5 9.7 Operating profit (YoY) n.a. 10.2 23.0 31.5 26.3 25.1 13.4 9.1 Net profit (YoY) n.a. 18.7 26.2 23.7 18.3 27.2 21.2 15.6 Core EPS (fully-diluted) (YoY) n.a. 17.6 23.2 23.7 16.9 26.2 21.2 15.6 Gross-profit margin 27.7 30.2 26.9 25.9 26.9 27.1 24.9 22.5 EBITDA margin 19.4 21.4 19.5 18.6 19.7 20.3 17.9 15.3 Operating-profit margin 16.4 17.8 16.4 16.1 17.0 17.2 15.1 12.9 Net profit margin 8.2 9.5 9.0 8.3 8.2 8.5 8.0 7.2 ROAE 31.8 17.1 18.2 19.2 18.9 20.1 20.9 20.7 ROAA 9.3 5.1 5.6 5.4 5.1 5.4 5.5 5.5 ROCE n.a. 24.3 14.1 14.5 14.8 15.4 14.9 14.9 ROIC n.a. 24.6 14.0 14.2 14.8 16.4 17.8 19.5 Net debt to equity 84.5 59.7 55.5 66.0 55.1 43.8 24.5 1.5 Effective tax rate 22.1 22.0 22.6 28.4 30.1 30.1 27.6 25.1 Accounts receivable (days) 31.6 57.3 41.7 38.7 39.5 36.6 35.1 35.1 Current ratio (x) 0.8 0.9 0.7 0.9 0.8 1.1 1.0 1.0 Net interest cover (x) 3.6 4.6 5.9 5.3 4.9 5.4 5.8 6.3 Net dividend payout 22.9 24.8 29.7 24.7 24.8 25.0 25.0 25.0 Free cash flow yield 0.1 1.5 1.4 n.a. 2.1 2.8 6.0 9.2 Source: FactSet, Daiwa forecasts

 Company profile ENN Energy is one of the leading city-gas distributors in China, owning 126 projects (as of August 2013) with geographical focus on Guangdong, Shandong, Jiangsu and Hunan

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Investor concerns associated with the city-gate tariff hike

ENN’s share price corrected by 4% during August 2013 Risk resilience plus due to concerns about how the city-gate tariff hike might affect the company. To recap, on 28 June 2013, growth from vehicle the National Development and Reform Commission (NDRC) increased the city-gate non-residential natural LNG sales gas price by 15%, to CNY1.95/m3 from CNY1.69/m3, effective 10 July 2013.

ENN’s organic gas sales volume should Under the plan, China has adopted a ladder-like continue to outperform peers’ in 2013-15E pricing mechanism for natural gas, allowing substantial price increases at one time for incremental gas supply, which the NDRC estimates will account for 9% of the Company description country’s piped gas supply in 2013. Meanwhile the NDRC will grant a grace period until 2015 for the price ENN is one of the big-4 city-gas distributors in China, of existing base volumes (91% of piped-gas supply for in terms of number of city-gas distribution 2013) to be linked to regional competing fuels, such as concessions, with a connectable population of 66.5m heating oil and LPG, with a 15% discount. households under its 126 city-gas concession as of 30 June 2013. More than 50% of the company’s A further CNY0.88/m³ hike for non- connectable population is located in Guangdong, residential gas (base volume) nationwide Hunan, Shandong and Jiangsu. in 2013-15E Under this city-gate tariff-hike schedule, we estimate there will be an additional 42% price rise (nationwide) Highest organic gas sales growth at the city gate from CNY1.95/m3 to CNY2.77/m3 by the end of 2015E. As a result, the total tariff hike for city- ENN has recently been focusing on organic gas sales gate of non-residential customers would be growth by starting to expand its number of vehicular CNY1.08/m3 higher than the level in June 2013. LNG refuelling stations, enhancing gas sales to industrial parks, and providing C&I users with  Average city-gate price for non-residential gas in 2013-15E integrated energy projects to promote more natural gas (CNY/cm) consumption. We forecast the company to record a 3.00 2.77 natural gas sales volume CAGR of 23% for 2012-15, 2.50 higher than that of its peers of 15-20%. 1.95 2.00 1.69 1.50

1.00 0.50

0.00 Average city-gate price, Average city-gate price, Average city-gate price, CNY/cm (before July-2013) CNY/cm (after July-2013) CNY/cm (as of July-2015E) Source: NDRC, Daiwa

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The reasons we think ENN is the most defensive to the Why is ENN the most defensive to city-gate tariff hike are listed below. the city-gate tariff hike? Reason #1: Geographical focus on Based on our analysis, the hike in ENN’s city-gate Guangdong tariffs would be lower than the national average hike, Before the commissioning of the W-E pipeline II at the with ENN’s tariffs rising by CNY0.75/m3 (national: end of 2011, Guangdong had been using more CNY0.88/m3), implying that its base volume would rise expensive LNG, priced at CNY4-5/m3. In 2012, W-E by 32% (national: 40%) under the plan. piped gas started to supply Guangdong at CNY2.74/ m3, a 30-45% discount to LNG. Therefore, ENN should be less susceptible to cost pass- through risk than its peers. This is because ENN has In our view, a rise in piped gas prices to CNY3.32/m3 more of a geographical focus on Guangdong Province, would not lead to a destruction in demand from where tariffs have been linked to competing fuels since industrial customers, given that the higher piped gas 2012, resulting in a lower additional city-gate price would still be 15-35% cheaper than LNG, in this hike of 21% (versus the national average of 40%) by province. 2015E. In addition, an expansion of its high-margin vehicular LNG sales would protect ENN’s gas sales In addition, the city-gate tariff hike in Guangdong over margin, in our view. 2014-15 would only be CNY0.58/cm, which is lower than CNY0.88/cm in other provinces, given city-gate  ENN: further city-gate hike for non-residential tariffs in 2013-15E tariffs for Guangdong have been linked with LPG and Premium for incremental Premium for ENN's heating oil since the end of 2011. Some 24% of ENN’s (Unit: CNY Base Incremental volume (unit incremental geographical connectable population is located in Guangdong. per m3) volume volume CNY/cm) volume (%) proportion Guangdong 2.74 3.32 0.58 21% 24% Natural gas prices in Guangdong Province Guangxi 2.57 3.15 0.58 23% 2% Zhejiang 2.43 3.31 0.88 36% 7% Jiangsu 2.42 3.30 0.88 36% 10% Anhui 2.35 3.23 0.88 37% 5% Henan 2.27 3.15 0.88 39% 9% Hebei 2.24 3.12 0.88 39% 8% Liaoning 2.24 3.12 0.88 39% 1% Shandong 2.24 3.12 0.88 39% 11% Hunan 2.22 3.10 0.88 40% 14% Yunnan 1.97 2.85 0.88 45% 1% Inner Mongolia 1.60 2.48 0.88 55% 1% Weight average Premium for Premium for (as of 2011 gas incremental incremental 2.06 2.89 0.83 sales volume in volume of volume of ENN: China) China: 40% 32% Source: NDRC, Company, Daiwa Note: highlighted provinces are the major service regions for ENN

 ENN: city-gate hikes in major service provinces CNYb/m3 4 80%

3 60%

2 40% Source: NDRC, Daiwa research 1 20% 0 0% g g xi g hai Jilin ian g j don g Hunan Henan Gansu Tianjin Jian Jiangsu Yunnan Xin Sichuan Shaanxi Liaoning Shan Chongqing Guan City-gate for base volume (LHS) City-gate for incremental volume (LHS)

Further city-gate hike for base volume in 2013-15E (RHS) Source: NDRC, Company Daiwa research

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Reason #2: Expand LNG vehicle gas sales  ENN: unit dollar margin of C&I and vehicle gas in 2012 to protect margins (Unit: CNY/m3) 1.40 ENN has an ambitious plan to expand its vehicle LNG refuelling station coverage from 123 stations in 1H13 to 1.20 500 stations by 2015. We believe the resulting higher 1.00 contribution of gas sales from vehicles could protect its 0.80 margins given our view that all city-gas operators 0.60 would suffer a margin squeeze from C&I gas sales, as natural gas could be priced at premium to competing 0.40 fuels, causing demand destruction if an additional 0.20

CNY0.88/cm (national average) upstream hike for base 0.00 gas volumes, from 2013-15, is fully passed through. C&I Vehicle

Source: Company, Daiwa research As such, we forecast ENN’s gas sales volume contribution from vehicles to increase by 7pp to 21% Results: immune from margin risks over 2012-15E. Therefore, the margin squeeze for ENN should be less  Natural gas discount/premium to competing fuel for vehicular of a concern given its geographical focus on Guangdong gas and industrial gas in 2015E and the defensiveness of its LNG vehicle gas sales, 60% which should protect its margins. Our calculations 50% show a margin expansion of CNY0.01/m3 in 2014-15E, 40% from CNY0.83/m³ to CNY0.84/m³, despite an 30% assumption that ENN would able to pass on 98% of the 20% final city-gate tariff hike in 2015, given our expected 10% higher proportion of high-margin vehicular LNG gas 0% (10%) sales, from 14% in 2012 to 21% in 2015E. (20%)  ENN: unit margin of gas sales and vehicular gas sales Anhui Hubei Hebei contribution Hunan Tianjin Gansu Beijing Jiangsu Sichuan Shanghai Shandong

Chongqing (Unit: CNY/m3) Shengyang Guangzhou Heilongjiang Natural gas discount for industrial usage Natural gas discount for vehicular usage 0.85 25%

Source: Provincial Development and reform Commissions, Daiwa research 0.80 20%  ENN: vehicular gas sales volume growth and contribution 25% 50% 0.75 15% 20% 40%

15% 30% 0.70 10% 2011 2012 2013E 2014E 2015E 10% 20% ENN's profit spread of natural gas sales (LHS) Vechile gas sales as proportion of total gas sales (RHS) 5% 10% Source: Company, Daiwa forecasts

0% 0% 2009 2010 2011 2012 2013E 2014E 2015E

Gas sales volume proportion from vehicular gas sales (LHS)

Vehicular gas sales volume growth (RHS) Source: Company, Daiwa forecasts

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Sensitivity analysis of margin squeeze for industrial gas sales MTM loss from CB not a concern We conducted an analysis to gauge the sensitivity of In 1H13, ENN booked a CNY214m non-cash non- ENN’s NAV, 2016E earnings and 2016E ROE to recurring loss from its USD500m CB issued in different percentages of the hike in 2015E that would February 2013, including a CNY270m MTM loss at the be passed on to C&I gas customers. CB price of USD108.6 on 30 June 2013, some 8.6% above its par value, given every USD1 above par would  ENN: sensitivity of NAV, earnings, ROE to different levels of industrial gas price hike pass-through in 2016E be equivalent to a MTM non-cash loss of USD5m. The % of hike not able to pass- 2016E net 2016E 2016 Industrial CB MTM non-cash loss could be reversed in the FY13 through NAV profit ROE tariff results if the CB price is lower than USD108.6 on 31 Base case 51.00 3,023 20.3% 4.45 December 2013. -5% 49.32 2,937 19.8% 4.42 -10% 47.64 2,851 19.3% 4.39 -15% 45.96 2,765 18.8% 4.36 Therefore, we do not think the MTM gain/loss is a Source: Daiwa forecasts concern given it is non-cash, and reversible based on the CB price correlating to ENN’s share price by end of  ENN: sensitivity of NAV, earnings, ROE to different levels of the reporting period. industrial gas price hike pass-through relative to base case NAV 2016E net profit 2016E ROE 2016 industrial tariff -3.3% -2.9% -.49ppt -0.6% To date, none of the USD500m CB has been converted -6.6% -5.7% -.98ppt -1.3% given it is all out of the money under an exercise price -9.9% -8.6% -1.48ppt -1.9% of HKD48.62/share. If all of it is converted, ENN’s Source: Daiwa forecasts issued shares would rise by 6.9%. In addition, the dividend payout is unlikely to be affected given the In our model, we assume that ENN would only able to board is considering excluding the CB MTM gain or pass on 98% of the city-gate hike to C&I customers. loss, ie, only considering the recurring profit, from the dividend calculation. ENN has a cash settlement option Passed on 74% of the incremental piped to avoid dilution. gas costs after the city-gate hike in July According to management, as at 12 September 2013, ENN had hiked 51% of its gas volume by CNY0.49/m³ Risks on average following the hike on 10 July 2013, in which 74% of gas volume had completed the cost pass- Apart from a margin squeeze coming from city-gate through process. C&I gas prices had been completely tariff hikes, MTM losses from the CB (as discussed passed through by 12 September, while 86% of vehicle earlier), other key downside risks for ENN include gas volume had been passed through. slower-than-expect gas sales volume growth (management guides for 25% YoY growth for 2013) and Management expects the cost pass-through for all non- residential gas connections (management guidance for residential gas customers to be completed retroactively 2013: 1.2m), and less-than-expected growth of vehicle by the end of 2013. gas sales, which we see unlikely given the State Council has mandated the adoption of clean-energy vehicles for new buses, while some local governments have offered subsidies for vehicles’ fuel conversion cost from diesel to natural gas, in order to mitigate air pollution.

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Valuations

We value ENN using DCF methodology reflecting the stable long-term income incurred by our gas sales volume and residential connection forecasts. We assume a WACC of 7.6% and a terminal growth rate of 2%. Our DCF-based valuation yields a fair value of HKD51.0, implying a 19x 2014E PER.

We initiate coverage of ENN with an Outperform (2) rating given it has the highest 23% organic gas sales volume CAGR for 2012-15E (peers: 15-20%), with minimal risk of a margin squeeze as a result of the potential city-gate tariff hike in 2014-15E.

 ENN: DCF valuation (CNYm) 2013E 2014E 2015E 2016E 2017E 2018E Year 0 0 1 2 3 4 Net income 1,885 2,284 2,640 3,023 3,574 1,963 Interest x (1-tax) 499 542 561 561 561 561 Depreciation 688 788 888 976 1,065 1,154 Change in working capital 671 1,370 2,107 992 (528) 2,443 CAPEX (3,329) (3,329) (3,329) (2,959) (2,959) (2,959) FCF 413 1,656 2,866 2,594 1,714 3,161 Discount Factor (Base 2014) 1.00 1.00 0.93 0.86 0.80 0.75 PV Cash flow (Base 2014) 413 1,656 2,664 2,242 1,377 2,360 Terminal Growth Rate 2.0%

Sum PV Cash Flow (to 2018) 10,298 PV of Terminal Value (from 2019) 32,212 Minus net debt on Balance Sheet 470 Equity Value (CNY) 42,980 FX(HKD/CNY) 1.26 NPV/Share (HKD) 51.0 Valuation assumption China Risk Free Rate 3.5% Market Risk Premium 9.0% Beta 0.66 Cost of Equity 9.4% Yr n-1 Debt/Capitalization 35.0% Pre-Tax Cost of Debt 5.5% After Tax Cost of Debt 4.1% WACC 7.6% Source: Daiwa forecasts

 ENN: DCF sensitivity over WACC and terminal growth rate WACC 6.0% 7.0% 7.6% 9.0% 10.0% 3.0% 94.0 69.1 59.8 44.8 38.0 Terminal 2.5% 82.1 62.6 55.0 42.2 36.2 Growth rate 2.0% 73.2 57.5 51.0 39.9 34.6 1.5% 66.2 53.2 47.7 37.9 33.1 1.0% 60.7 49.7 44.9 36.2 31.9 Source: Daiwa forecasts

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Appendix 1

  ENN: geographical footprint and key operation data (1H13)

Province Connectable Population ('000) Proportion Guangdong 13,332 24% Henan 5,134 9% Shandong 6,305 11% Jiangsu 5,431 10% Hunan 7,842 14% Zhejiang 4,076 7% Hebei 4,316 8% Fujian 3,290 6% Anhui 2,663 5% Guangxi 1,242 2% Liaoning 631 1% Inner Mongolia 768 1% Beijing 116 0% Yunnan 293 1% Jiangxi 82 0% Total* 55,521 100% Source: Company, Daiwa *Note: figures are for 2012

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Utilities / Hong Kong 1083 HK Utilities / Hong Kong 11 November 2013

Towngas China

Towngas China Target (HKD): 8.60 Upside: 15.1% 1083 HK 7 Nov price (HKD): 7.47

Initiation: superior bottom-line growth, margin risk not severe 1 Buy 2 Outperform (initiation) • TCCL’s high-margin subsidiaries are in a harvesting stage and 3 Hold should continue to drive strong net profit growth 4 Underperform • Its geographical focus on Liaoning should help to limit margin 5 Sell compression risk from further city-gate tariff hikes • We forecast a net profit CAGR for 2012-15 of 25% (peers: 21- 22%); initiating with Outperform and target price of HKD8.60 How do we justify our view?

Less pass-through risk in ■ Risks Liaoning. About 30% of TCCL’s As TCCL (together with HKCG) has investments are in Liaoning, a only about 50 CNG vehicular- province where 35% of the gas is refuelling stations, a 2015E net-profit supplied by an LNG-receiving terminal margin improvement could be curbed Dennis Ip, CFA in Dalian at a high ASP of CNY3.5- if it sees a margin squeeze on C&I gas (852) 2848 4068 4.0/m3, versus piped gas. Similar to without a sufficient hedge from high- [email protected] Guangdong, where the main gas gross-margin vehicular gas. source is from expensive LNG, we see Gary Zhou a low risk in Liaoning of TCCL not (852) 2773 8535 being able to pass on higher costs, as [email protected] Share price performance the post-2015 tariff of piped gas, at CNY3.12/m3 (including a further (HKD) (%) ■ Investment case CNY0.88/m3 hike on base volume), 8.5 135 still looks attractive for end customers. 7.9 124 Before Towngas China (TCCL) was 7.3 113 majority acquired by The Hong Kong 6.6 101 and China Gas Company (HKCG) ■ Catalysts 6.0 90 (3HK, Not rated) in 2007, its main In our view, near-term catalysts Nov-12 Feb-13 May-13 Aug-13 Nov-13 market was Sichuan, where city-gas include additions of new city-gas Towngas Ch (LHS) Relative to HSI (RHS) operators earn a low single-digit projects in 2H13 (11 projects added return due to low gas prices. Following as of 1H13, compared with its full- 12-month range 6.12-8.20 several asset injections and year 2013 target of 10 projects). A Market cap (USDbn) 2.52 acquisitions, its footprint has extended further improvement in segmental 3m avg daily turnover (USDm) 3.25 to Liaoning and Shandong provinces, margins on gas sales could be a Shares outstanding (m) 2,610 Major shareholder The Hong Kong and China Gas (62.4%) where margins are much higher. As long-term catalyst. such, we think TCCL’s earnings quality Financial summary (HKD) has improved with its restructured ■ Valuation Year to 31 Dec 13E 14E 15E city-gas portfolio and initiate coverage Our DCF-based six-month target Revenue (m) 6,371 8,059 10,041 with an Outperform (2) rating. price of HKD8.60 assumes TCCL Operating profit (m) 1,126 1,361 1,604 would only able to pass on 97% of the Net profit (m) 1,107 1,373 1,659 Core EPS (fully-diluted) 0.424 0.525 0.634 High-margin subsidiaries city-gate hike to its non-residential EPS change (%) 24.5 23.7 20.8 driving net profit growth. customers in 2015. TCCL’s 14.2x Daiwa vs Cons. EPS (%) 6.4 10.2 14.2 TCCL’s unit dollar segmental margin 2014E PER is lower than its China PER (x) 17.6 14.2 11.8 rose from CNY0.15/m3 in 2010 to peers’ 15-17x, unjustified in our view, Dividend yield (%) 1.1 1.4 1.8 CNY0.29/m3 in 1H13, due to a given our strong net profit CAGR of DPS 0.083 0.107 0.135 PBR (x) 1.6 1.5 1.3 higher contribution from subsidiary 25% for 2012-15E (peers at 21-12%). EV/EBITDA (x) 12.3 10.0 8.1 gas sales in high-margin provinces ROE (%) 9.7 10.7 11.8 such as Liaoning and Shandong. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  TCCL: gas sales volume, EBIT and net profit Though we forecast TCCL’s natural gas sales (at the 70% subsidiary level) to increase at only about a 15% CAGR 60% over 2012-15 (peers: 15-25%), we project a CAGRs of 50% 21% for its EBIT and 25% for its net profit over the same 40% period, given that the gas sales generated by its new subsidiaries, located mostly in Shandong and Liaoning, 30% have higher gross-profit margins than those for aged 20% projects at the associate and joint-controlled company 10% levels. 0% 2009 2010 2011 2012 2013E 2014E 2015E Our EPS CAGR forecast of 25% for 2012-15 is higher Subsidiaries gas sales YoY growth EBIT YoY growth than our forecast of 21-22% for its domestic peers. Net profit YoY growth Source: Company, Daiwa forecasts

 Valuation  TCCL: one-year forward PER TCCL is trading currently at a 14.2x PER based on our (x) 2014 EPS forecast, which is on a par with its past-five- 20 year average 12-month-forward PER of 14.0x. The 18 stock’s 2014E PER is lower than 15-17x for its domestic 17.3x Avg+2SD peers, which we consider unjustified given we forecast 16 15.6x Avg+1SD TCCL’s net profit CAGR over 2012-15 to exceed that of 14 14.0x Avg its peers (25% vs. 21-22% for its peers), on a rising contribution of gas sales from high-margin regions. 12 12.3x Avg-1SD 10.6x Avg-2SD 10 8 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Company, Daiwa forecasts

 Earnings revisions  TCCL: consensus EPS-forecast revisions The Bloomberg consensus 2013-14 EPS forecasts were (HKD) revised up following the company’s 2011 and 2012 0.55 results announcements in March 2012 and March 2013, 0.50 respectively. 0.45

In the past, we believe the market had underestimated 0.40 TCCL’s net profit growth potential by focusing only on its total gas-sales volume growth, which was 0.35 consistently lower than its peers’ growth. We believe the 0.30 consensus has now recognised that TCCL’s unit dollar Jul-12 Jul-13 Apr-12 Oct-12 Apr-13 Oct-13 Jan-12 Jun-12 Jan-13 Jun-13 Mar-12 Mar-13 Feb-12 Feb-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 May-12 margin of gas sales has been expanding given its May-13 accelerated growth in high-margin regions, and hence 2013E EPS 2014E EPS has started to revise up its earnings for the company. Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Total natural gas sales volume (mn 2,700 3,200 4,030 4,670 5,320 5,930 6,564 7,212 Subsidary natural gas sales volume 582 760 987 1,200 1,310 1,520 1,748 1,992 (mn m3) Gas ASP, incl tax (HKD/m3) 2.08 2.02 2.32 2.75 3.03 3.31 3.70 4.10 Gas purchase cost, incl tax (HKD/m3) 1.94 1.87 2.17 2.56 2.79 3.03 3.42 3.83 Segment profit contribution - 56 61 66 66 64 61 62 65 connection fee (%)

 Profit and loss (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales of gas 1,210 1,534 2,286 3,288 3,972 5,026 6,470 8,168 Gas connection 448 492 695 1,034 1,211 1,345 1,588 1,873 Other Revenue 2,751 880000(0)(0)(0) Total Revenue 4,409 2,906 2,981 4,321 5,183 6,371 8,059 10,041 Other income 70 68 138 195 160 197 249 310 COGS (4,090) (2,577) (2,560) (3,634) (4,324) (5,293) (6,766) (8,522) SG&A 00000000 Other op.expenses (240) (241) (289) (338) (392) (483) (573) (675) Operating profit 298 330 469 782 904 1,126 1,361 1,604 Net-interest inc./(exp.) (145) (127) (142) (142) (148) (121) (121) (121) Assoc/forex/extraord./others 208 211 300 394 480 531 672 837 Pre-tax profit 361 414 626 1,034 1,236 1,536 1,912 2,320 Tax (89) (102) (136) (257) (299) (342) (434) (536) Min. int./pref. div./others (69) (47) (54) (68) (95) (86) (105) (126) Net profit (reported) 203 265 436 709 841 1,107 1,373 1,659 Net profit (adjusted) 203 265 436 709 841 1,107 1,373 1,659 EPS (reported)(HKD) 0.104 0.135 0.199 0.289 0.342 0.425 0.526 0.635 EPS (adjusted)(HKD) 0.104 0.135 0.199 0.289 0.342 0.425 0.526 0.635 EPS (adjusted fully-diluted)(HKD) 0.103 0.135 0.199 0.288 0.341 0.424 0.525 0.634 DPS (HKD) 0.010 0.020 0.034 0.050 0.064 0.083 0.107 0.135 EBIT 298 330 469 782 904 1,126 1,361 1,604 EBITDA 447 503 666 1,019 1,179 1,461 1,754 2,055

 Cash flow (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 361 414 626 1,034 1,236 1,536 1,912 2,320 Depreciation and amortisation 169 178 189 237 276 335 393 451 Tax paid (51) (64) (136) (257) (299) (342) (434) (536) Change in working capital 302 431 241 48 524 387 628 758 Other operational CF items (356) (497) (319) (433) (661) (531) (672) (837) Cash flow from operations 426 461 601 628 1,075 1,384 1,827 2,156 Capex (644) (794) (719) (894) (1,610) (1,747) (1,747) (1,747) Net (acquisitions)/disposals (72) (278) (294) (170) (136) 0 0 0 Other investing CF items192361383396000 Cash flow from investing (698) (836) (875) (1,031) (1,651) (1,747) (1,747) (1,747) Change in debt 556 492 712 1,044 670000 Net share issues/(repurchases) 3 2 8 40 0 930 0 0 Dividends paid (10) (37) (57) (97) (147) (157) (216) (280) Other financing CF items (222) 14 36 37 567000 Cash flow from financing 326 470 698 1,025 1,089 774 (216) (280) Forex effect/others 00000000 Change in cash 55 95 425 622 513 411 (136) 129 Free cash flow (219) (333) (117) (266) (536) (363) 80 409 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (HKDm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 864 964 1,434 2,071 2,699 2,890 2,754 2,883 Inventory 193 102 148 388 395 395 431 470 Accounts receivable 452 484 531 852 1,057 1,173 1,484 1,849 Other current assets 102 26 101 336 415 196 196 196 Total current assets 1,611 1,575 2,214 3,498 4,346 4,654 4,865 5,397 Fixed assets 3,811 4,077 5,074 6,128 7,652 9,072 10,433 11,736 Goodwill & intangibles 2,687 2,935 3,935 4,031 4,462 4,453 4,446 4,438 Other non-current assets 2,277 2,743 3,660 4,526 4,795 5,319 5,983 6,813 Total assets 10,387 11,330 14,883 18,183 21,255 23,498 25,727 28,385 Short-term debt 223 562 2,792 1,513 1,946 1,946 1,946 1,946 Accounts payable 947 1,319 1,654 2,263 2,998 3,502 4,476 5,638 Other current liabilities 203 272 255 516 629 461 518 518 Total current liabilities 1,372 2,153 4,701 4,291 5,574 5,909 6,941 8,103 Long-term debt 1,600 1,731 432 2,902 3,145 3,145 3,145 3,145 Other non-current liabilities 501 558 614 691 1,249 1,248 1,248 1,314 Total liabilities 3,474 4,442 5,748 7,884 9,968 10,303 11,334 12,562 Share capital 196 196 245 246 246 1,176 1,176 1,176 Reserves/R.E./others 5,982 6,238 8,319 9,369 10,236 11,127 12,219 13,524 Shareholders' equity 6,178 6,434 8,563 9,615 10,482 12,303 13,395 14,700 Minority interests 735 455 572 684 805 892 997 1,123 Total equity & liabilities 10,387 11,330 14,883 18,183 21,255 23,498 25,727 28,385 EV 19,407 19,316 18,996 18,800 18,624 17,988 17,558 16,718 Net debt/(cash) 959 1,330 1,791 2,344 2,393 2,202 2,338 2,209 BVPS (HKD) 3.156 3.285 3.497 3.908 4.261 4.714 5.132 5.632

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) n.a. (34.1) 2.6 44.9 20.0 22.9 26.5 24.6 EBITDA (YoY) n.a. 12.5 32.5 52.9 15.8 23.9 20.1 17.1 Operating profit (YoY) n.a. 10.8 42.1 66.8 15.6 24.6 20.9 17.8 Net profit (YoY) n.a. 30.5 64.7 62.6 18.6 31.7 23.9 20.8 Core EPS (fully-diluted) (YoY) n.a. 30.5 47.7 44.7 18.2 24.5 23.7 20.8 Gross-profit margin 7.2 11.3 14.2 15.9 16.6 16.9 16.0 15.1 EBITDA margin 10.1 17.3 22.3 23.6 22.8 22.9 21.8 20.5 Operating-profit margin 6.8 11.3 15.7 18.1 17.4 17.7 16.9 16.0 Net profit margin 4.6 9.1 14.6 16.4 16.2 17.4 17.0 16.5 ROAE 6.6 4.2 5.8 7.8 8.4 9.7 10.7 11.8 ROAA 3.9 2.4 3.3 4.3 4.3 4.9 5.6 6.1 ROCE n.a. 7.2 4.4 5.8 5.8 6.5 7.2 7.9 ROIC n.a. 6.0 3.8 5.0 5.2 6.0 6.6 7.1 Net debt to equity 15.5 20.7 20.9 24.4 22.8 17.9 17.5 15.0 Effective tax rate 24.8 24.7 21.8 24.9 24.2 22.3 22.7 23.1 Accounts receivable (days) 18.7 58.8 62.1 58.4 67.2 63.9 60.2 60.6 Current ratio (x) 1.2 0.7 0.5 0.8 0.8 0.8 0.7 0.7 Net interest cover (x) 2.1 2.6 3.3 5.5 6.1 9.3 11.2 13.2 Net dividend payout 9.6 14.8 16.9 17.3 18.6 19.5 20.4 21.3 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. 0.4 2.1 Source: FactSet, Daiwa forecasts

 Company profile Towngas China is one of the leading city-gas distributors in China, owning 84 projects (as of June 2013) with geographical focus on Sichuan, Shandong and Liaoning

- 64 - China Gas Sector 11 November 2013

Highest net profit growth, margin expansion

While we forecast TCCL’s gas-sales volume CAGR (at Highest bottom line the subsidiary level) for 2012-15 to be lower than peers’ (15% for TCCL versus 15-25% for peers), we forecast growth, margin risk the company to post the highest net profit CAGR (25% vs. peers’ 21-22%) over the same period, due to a not severe higher contribution of high-margin gas sales from subsidiaries located in Liaoning and Shandong provinces. The increasing contribution from high-  China city-gas operators: comparison of 2013E net profit YoY gross-margin subsidiaries in Liaoning growth to 2013E natural gas sales volume YoY growth and Shandong should enable TCCL to 45% Net profit growth faster than post the highest net profit growth in this 40% gas sales volume growth CGHL, 30%, 39% sector for 2012-15E, and we see low risk 35% of margin compression. TCCL, 16%, CRG, 46%, 31% 30% 32% ENN, 24%, 27% 25% Company background

Net profitNet yoy growth in 2013E 20% BEH, 20%, 18% TCCL is one of the big-4 city-gas distributors in China, 15% in terms of number of city-gas distribution 10% 15% 20% 25% 30% 35% 40% 45% 50% concessions, with 83 city-gas concessions as of 30 June Natural gas sales volume yoy growth in 2013E 2013. It was founded in 1998 as Panva Gas, and was Source: Companies, Daiwa forecasts Note: highlighted dots represent company name, 2013E natural gas sales volume growth acquired by HKCG through the asset disposal of 10 YoY, and 2013E net profit growth YoY projects from HKCG in exchange for new TCCL shares. ENN = ENN Energy (2688 HK, HKD44.05, Buy [1], BEH = Beijing Enterprises Holdings (392 HK, HKD62.45, Outperform [2], CGHL = China Gas (384 HK, HKD8.77, Outperform As of 1H13, over 60% of the company’s investments [2]), CRG=China Resources Gas (1193 HK, HKD19.82, Hold [3]) were in Liaoning, Shandong and Sichuan.  TCCL: YoY growth of gas sales, revenue, EBIT and net profit  TCCL: corporate structure 70% 60%

50% 40%

30%

20%

10%

0% 2009 2010 2011 2012 2013E Total gas sales YoY growth Subsidiaries gas sales YoY growth Revenue YoY growth EBIT YoY growth Net profit YoY growth Source: Company, Daiwa forecasts

Sichuan and Chengdu, another of TCCL’s geographical focus regions with a very low dollar segment margin (CNY0.14/m3), is likely to see stagnant gas-sales volume growth in future, in our view, as natural gas penetration for these regions is mature (at above 60%). On the other hand, high-margin regions should continue to contribute more gas-sales volume growth, and should lead TCCL’s overall dollar segment margin to rise from CNY0.14/m3 in 2008 to CNY0.28/m3 in 2013E, based on our forecasts. Source: Companies, Daiwa forecasts

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TCCL: legend services regions and new services regions 

Heilongjiang

Jilin

Liaoning

Beijing Xinjiang Gansu Inner Mongolia Tianjin Hebei New service regions Shanxi - Either injected by parent HKCG or acquired Ningxia Shandong externally after 2007 Qinghai - High dollar spread margin at >CNY0.4/m3 - High gas sales volume growth at 15-20% yoy Jiangsu Shaanxi Henan - Mostly subsidiaries with over 50% ownership Tibet Anhui Hubei

Sichuan Chongqing Zhejiang

Hunan Jiangxi Fujian Guizhou Total investments (CNYm) Yunnan TCCL Legend service regions Guangdong > 2,800 Guangxi - In operation before HKCG’s acquisition Hong Kong 2,101 – 2,800 - Low dollar spread margin at c.CNY0.14/m3 - Low gas sales volume growth at 0-5% yoy 1,501 – 2,100 - Significant gas volume contribution from 701 – 1,500 13% owned Chengdu (not consolidated) Hainan < 700

Source: Company, Daiwa forecasts

Unit margin spread to increase on higher After parent HKCG injected 16 city-gas project assets in growth from high-margin areas, while flat 2007 and 2010, located in Shandong, Liaoning and growth from low-margin areas Zhejiang provinces, and further city-gas project acquisitions outside Sichuan, the company’s unit Before the acquisition of TCCL by HKCG via an asset segment dollar margin improved from CNY0.14/m3 in injection, TCCL was focused mostly on Sichuan and 2008 to CNY0.23/m3 at the end of 2012, given the Chengdu, where ASPs and dollar margins are lower ASPs in the above regions are higher than those in than the national averages. Sichuan.

 TCCL: current ASP for city-gate tariff of major service area  TCCL: HKCG’s previous asset injections (CNY/m3) Stake 2.30 Date Projects acquired Consideration Injection from parent 2.20 Jan-07 10 city-gas projects in the Shandong and Anhui Province 27%- HKD3.2bn (Jimo, Qingdao Laoshan, Longkou, Zibo, Zibo Lubo, 100% 2.10 Weifang, Weihai, Taian, Maanshan, Anqing) Mar-10 6 city-gas projects in the Liaoning and Zhejiang Province 40%- HKD1.7bn 2.00 (Yingkou, Dalian Changxing, Dalian EDZ, Tongxiang, 100% Huzhou, Yuhang) 1.90 Source: Company

1.80 In the future, we expect the ramp-up of gas sales in 1.70 Shandong and Liaoning from the introduction of coal- Sichuan Liaoning Shandong National average to-gas plants, as well as the commissioning of further Source: NDRC LNG receiving terminals and new pipeline, to lead to a further increase in TCCL’s unit segment dollar margin of natural gas.

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 TCCL: unit segment dollar margin of gas sales  Average city-gate price for non-residential gas in 2013-15E (CNY/m3) (CNY/cm) 0.28 3.00 2.77 0.26 2.50 0.24 1.95 0.22 2.00 1.69

0.20 1.50 0.18 1.00 0.16 0.50 0.14 0.12 0.00 2008 2009 2010 2011 2012 2013E Average city-gate price, Average city-gate price, Average city-gate price, CNY/cm (before July-2013) CNY/cm (after July-2013) CNY/cm (as of July-2015E) Source: Company, Daiwa forecasts Source: NDRC, Daiwa forecasts

Risk of a margin squeeze from Easier to pass on tariff hike in Liaoning city-gate hike does not look high Liaoning Province has historically lacked a natural gas supply. In 2012, we estimate that 30% of gas in the province was supplied by expensive LNG from Kunlun In the previous section, we concluded that TCCL’s unit Energy’s (135 HK, Not rated) LNG-receiving terminal segment dollar margin should expand on higher gas in Dalian, whose wholesale cost is CNY3.5-4.0/m3 – at sales volume growth from high-gross-margin regions a premium to piped gas even after accounting for about like Liaoning and Shandong. However, given TCCL’s lack of exposure of gas sales to natural gas vehicles a further 39% city-gate tariff hike to CNY3.12/cm in 2015E. (NGVs), we are concerned as to whether TCCL would be able to pass through a potential further CNY0.88 city-gate tariff hike on base volume in 2015. Over the next three years, we expect a substantial increase in the gas supply in Liaoning from Datang’s

(991 HK, Not rated) Fuxin coal-to-gas plant (targeted to be commissioned in 2014) and the new Shaanxi- Beijing Pipeline #4 from Kunlun Energy and Beijing Enterprises Holdings (392 HK, HKD62.45, Outperform [2]) (commissioning targeted for 2015).

We expect the cost of this new piped natural gas to be passed on fully to commercial and industrial (C&I) and NGV customers, as some of them currently consume expensive LNG from the Dalian LNG terminal.

  

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 Natural gas prices in Liaoning Province

Datang Coal-to-gas pipeline (target to commission in end-2013E) City-gate gas price: CNY2.24/cm post July 2013 CNY3.12/cm post July 2015 Liaoning

Liaoning natural gas price from different sources (CNY/cm) 5.00 4.5

4.00 3.12 3.00 2.24 2.00

1.00

0.00 Non-residential city-gate Non-residential city-gate LNG tariff (before July-2013) tariff (end of July-2015E) Shaanxi-Beijing Pipelines III (since 2012) City-gate gas price: CNY2.24/cm post July 2013 CNY3.12/cm post July 2015 Kunlun Dalian LNG terminal (since 2H11) FOB LNG price: CNY4-5/cm

Source: NDRC, Daiwa research

 TCCL: geographical footprint in terms of total investments  TCCL: further city-gate hike for non-residential tariffs in 2013-15E Premium for incremental Premium for TCCL's Base Incremental volume (unit incremental geographical (CNY/m3) volume volume CNY/m3) volume (%) proportion Guangdong 2.74 3.32 0.58 21% 5% Guangxi 2.57 3.15 0.58 23% 1% Zhejiang 2.43 3.31 0.88 36% 5% Anhui 2.35 3.23 0.88 37% 8% Liaoning 2.24 3.12 0.88 39% 25% Shandong 2.24 3.12 0.88 39% 21% Jiangxi 2.22 3.10 0.88 40% 6% Hunan 2.22 3.10 0.88 40% 2% Jilin 2.02 2.90 0.88 44% 9% Heilongjiang 2.02 2.90 0.88 44% 2% Sichuan 1.93 2.79 0.86 45% 16% Chongqing 1.92 2.78 0.86 45% 1% Wtd. avg. (as of 2.06 2.89 0.83 Premium for Premium for 2011 gas sales incremental incremental volume in volume of volume of TCCL: China) China: 40% 39% Source: Company, Daiwa Source: NDRC, Company, Daiwa forecasts Note: provinces that are highlighted represent major service regions for TCCL

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 TCCL: city-gate hikes in major service provinces (CNYb/m3) Share trading liquidity has 4 80% improved since January 2013 3 60% placement 2 40% 1 20% Our research indicates that TCCL’s share trading 0 0% liquidity has improved from less than USD1m since before its placement of 150m new shares at Jilin Henan Tianjin Hunan Gansu Jiangxi Jiangsu Yunnan

Xinjiang HKD6.31/share on 16 January 2013 to about USD3-4m Sichuan Shaanxi Liaoning Shanghai Chongqing

Guangdong now. City-gate for base volume (LHS) City-gate for incremental volume (LHS)  TCCL: three-month average share trading volume Further city-gate hike for base volume in 2013-15E (RHS) (USDm) Source: NDRC, Company Daiwa 7.0

Sensitivity analysis of NAV, net profit and 6.0 ROE to industrial gas sales 5.0 We have conducted an analysis to gauge the sensitivity 4.0 of TCCL’s NAV, 2016E net profit and 2016E ROE to 3.0 different percentages of the city-gate tariff hike in 2015E that the company would not be able to pass on 2.0 to C&I gas customers. 1.0

0.0 In our model, we have already assumed that TCCL Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 would only be able to pass on 97% of the city-gate tariff Source: Bloomberg hike that we believe is likely to take place in 2015 to C&I customers. This represents our base case. Valuation  TCCL: sensitivity of NAV, net profit and ROE to different levels of C&I gas hike pass-through in 2016E We value TCCL using a DCF methodology, which % of hike unable to be NAV 2016E net 2016E 2016E C&I tariff passed on (HKD) profit (HKDm) ROE (CNY/m3) captures the stable long-term income incurred by our Base case 8.60 2,064 13.3% 4.97 gas sales volume and residential connection forecasts. -5% 8.14 2,009 13.0% 4.93 We assume a WACC of 6.8% and a terminal growth rate -10% 7.69 1,955 12.7% 4.89 of 2%. Our DCF-based valuation yields a fair value of per -15% 7.24 1,900 12.4% 4.85 share of HKD8.60, which we set as our six-month target Source: Daiwa forecasts price, and which implies a 2014E PER of 16x.  TCCL: degree of sensitivity of NAV, net profit, ROE to different levels of C&I gas hike pass-through relative to base case We initiate coverage of TCCL with an Outperform (2) NAV 2016E net profit 2016E ROE 2016E C&I tariff rating, as we forecast it to generate the highest 25% net -5.2% -2.6% -0.31pp -0.8% profit CAGR for 2012-15 of 25%, compared to its peer -10.4% -5.3% -0.63pp -1.6% -15.7% -7.9% -0.95pp -2.4% group average of 21-22%), and we see low risk of Source: Daiwa forecasts margin compression as a result of a potential city-gate Note: rows assume the respective 5%, 10% and 15% hike inability pass-through tariff hike in 2015. percentages shown in the first table

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 TCCL: DCF valuation  TCCL: geographical footprint and key operational data (1H13) (HKDm) 2013E 2014E 2015E 2016E 2017E 2018E 2019E Year 0 0 1 2 3 4 5 Net income 1,107 1,373 1,659 2,064 2,525 3,049 905 Interest x (1-tax) 94 94 93 93 92 92 91 Depreciation 335 393 451 509 567 625 684 Change in working capital 387 628 758 661 577 621 1,253 Capex (1,610) (1,610) (1,610) (1,610) (1,610) (1,610) (1,570) FCF 312 877 1,350 1,716 2,151 2,777 1,362 Discount factor (base 2014E) 1.00 1.00 0.94 0.88 0.82 0.77 0.72 PV of cash flow (base 2014E) 312 877 1,264 1,504 1,765 2,133 980 Terminal growth rate 2.0%

Sum PV cash flow (to 2019E) 8,523 PV of terminal value (from 2020) 14,932 Less net debt on balance sheet (2,338) Equity value (CNY) 21,117 NPV/Share (HKD) 8.6 Valuation assumptions China risk-free rate 3.6% Province Investment (CNYm) Proportion Market risk premium 8.9% Anhui 769 8% Beta 0.57 Chongqing 60 1% Cost of equity 8.7% Guangdong 538 5% Yr n-1 debt/capitalisation 30.0% Guangxi 100 1% Pre-tax cost of debt 3.2% Heilongjiang 148 2% After-tax cost of debt 2.4% Hunan 220 2% WACC 6.8% Jiangsu 12 0% Jiangxi 543 6% Source: Daiwa forecasts Jilin 890 9% Liaoning 2,428 25%  TCCL: DCF sensitivity to WACC and terminal growth rate (HKD) Shandong 2,039 21% WACC Sichuan 1,530 16% 6.0% 6.5% 6.8% 7.0% 7.5% Zhejiang 523 5% 3.0% 13.2 11.2 10.3 9.7 8.6 Total* 9,800 100% Terminal 2.5% 11.6 10.1 9.4 8.9 8.0 Source: Company, Daiwa growth rate 2.0% 10.5 9.2 8.6 8.2 7.4 *Note: data is for 2012 1.5% 9.6 8.5 8.0 7.7 7.0 1.0% 8.8 8.0 7.5 7.2 6.6 Source: Daiwa estimates

Risks

Potential margin compression on natural gas sales to industrial customers should the city-gas tariff hike go ahead in 2015 is a major risk to our rating, target price and forecasts for TCCL. Other risks we see are slower- than-expected gas sales-volume growth and residential gas connections, which we consider as unlikely given that upstream suppliers such as CNPC (Not listed) would probably be more motivated to supply natural gas after the city-gate tariff hike.

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Utilities / China 384 HK Utilities / China 11 November 2013

China Gas

China Gas Target (HKD): 10.00 Upside: 14.0% 384 HK 7 Nov price (HKD): 8.77

Initiation: favourable risk- adjusted reward 1 Buy 2 Outperform (initiation) • We think China Gas now offers a favorable risk-adjusted reward 3 Hold profile following corporate governance issues in 2011-12 4 Underperform • Alliance with Beijing Enterprises Group could enhance gas-sales 5 Sell growth and acquisition pace • Initiate with an Outperform; recent accumulation by substantial shareholder could boost the share price

How do we justify our view?

Ramping up to protect its ■ Risks margin. CGHL plans to ramp up its Risks to our call would include CNG gas sales by opening 200 new lower-than-expected gas-sales- CNG stations a year for both FY14 volume growth and residential-gas and FY15 (FY13: 170) to enhance its connections, and a higher-than- Dennis Ip, CFA gross margin. We believe CNG will expected margin squeeze on gas (852) 2848 4068 see a higher proportion of NGV gas sales to industrial customers. [email protected] sales, from 9% in FY13 to 14% in FY16, which should reduce the risk Gary Zhou of the unit-dollar margin squeeze on (852) 2773 8535 its commercial and industrial gas [email protected] Share price performance sales that we expect in 2015. (HKD) (%) LPG business may turn around. 10 215 ■ Investment case 8 181 CGHL plans to dispose of its mid- China Gas Holdings Limited 7 148 (CGHL), one of China’s leading city- stream LPG storage facility and 5 114 gas distributors, is now focusing on terminal, which we believe could 4 80 enhancing its gas-sales growth, increase the gross margin to 13%, Nov-12 Feb-13 May-13 Aug-13 Nov-13 project M&A and CNG-refuelling from 6% in FY13, and reduce its LPG China Gas (LHS) Relative to HSI (RHS) expansion, as well as restructuring trade-finance-related costs by its LPG business – the company was c.CNY4.8bn. We estimate that the 12-month range 4.32-9.25 hit with corporate-governance issues disposal could lower CGHL’s net Market cap (USDbn) 5.30 followed by a failed hostile takeover debt-to-equity ratio to 60% from 3m avg daily turnover (USDm) 8.38 100% in FY13. Shares outstanding (m) 4,681 bid by ENN/Sinopec in 2012. As Major shareholder Mr. Liu Minghui (22.2%) such, we initiate coverage with an ■ Catalysts Outperform (2) rating. Financial summary (HKD) Near-term catalysts should include Year to 31 Mar 14E 15E 16E Strong gas sales growth strong 1H14 results, due to be Revenue (m) 28,218 36,637 47,008 expected. CGHL has about 200 announced on 26 November, as the Operating profit (m) 3,679 4,081 4,351 Net profit (m) 2,458 2,753 3,009 city-gas projects (among its peers, it company issued a positive profit Core EPS (fully-diluted) 0.507 0.552 0.603 has the most diverse geographical alert on 28 October. EPS change (%) 37.4 9.0 9.3 footprint, covering 21 provinces) and Daiwa vs Cons. EPS (%) 14.6 4.4 (1.2) an average 41% residential ■ Valuation PER (x) 17.3 15.9 14.5 penetration rate (peers: 42-47%) for We have a DCF-based six-month Dividend yield (%) 1.3 1.5 1.7 target price of HKD10.00. Trading DPS 0.115 0.132 0.151 FY13. We forecast a 28% gas-sales- PBR (x) 3.1 2.7 2.3 volume CAGR for FY13-16, including at an FY15E PER of 16x, the EV/EBITDA (x) 10.8 9.6 8.7 the contribution from Fortune Gas, valuation is within the range of that ROE (%) 19.8 19.1 18.1 its newly acquired subsidiary. of its peers, at 14-17x. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

3  Growth outlook  CGHL: natural gas sales volume forecast (million m ) We forecast a gas-sales-volume CAGR of 30% for FY14- 16,000 35% 15, for which we include the sales-volume contribution 14,000 30% from the company’s Fortune Gas acquisition, which was 12,000 25% completed in August 2013. We believe management will 10,000 raise its FY15 natural-gas sales guidance further, from 20% 8,000 10bcm to 11bcm, based on a full-year contribution from 15% Fortune Gas. 6,000 10% 4,000 2,000 5% 0 0% FY11 FY12 FY13 FY14E FY15E FY16E Natural gas sales volume (LHS) YoY natural gas sales volume growth (RHS)

Source: Company, Daiwa forecasts

 Valuation  CGHL: one-year forward PER

We have a DCF-derived six-month target price of (x) HKD10.00. This translates into a target FY15E PER of 35

18x, which is 0.6SD above its past-five-year mean PER. 30 4 29.4x Avg+2SD This low PER was partly driven by the corporate- governance issues that came to light when the 25 21.5x Avg+1SD company’s chairman Liu Minghui was detained in 20 December 2010 on accusations of embezzling the 15 company’s assets. We believe CGHL deserves to trade at 13.7x Avg a higher valuation, given that it now has the support of 10 5.8x Avg-1SD its new substantial shareholder, Beijing Enterprises 5 Group, on future business development activities. 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Company, Daiwa forecasts

 Earnings revisions  CGHL: consensus earnings-forecast revisions

Bloomberg consensus FY14-15 EPS forecasts for CGHL (HKD) rose during the release of 1H12 results in November 0.55 2012 and the release of FY13 results in June 2013, 0.50 driven by strong results from the company’s city-gas 0.45 operation, a lower effective tax rate and financial cost 0.40 savings. 0.35 0.30 Management raised its FY14 gas-sales target from 8bcm 0.25 to 8.5bcm (not factoring in the Fortune Gas acquisition) 0.20 during the company’s FY13 results announcement. We Jul-13 Jul-12 Apr-13 Apr-12 Oct-12 Jun-13 Jun-12 Jan-13 Jan-12 Feb-13 Mar-13 Feb-12 Mar-12 Aug-13 Sep-13 Aug-12 Sep-12 Nov-12 Dec-12 May-13 think there could be further consensus upgrades after May-12 the market starts to factor in the contribution from 2014E EPS 2015E EPS Fortune Gas, which will have guaranteed profit of at Source: Bloomberg least HKD200m for 2013 and HKD400m for 2014.

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Financial summary

 Key assumptions Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Natural gas sales volume (mn m3) 2,130 3,380 4,452 5,563 6,825 8,850 11,476 14,306 Gas ASP, incl tax (CNY/m3) 2.31 2.43 2.71 2.77 2.86 3.10 3.53 3.97 Gas purchase cost, incl tax (CNY/m3) 1.46 1.55 1.84 1.86 1.96 2.16 2.51 2.89 Residential gas connection ('000 419 658 902 1,105 1,226 1,306 1,366 1,426 houesholds) Gross profit contribution - connection 53 49 55 51 52 44 39 36 fee (%)

 Profit and loss (HKDm) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales of piped gas 2,678 3,832 6,359 7,663 9,349 14,962 22,079 30,930 Gas connection income 1,127 1,462 2,346 2,804 3,301 3,565 3,771 3,970 Other Revenue 2,518 4,919 7,156 8,467 8,601 9,691 10,787 12,108 Total Revenue 6,324 10,212 15,862 18,934 21,250 28,218 36,637 47,008 Other income (264) 570 330 516 687 696 655 751 COGS (4,894) (8,096) (12,951) (15,328) (16,876) (22,393) (29,567) (38,788) SG&A (799) (1,052) (1,524) (1,672) (2,165) (2,841) (3,645) (4,620) Other op.expenses (347) (495) (648) (603) (743) (761) (857) (950) Operating profit 366 1,634 1,716 2,450 2,896 3,679 4,081 4,351 Net-interest inc./(exp.) (410) (523) (635) (916) (727) (640) (712) (712) Assoc/forex/extraord./others 249 62 16 86 340 490 623 769 Pre-tax profit 205 1,174 1,097 1,620 2,508 3,530 3,992 4,408 Tax (71) (158) (316) (479) (467) (688) (815) (939) Min. int./pref. div./others (30) (140) (155) (188) (277) (383) (425) (460) Net profit (reported) 104 876 626 954 1,765 2,458 2,753 3,009 Net profit (adjusted) 104 876 626 954 1,765 2,458 2,753 3,009 EPS (reported)(HKD) 0.031 0.262 0.163 0.218 0.394 0.541 0.588 0.643 EPS (adjusted)(HKD) 0.031 0.262 0.163 0.218 0.394 0.541 0.588 0.643 EPS (adjusted fully-diluted)(HKD) 0.029 0.198 0.146 0.205 0.369 0.507 0.552 0.603 DPS (HKD) 0.013 0.014 0.022 0.037 0.079 0.115 0.132 0.151 EBIT 366 1,634 1,716 2,450 2,896 3,679 4,081 4,351 EBITDA 713 2,129 2,364 3,053 3,638 4,440 4,938 5,300

 Cash flow (HKDm) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 205 1,174 1,097 1,620 2,508 3,530 3,992 4,408 Depreciation and amortisation 347 495 648 603 743 761 857 950 Tax paid (71) (158) (316) (479) (467) (688) (815) (939) Change in working capital 649 (30) 292 (1,215) 578 349 579 865 Other operational CF items (106) (228) 359 982 19 150 89 (57) Cash flow from operations 1,023 1,252 2,080 1,512 3,382 4,101 4,703 5,226 Capex (1,557) (1,263) (1,909) (2,116) (3,065) (3,100) (3,100) (3,100) Net (acquisitions)/disposals (2,039) (1,133) (905) 1,347 (179) (1,892) 0 0 Other investing CF items 1,613 801 (697) (355) 127 13 13 13 Cash flow from investing (1,984) (1,595) (3,511) (1,124) (3,116) (4,980) (3,087) (3,087) Change in debt 1,879 2,768 692 640 67000 Net share issues/(repurchases) 2 14 3,192 0 193000 Dividends paid (40) (47) (61) (96) (278) (379) (558) (658) Other financing CF items (387) (577) (1,249) (1,258) (850) (640) (712) (712) Cash flow from financing 1,454 2,159 2,574 (715) (867) (1,019) (1,270) (1,370) Forex effect/others 00000000 Change in cash 493 1,816 1,143 (327) (602) (1,897) 346 769 Free cash flow (534) (11) 171 (604) 316 1,001 1,603 2,126 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (HKDm) As at 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 2,896 4,361 6,729 5,528 4,949 3,051 3,397 4,166 Inventory 541 564 1,077 1,743 1,123 1,297 1,478 1,668 Accounts receivable 1,286 1,871 2,388 3,170 4,019 4,773 6,197 7,952 Other current assets 492 287 305 343 884 595 595 595 Total current assets 5,215 7,084 10,499 10,784 10,975 9,716 11,667 14,380 Fixed assets 9,132 11,064 13,800 14,424 17,358 19,745 22,034 24,229 Goodwill & intangibles 1,005 2,155 2,980 2,320 2,477 3,205 3,158 3,114 Other non-current assets 2,672 2,694 3,621 4,346 4,558 5,254 5,884 6,653 Total assets 18,025 22,998 30,899 31,874 35,368 37,919 42,743 48,376 Short-term debt 406 2,844 3,979 3,866 4,277 4,308 4,402 4,452 Accounts payable 2,603 3,182 4,503 4,737 5,544 6,821 9,006 11,814 Other current liabilities 2,872 2,860 3,819 5,539 5,303 4,774 4,681 4,630 Total current liabilities 5,881 8,886 12,302 14,142 15,123 15,903 18,088 20,897 Long-term debt 7,194 8,021 7,720 6,407 6,863 6,863 6,863 6,863 Other non-current liabilities 967 860 537 527 545 34 153 263 Total liabilities 14,043 17,767 20,559 21,075 22,531 22,799 25,104 28,022 Share capital 3334444446464646 Reserves/R.E./others 3,190 4,089 8,721 9,698 11,439 13,339 15,434 17,688 Shareholders' equity 3,223 4,123 8,765 9,742 11,485 13,385 15,480 17,734 Minority interests 759 1,107 1,575 1,057 1,352 1,735 2,160 2,620 Total equity & liabilities 18,025 22,998 30,899 31,874 35,368 37,919 42,743 48,376 EV 45,517 47,709 46,591 44,570 45,946 47,768 47,317 46,290 Net debt/(cash) 4,703 6,504 4,970 4,744 6,191 8,120 7,867 7,148 BVPS (HKD) 0.967 1.233 2.284 2.223 2.563 2.859 3.307 3.788

 Key ratios (%) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 147.8 61.5 55.3 19.4 12.2 32.8 29.8 28.3 EBITDA (YoY) 54.9 198.7 11.0 29.1 19.2 22.0 11.2 7.3 Operating profit (YoY) 39.3 346.4 5.0 42.8 18.2 27.1 10.9 6.6 Net profit (YoY) (26.5) 744.6 (28.5) 52.4 85.0 39.3 12.0 9.3 Core EPS (fully-diluted) (YoY) (26.8) 576.2 (26.3) 40.7 79.4 37.4 9.0 9.3 Gross-profit margin 22.6 20.7 18.3 19.0 20.6 20.6 19.3 17.5 EBITDA margin 11.3 20.8 14.9 16.1 17.1 15.7 13.5 11.3 Operating-profit margin 5.8 16.0 10.8 12.9 13.6 13.0 11.1 9.3 Net profit margin 1.6 8.6 3.9 5.0 8.3 8.7 7.5 6.4 ROAE 6.4 23.8 9.7 10.3 16.6 19.8 19.1 18.1 ROAA 1.2 4.3 2.3 3.0 5.2 6.7 6.8 6.6 ROCE 6.3 11.8 9.0 11.4 12.9 14.6 14.8 14.4 ROIC 5.5 13.9 9.0 11.2 13.6 14.0 13.3 12.9 Net debt to equity 145.9 157.8 56.7 48.7 53.9 60.7 50.8 40.3 Effective tax rate 34.8 13.5 28.8 29.5 18.6 19.5 20.4 21.3 Accounts receivable (days) 37.1 56.4 49.0 53.6 61.7 56.9 54.6 54.9 Current ratio (x) 0.9 0.8 0.9 0.8 0.7 0.6 0.6 0.7 Net interest cover (x) 0.9 3.1 2.7 2.7 4.0 5.8 5.7 6.1 Net dividend payout 42.4 5.3 13.8 17.0 20.1 21.3 22.4 23.6 Free cash flow yield n.a. n.a. 0.4 n.a. 0.8 2.4 3.9 5.2 Source: FactSet, Daiwa forecasts

 Company profile China Gas is one of the leading city-gas distributors in China, owning c.200 projects (as of August 2013) with geographical focus on Heilongjiang, Shandong and Inner Mongolia. It also owns LPG wholesales and distribution business. .

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Fortune Gas acquisition should be value-accretive

In August 2013, CGHL completed its HKD3.1bn Initiation: Favourable (100%) acquisition of Fortune Gas, owned by UK-listed Fortune Oil, one of China Gas’ substantial risk-adjusted reward shareholders. Fortune Gas has various natural gas assets in China, including 28 city-gas projects, covering a combined 2.1m households, as well as coal-bed Initiate coverage with an Outperform. methane (CBM) exploration projects, and liquefied natural gas (LNG) refuelling businesses for vehicles and vessels. Company background The acquisition was financed with 50% cash and 50% CGHL is one of China’s Big-4 city-gas distributors in new issued shares, capped at 250m. The new share terms of the number of city-gas distribution issuance would be set with reference to CGHL’s average concessions. It has 20.2m ‘connectable’ households share price for 30 consecutive trading days, between 1 under its about 200 city-gas concessions (as at 31 November 2013 and 31 December 2013. We estimate October 2013). About 40% of CGHL’s connectable that CGHL would need to issue about 200m new households are located in Heilongjiang, Shandong, shares, based on the recent share price of about HKD8, Inner Mongolia and Guangxi. and have factored this into our model. The share issuance would include an interest component of 6% per year, accruing from the date of completion until the Focusing on business growth date the new shares are issued.

The company was in the headlines for its corporate We believe the acquisition will be EPS-accretive despite governance because of the detention of the company’s the 4% equity dilution, and expect EPS enhancement of chairman Liu Minghui in December 2010 on 4.4% for FY14 and 9.4% for FY15, based on guaranteed accusations of embezzling the company’s assets. This profit of HKD200m for FY14 and HKD400m for FY15. was followed by a failed hostile takeover bid by ENN/Sinopec in 2012. Since then, CGHL has been focussing on developing its business to increase its Expanding CNG gas sales to overall gross profit margin: increasing residential protect the gross margin penetration of its existing city-gas projects from 37.4% in FY12 to 41.0% in FY13; acquiring city-gas projects CGHL has an ambitious plan to expand its CNG-station (24 city-gas projects in FY13E, plus 11 projects from coverage from 170 stations currently to 570 stations Fortune Gas and 2 projects from SK Group also in within the next two years. The company wants to do FY13); and streamlining its LPG business. this to ramp up its CNG-gas sales, as management expects rising demand from private vehicles. We Superior growth; attractive valuation believe the company’s move to expand its gas sales to Even though we forecast a superior (compared with vehicles could protect the gross margin. peers) natural-gas-sales-volume CAGR of 28% for FY13-16, the stock is trading at an FY15E PER of 16x, The price of industrial natural gas could be at a which is within the range for its sector peers, at 14-17x, premium to competing fuels, such as LPG and heating based on our forecasts. oil, which could cause demand destruction should the city-gas operators decide to fully pass on the CNY0.88/m³ upstream hike on base gas volume stipulated by National Development and Reform Commission (NDRC) in June 2013. We forecast CGHL to increase its gas-sales volume contribution from CNG by 5pp to 14% for FY16 over the expected FY13 level.

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 Natural gas premium/discount to price of competing NGV and Management believes the disposals could increase the industrial gas in 2015E gross margin of its LPG business to 13%, from 6% currently, and reduce its LPG-trade-related finance costs 50% 40% by CNY4.8bn, which could lead to a lower net debt-to- 30% equity ratio, from 100% currently to 60%. 20% 10% As at the end of March 2012 (FY12 results), the LPG 0% business accounted for 15% of total assets, 17% of total (10%) consolidated net assets, and 4% of annual capex (20%) (measured by counting the number of new properties, (30%) plants and equipment).

Anhui Hebei Hubei Hunan Gansu Tianjin Beijing Jiangsu Sichuan  CGHL: gross margin for LPG business Shanghai Shandong Chongqing Shengyang Guangzhou Heilongjiang 12% NG discount for industrial usage NG discount for vehicular usage Source: Provincial NDRCs, Daiwa 9%

 CGHL: NGV sales volume growth and contribution to total 6% sales 3% 16% 80%

14% 70% 0% 12% 60% 10% 50% (3%) 8% 40% FY09 FY10 FY11 FY12 FY13 6% 30% FY14E FY15E FY16E FY17E FY18E FY19E FY20E LPG - GPM LPG - EBIT margin LPG - NPM 4% 20% 2% 10% Source: Company, Daiwa forecasts 0% 0% FY10 FY11 FY12 FY13 FY14E FY15E FY16E  CGHL: net debt-to-equity with and without LPG-trade-finance- related facilities Gas sales volume proportion from vehicular CNG (LHS) 250% Vehicular CNG sales volume growth (RHS) Source: Company, Daiwa forecast 200%

150% Refocusing on downstream LPG 100% distribution to aid profitability 50%

CGHL entered the LPG industry by acquiring an 0% integrated LPG business from Zhongyou (not listed) in FY09 FY10 FY11 FY12 FY13 FY14E 2008. However, the upstream and midstream Net-debt-to-equity gearing segments of this LPG business have not performed well Net-debt-to-equity gearing ex-LPG trade finance related facilities in terms of profitability, which has dragged down the Source: Company, Daiwa forecasts gross margin of the segment since 2008 (9pp YoY decline in gross margin in FY09). Cooperating with Sinopec and In August 2013, CGHL exercised an option to acquire Beijing Enterprises the remaining 51% stake in Panva Gas (not listed), one of the country’s biggest LPG distributors with 450 retail CGHL has entered into cooperation agreements with stores and 120 franchise outlets in Jiangsu, Hubei and its strategic shareholders, Sinopec (c.4%) and Beijing Zhejiang. CGHL is now focusing on its LPG-downstream Enterprises Group (BEG, c.21%), in 2013. But as BEG distribution business and might dispose of its eight LPG- is now one of CGHL’s two leading shareholders, we receiving terminals and storage facilities. believe the scale of any proposed joint ventures between Sinopec and CGHL for its LPG and NGV refuelling projects could be limited.

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 CGHL: substantial shareholders after CGHL shares are issued  CGHL: BEH’s share accumulation of CGHL on the open to Fortune Oil market since May 2012 Name of shareholders Options included Ex-options (in millions) (HKD) Liu Ming Hui + Daniel Chiu + Fortune 1,200 10 Oil PLC L 1,116,921,524 20.53% 1,116,921,524 22.15% Beijing Enterprises Group L 1,054,088,132 19.38% 1,054,088,132 20.90% 1,000 9 SK Holdings L 687,603,000 12.64% 687,603,000 13.64% 8 800 Deutsche Bank Aktiengesellschaft L 353,850,204 6.50% 353,850,204 7.02% 7 Strait Finance L 211,282,221 3.88% 211,282,221 4.19% 600 6 Sinopec L 210,000,000 3.86% 210,000,000 4.16% 400 Gail (India) Limited L 210,000,000 3.86% 210,000,000 4.16% 5 Total no. of shares of substantial 200 4 shareholders L 3,843,745,081 70.65% 3,843,745,081 70.65% 0 3 Total no. of shares 5,440,229,098 5,042,535,098 Jul-13 Source: Company, Bloomberg, HKEx, Daiwa’s estimates Jul-12 Apr-13 Oct-12 Jan-13 Jun-13 Jun-12 Mar-13 Feb-13 Aug-13 Sep-13 Aug-12 Sep-12 Nov-12 Dec-12 May-13 May-12 Amount Held (LHS) Share price (RHS) BEH’s partnership with BEG seems more Source: Bloomberg, Daiwa promising after BEH’s CEO named chairman of CGHL’s board in August 2013 We think the cooperation with BEG is promising, Valuation looks attractive especially as the board appointed the CEO of Beijing Enterprises Holdings (BEH, Not rated), BEG’s listed The stock is trading at an 16x FY15E PER, which is vehicle, as chairman of CGHL’s board. According to the within the current range for its peers of 14-17x. We agreement, BEH and CGHL will co-develop CNG- value CGHL using a DCF valuation methodology, with refuelling and distributed-energy projects in CGHL’s a WACC of 8.1% and a terminal growth rate of 2%. concession area. The parties might also jointly bid for large city-gas projects. Given that BEH has few city-gas  CGHL: DCF valuation HKDm FY14E FY15E FY16E FY17E FY18E FY19E FY20E projects outside the Beijing area, we do not rule out the Year - 1 2 3 4 5 6 possibility of CGHL acquiring projects with cash or Net income 2,458 2,753 3,009 3,641 4,526 5,574 3,495 through the issuance of new shares. CGHL could Interest x (1-tax) 646 646 515 566 560 554 547 become BEH’s investment vehicle for city-gas projects Depreciation 603 603 761 857 950 1,038 1,059 Change in working capital (1,215) 578 (1,215) 578 349 579 865 outside Beijing. CAPEX (4,992) (3,100) (3,100) (1,550) (1,550) (1,550) (1,550) FCF (908) 1,656 2,283 4,468 5,416 6,684 5,650  BEH: city-gas exposure outside Beijing Discount Factor (base 2014) 1.00 0.93 1.00 0.93 1.00 0.93 0.86 PV Cash flow (base 2014) (908) 1,532 (908) 1,532 (908) 1,532 1,955 Terminal growth rate 2.0%

Sum PV Cash Flow (to 2020) 18,169 PV of terminal value (from 2021) 37,395 Add Cash on balance sheet 2,401 Less total borrowing (11,171) Equity value 46,795 NPV/Share (HKD) 10.00 Valuation assumption China risk-free rate 2.5% Market risk premium 12.0% Beta 0.64 Source: Company Cost of equity 10.2% Yr n-1 debt/capitalisation 35.0% Pre-tax cost of debt 5.6% After tax cost of debt 4.2% WACC 8.1% Accumulation by strategic Source: Daiwa forecasts shareholders should limit  CGHL: DCF sensitivity to changes in WACC and terminal downside growth rate WACC 7.0% 7.5% 8.1% 8.5% 9.0% Following the completion of the Fortune Gas 3.0% 15.97 13.69 11.66 10.44 9.24 acquisition, BEH’s 22% share of CGHL could be diluted Terminal 2.5% 14.38 12.48 10.76 9.69 8.64 to about 21% and it could lose its leading stake in growth rate 2.0% 13.10 11.49 10.00 9.06 8.12 CGHL to Liu Ming Hui & Fortune Oil. Therefore, we 1.5% 12.06 10.67 9.35 8.52 7.68 1.0% 11.19 9.97 8.80 8.05 7.29 believe BEH is likely to accumulate CGHL shares on Source: Daiwa forecasts the open market in the near future, which would enable it to retain its leading ownership position in CGHL. - 77 - China Gas Sector 11 November 2013

 Average city-gate price for non-residential gas in 2013-15E [ Risks (CNY/m3) 3.00 2.77 Risks to our call would include lower-than-expected 2.50 gas-sales-volume growth and residential-gas 1.95 connections, and a higher-than-expected margin 2.00 1.69 squeeze on gas sales to industrial customers. We think 1.50 a slowdown in gas-sales-volume growth is unlikely given the PRC Government’s policy to promote natural 1.00 gas usage for mitigating air pollution. If a margin 0.50 squeeze on industrial gas sales were to occur, we think 0.00 this could be offset by NGV gas sales, which we have Average city-gate price, Average city-gate price, Average city-gate price, expanded upon in previous sections. CNY/m³ (before July-2013) CNY/m³ (after July-2013) CNY/m³ (as of July-2015E) Source: NDRC, Daiwa

Impact of city-gate tariff hike Impact on CGHL would be in line with national average, in our view On 28 June 2013, the NDRC increased the price of city- We believe that any further city-gate tariff hikes by 3 gate non-residential natural gas by 15%, to CNY1.95/m CGHL will be in line with the national average. Based 3 from CNY1.69/m , effective 10 July 2013. CGHL’s on NDRC data, we forecast a city-gate tariff for CGHL share price declined by 15% in July 2013, due to market to increase by an average of CNY0.85/m3 (national: concerns about the impact of the tariff hikes and CNY0.88/m3). This is because CGHL has wide whether they could be passed on. geographical exposure, with an operating footprint in the provinces that should see a higher degree of the This is part of a bigger plan that would allow a city-gate gas price hike, such as Heilongjiang and Inner substantial one-off price rise and under which China Mongolia, and at the other extreme, those provinces will adopt a ladder-like pricing mechanism for that should see a lower degree, such as Guangxi and incremental natural gas (over the 2012 level), which Henan (according to NDRC data). the NDRC expects to account for 9% of the total piped gas supply for 2013. The plan also provides a grace  CGHL: rise in city-gate non-residential tariffs in 2013-15E period, until 2015, for the price of the 2012 base Premium for Proportion of volume (91% of piped-gas supply for 2013) to be linked incremental Premium for CGHL’s Base Incremental volume incremental connectable to competing fuels, such as heating oil and LPG, with a (CNY/m3) volume volume (CNY/m3) volume (%) population 15% discount. Guangdong 2.74 3.32 0.58 21% 1% Guangxi 2.57 3.15 0.58 23% 9% Average national hike of CNY0.88 per m3 Zhejiang 2.43 3.31 0.88 36% 1% Jiangsu 2.42 3.30 0.88 36% 6% for non-residential gas (base volume) Anhui 2.35 3.23 0.88 37% 8% nationwide for 2013-15 Henan 2.27 3.15 0.88 39% 8% Hebei 2.24 3.12 0.88 39% 2% Under the city-gate tariff-hike schedule, we expect a 42% Liaoning 2.24 3.12 0.88 39% 6% price increase nationwide for city gas, from Shandong 2.24 3.12 0.88 39% 11% CNY1.95/m3 post-July 2013 to CNY2.77/m3 by 2015. Hubei 2.22 3.10 0.88 40% 6% Thus, the total tariff hike for city-gate non-residential Hunan 2.22 3.10 0.88 40% 1% 3 Heilongjiang 2.02 2.90 0.88 44% 18% customers should be CNY1.08/m , higher than the Chongqing 1.92 2.78 0.86 45% 1% 3) level in June 2013 (CNY1.69/m . Inner Mongolia 1.60 2.48 0.88 55% 10% Shaanxi 1.60 2.48 0.88 55% 4% Weight average Premium for Premium for (as of 2011 gas incremental incremental 2.06 2.89 0.83 sales volume in volume of volume of CGHL: China) China: 40% 38% Source: NDRC, Company, Daiwa Note: provinces that are highlighted represent key service regions for CGHL

- 78 - China Gas Sector 11 November 2013

 CGHL: city-gate hikes in major service provinces 2013-15E Assuming the company is able to pass on the full city- (CNYb/m3) gate price hike of CNY0.85/m3 in 2015, we estimate 4 80% that its NGV gas would still be priced at about a 28% 3 60% discount (currently about 39%) to competing fuels –

2 40% gasoline and diesel. Therefore, we believe demand for gas for NGVs will be strong – we think CGHL will focus 1 20% on CNG sales in 2014-15, raising the proportion of this 0 0% gas as a percentage of total gas-volume sales from 9% g in j hai Jilin g

don for FY13 to 14% for FY16E. We believe this should g Hunan Henan Gansu Tian Jiangxi Yunnan Jiangsu Xinjiang Sichuan Shaanxi Liaoning Shan enable CGHL to mitigate any risks to its gross margin. Chongqing Guan City-gate for base volume (LHS) City-gate for incremental volume (LHS) We forecast the gross margin on CGHL’s gas sales to Further city-gate hike for base volume in 2013-15E (RHS) decline from 17.7% for FY13 to 14.5% for FY16. Source: NDRC, Company, Daiwa Impact of city-gate tariff hike CGHL could experience a margin squeeze in FY16 as the city-gas operators might not be able to fully pass on We assess the sensitivity of CGHL’s NAV, 2016E net the city-gate hike that becomes phased in by 2015. profit, and 2016E ROE to different pass-through levels Fully passing on the average CNY0.85/m3 city-gate for C&I gas sales at the end of 2015. hike on base gas volume could make natural gas more expensive than competing fuels for industrial users, In our model, we assume that China Gas would only be leading to potential demand destruction. We assume able to pass on 95% of the city-gate hike to its CGHL would only be able to pass through 95% of the commercial-gas and industrial-gas customers, which 2015 hike to its commercial-gas and industrial-gas would result in a margin squeeze of CNY0.01/m3. As customers (CNY0.43/m3). such, our FY16 EPS forecasts are 0.4% lower than those of the Bloomberg consensus, even though we have  Natural gas price discount /premium to competing fuels for accounted for the anticipated EPS contribution from NGV and industrial gas in 2015 Fortune Gas. 50% 40% Our analysis suggests that every 5% of the city-gas 30% 20% price hike that CRG is not able to pass through to its 10% customers would result in a 4.5% drop in FY16 NAV 0% and a 2.9% drop in net profit. (10%) (20%) (30%)

Anhui Hebei Hubei Hunan Tianjin Gansu Beijing Jiangsu Sichuan Shanghai Shandong Chongqing Shengyang Guangzhou Heilongjiang NG discount for industrial usage NG discount for vehicular usage Remarks: Natural gas would be more expensive in Guangdong, Hubei, Shandong, Shenyang and Heilongjiang if city-gas operators fully pass-through the city-gate hike in 2015 Source: Provincial NDRCs, Daiwa forecasts

 CGHL: sensitivity of NAV, net profit and ROE to different levels of industrial gas hike pass-through (FY16E) NAV FY16E net profit FY16E industrial gas tariff Changes in % of hike not able to be passed through (HKD) (CNY m) FY16E ROE (CNY/m³) NAV FY16E earnings FY16E ROE FY16E industrial gas tariff Base case 10.00 3,009 18.1% 3.47 -5% 9.54 2,922 17.6% 3.45 -4.5% -2.9% -.49ppt -0.6% -10% 9.09 2,835 17.1% 3.43 -9.0% -5.8% -.98ppt -1.2% -15% 8.64 2,748 16.6% 3.41 -13.6% -8.7% -1.47ppt -1.8% Source: Daiwa forecasts

- 79 - China Gas Sector 11 November 2013

Appendix 1: CGHL’s geographical footprint and key operating data (FY13)

Province Connectable domestic Accumulated connected Proportion of Residential penetration Accumulated connected Accumulated connected households domestic households the population industrial customers commercial customers Heilongjiang 2,390,907 1,492,250 18% 62% 86 8,742 Shandong 1,316,111 917,770 11% 70% 25 4,827 Inner Mongolia 1,236,725 825,337 10% 67% 282 8,054 Guangxi 2,346,028 763,264 9% 33% 29 2,239 Henan 1,231,000 686,916 8% 56% 437 2,303 Anhui 1,503,063 665,571 8% 44% 213 1,964 Hubei 1,249,125 535,408 6% 43% 245 2,941 Jiangsu 1,068,500 535,030 6% 50% 91 1,519 Liaoning 1,646,937 455,473 6% 28% 61 6,907 Fujian 1,390,625 398,077 5% 29% 161 681 Shaanxi 530,333 334,648 4% 63% 96 1,038 Hebei 780,125 201,424 2% 26% 169 440 Zhejiang 465,875 116,045 1% 25% 22 382 Chongqing 878,750 120,580 1% 14% 110 340 Guangdong 243,611 106,570 1% 44% 26 6,123 Hunan 1,465,938 86,210 1% 6% 30 176 Ningxia 250,000 22,778 0% 9% 5 161 Jiangxi 118,126 13,483 0% 11% 2 41 Gansu 116,252 - 0% 0% - - Total 20,228,031 8,276,834 41% 2,090 48,878 Source: Company

- 80 -

Utilities / China 956 HK Utilities / China 11 November 2013

China Suntien Green Energy

China Suntien Green Energy Target (HKD): 3.20 Upside: 13.5% 956 HK 7 Nov price (HKD): 2.82

Initiation: clean-energy appeal in Hebei 1 Buy 2 Outperform (initiation) • Well-placed to benefit from Hebei Province’s increasing 3 Hold consumption of natural gas 4 Underperform • 2014-15 wind-power earnings should improve, driven by 5 Sell capacity growth and a wind-power low curtailment rate • Initiating with an Outperform; CSG’s 12.3x 2014E PER looks attractive vs. 12-17x for domestic gas and wind-power peers

How do we justify our view?

pipelines and the Caofeidian LNG- ■ Risks receiving terminal. Key risks would be greater-than- expected margin pressure on CSG’s Wind-power activities gas sales to industrial customers, performing well. Their utilisation and slower-than-expected expansion Dennis Ip, CFA rate improved further to 4% in 1H13, in its wind-power capacity. (852) 2848 4068 and the business has a low [email protected] curtailment rate (forced shutdown of a wind farm due to insufficient grid- Gary Zhou transmission capacity) of about 7% (852) 2773 8535 (peers: 13.5-18.9%). [email protected] Share price performance

We forecast about a 17% net profit (HKD) (%) CAGR over 2012-15, underpinned by 3.0 195 ■ Investment case 2.6 166 Hebei Province’s target to cut its China Suntien Green Energy (CSG) 2.2 138 distributes natural gas solely within coal consumption. 1.8 109 Hebei Province. It thus stands to 1.4 80 benefit from government policies to ■ Catalysts Nov-12 Feb-13 May-13 Aug-13 Nov-13 reduce air pollution through the use Near-term share-price catalysts Ch Suntien (LHS) Relative to HSI (RHS) of more clean energies, while the include additional gas supplies being operating efficiency of its wind- diverted to Hebei from Beijing and 12-month range 1.48-2.97 power business is improving. We Tianjin (if the latter two regions have a Market cap (USDbn) 1.35 initiate coverage with an warm winter), and a decline in CSG’s 3m avg daily turnover (USDm) 2.85 wind-farm curtailment rate. Shares outstanding (m) 3,715 Outperform (2) rating. Major shareholder ebei Construction & Investment (57.9%)

■ Valuation Ramp-up of clean energies in Financial summary (CNY) Hebei should lift demand for We set a SOTP-derived six-month Year to 31 Dec 13E 14E 15E CSG’s gas. Hebei’s government target price of HKD3.20. This Revenue (m) 4,687 6,042 7,857 targets a 14% cut in the province’s implies a 2014E PER of 14x, in line Operating profit (m) 1,384 1,600 1,902 with the current trading PERs of its Net profit (m) 595 669 883 coal consumption from 300m Core EPS (fully-diluted) 0.184 0.180 0.238 tonnes in 2012 to 260m tonnes by domestic wind-power peers but at a EPS change (%) 8.3 (2.0) 32.0 2017, to reduce air pollution. As c.10% discount to its gas peers. We Daiwa vs Cons. EPS (%) 5.6 (9.9) (3.4) such, we expect major power-plant expect the share-price overhang to PER (x) 12.1 12.3 9.3 fuel-conversion projects from coal to be resolved after CSG’s planned Dividend yield (%) 1.1 1.1 1.6 placement of 477m new shares in DPS 0.023 0.025 0.035 gas and centralised urban heating PBR (x) 1.3 1.1 1.0 over the next four years, with gas 1Q14, and see further placements as EV/EBITDA (x) 9.2 8.3 7.6 demand likely to be met by new unlikely given that CSG’s parent ROE (%) 10.2 10.1 11.7 aims to maintain a controlling stake. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 CSG: total gas sales and consolidated wind-power year-end  Growth outlook capacity

We forecast CSG’s total gas sales to increase by 16% and 3,000 Gas: 16% 2012-15E CAGR 150% consolidated wind-power year-end capacity to increase Wind: 20% 2012-15E CAGR by 20% over 2012-15, given that the Hebei Government targets to cut total coal production by 40m tonnes (2012 2,000 100% total coal consumption: 300m tonnes) as one of the measures to meet national guidelines for a 25% 1,000 50% reduction in the PM2.5 air pollutant in Hebei Province by 2017. 0 0% 2009 2010 2011 2012 2013E 2014E 2015E Total gas sales (mcm) - LHS Total consolidated wind power year-end capacity (MW) - LHS YoY Total gas sales volume growth - RHS YoY consolidated wind power year-end capacity growth - RHS"

Source: Company, Daiwa forecasts

 Valuation  CSG and peers: PER comparison (2014E)

The stock is trading currently at 2014E PER of 12.3x (x ) (factoring in the share placement being finalised in 18 15.7x 1Q14), representing around the average multiple of its 16 13.5x wind IPPs peers and a c.10% discount to the average 14 12.3x multiple of its gas-distributor peers (based on our and 12 the Bloomberg 2014E EPS forecasts). 10 8 We believe a rerating of the stock is possible in the near 6 future, especially as risks of power curtailment are lower 4 for CSG, as it has good grid connectivity, and because 2 we see rising demand for natural gas for coal-to-gas fuel 0 conversion projects in Hebei to cut coal consumption CSG Wind IPP average Gas distributors average and mitigate air pollution. Source: Bloomberg, Daiwa forecasts

 Earnings revisions  CSG: Bloomberg-consensus EPS forecasts Bloomberg-consensus 2013-14 EPS forecasts for CSG (HKD) have not changed year-to-date. There were significant 0.35 cuts (35%) to consensus 2013-14 EPS forecasts in 2012 0.30 due to the company’s lower-than-expected wind-power capacity addition in 2011-12. 0.25 0.20

0.15

0.10 Jul-13 Jul-12 Apr-13 Apr-12 Oct-12 Jun-13 Jan-13 Jan-12 Jun-12 Feb-13 Mar-13 Feb-12 Mar-12 Aug-13 Sep-13 Aug-12 Sep-12 Nov-12 Dec-12 May-13 May-12 2013E EPS 2014E EPS Source: Bloomberg

- 82 - China Gas Sector 11 November 2013

Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas sales volume (mn m3) 563 730 935 1,213 1,246 1,433 1,662 1,945 Wholesales gas proportion (%) 67 67 68 61 56 51 46 41 Gas ASP, excl tax (CNY/m3) 1.61 1.63 1.79 1.93 1.97 2.16 2.54 2.91 Gas cost, excl tax (CNY/m3) 1.26 1.30 1.47 1.61 1.57 1.74 2.10 2.45 Consolidated installed wind power 234 497 855 1,201 1,346 1,596 1,921 2,321 capacity (MW)

 Profit and loss (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas 932 1,252 1,726 2,405 2,569 3,219 4,351 5,804 Wind power 87 265 516 765 1,133 1,467 1,691 2,053 Other Revenue 00000000 Total Revenue 1,018 1,517 2,242 3,170 3,702 4,687 6,042 7,857 Other income 19 51 84 135 78 37 38 39 COGS (768) (1,091) (1,581) (2,257) (2,464) (2,990) (4,049) (5,459) SG&A (55) (70) (101) (153) (195) (296) (375) (480) Other op.expenses (73) (151) (274) (392) (522) (555) (656) (777) Operating profit 213 408 607 873 1,067 1,384 1,600 1,902 Net-interest inc./(exp.) (52) (104) (168) (245) (354) (397) (490) (526) Assoc/forex/extraord./others 0 2 50 73 90 40 36 76 Pre-tax profit 161 306 489 701 803 1,026 1,146 1,452 Tax (10) (19) (58) (82) (7) (174) (206) (274) Min. int./pref. div./others (64) (121) (152) (170) (246) (256) (271) (294) Net profit (reported) 87 166 279 449 550 595 669 883 Net profit (adjusted) 87 166 279 449 550 595 669 883 EPS (reported)(CNY) 0.043 0.083 0.124 0.139 0.170 0.184 0.180 0.238 EPS (adjusted)(CNY) 0.043 0.083 0.124 0.139 0.170 0.184 0.180 0.238 EPS (adjusted fully-diluted)(CNY) 0.043 0.083 0.124 0.139 0.170 0.184 0.180 0.238 DPS (CNY) 0.000 0.085 0.045 0.058 0.020 0.023 0.025 0.035 EBIT 213 408 607 873 1,067 1,384 1,600 1,902 EBITDA 284 559 844 1,243 1,535 1,885 2,202 2,625

 Cash flow (CNYm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 161 306 489 701 803 1,026 1,146 1,452 Depreciation and amortisation 70 151 237 370 468 501 602 723 Tax paid (10) (19) (58) (82) (7) (174) (206) (274) Change in working capital (0) 482 153 (331) (618) 4 58 159 Other operational CF items 90 (418) (167) 209 584 357 454 450 Cash flow from operations 311 502 654 866 1,230 1,715 2,054 2,510 Capex (1,779) (1,258) (1,918) (3,172) (1,413) (2,614) (3,148) (3,116) Net (acquisitions)/disposals (1) (2) (1) (2) (1) 0 0 0 Other investing CF items (88) (92) (1,542) (703) 86 47 47 47 Cash flow from investing (1,868) (1,353) (3,461) (3,877) (1,329) (2,567) (3,101) (3,069) Change in debt 1,312 819 2,002 1,645 694 1,774 684 1,323 Net share issues/(repurchases) 0000001,0220 Dividends paid 0 0 (245) (146) (272) (138) (168) (237) Other financing CF items 376 149 3,226 (232) (427) (397) (490) (526) Cash flow from financing 1,688 968 4,982 1,267 (5) 1,238 1,047 560 Forex effect/others 00000000 Change in cash 131 117 2,176 (1,743) (104) 386 0 0 Free cash flow (1,468) (757) (1,263) (2,306) (183) (899) (1,094) (606) Source: FactSet, Daiwa forecasts

- 83 - China Gas Sector 11 November 2013

Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 213 345 2,475 920 758 1,000 1,000 1,000 Inventory 1922252530516588 Accounts receivable 42 85 189 396 843 771 898 1,049 Other current assets 186 91 222 622 601 784 500 849 Total current assets 460 542 2,911 1,962 2,231 2,605 2,463 2,986 Fixed assets 3,232 4,358 6,079 7,713 8,602 10,822 13,471 15,961 Goodwill & intangibles 1 3 1,423 2,458 2,357 2,357 2,254 2,156 Other non-current assets 352 881 1,298 1,925 2,072 2,116 2,148 2,220 Total assets 4,046 5,783 11,712 14,059 15,263 17,901 20,336 23,324 Short-term debt 377 879 1,443 636 971 971 971 971 Accounts payable 36 440 326 125 197 102 131 178 Other current liabilities 375 410 927 1,062 928 982 1,259 1,666 Total current liabilities 789 1,728 2,696 1,824 2,096 2,055 2,362 2,815 Long-term debt 1,829 2,146 3,576 6,114 6,529 8,303 8,986 10,310 Other non-current liabilities 57 32 1 26 15 133 237 363 Total liabilities 2,674 3,906 6,274 7,964 8,640 10,491 11,585 13,488 Share capital 0 0 3,238 3,238 3,238 3,238 3,715 3,715 Reserves/R.E./others 975 1,344 1,572 1,967 2,329 2,860 3,453 4,244 Shareholders' equity 975 1,344 4,811 5,206 5,568 6,098 7,168 7,959 Minority interests 396 534 628 889 1,055 1,312 1,583 1,877 Total equity & liabilities 4,046 5,783 11,712 14,059 15,263 17,901 20,336 23,324 EV 10,526 11,223 11,056 14,569 15,617 17,365 18,284 19,826 Net debt/(cash) 1,993 2,680 2,544 5,831 6,742 8,274 8,958 10,281 BVPS (CNY) 0.489 0.673 2.133 1.608 1.719 1.641 1.929 2.142

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) 62.0 48.9 47.8 41.4 16.8 26.6 28.9 30.0 EBITDA (YoY) 116.3 97.1 50.9 47.3 23.5 22.8 16.8 19.2 Operating profit (YoY) 175.6 91.2 48.9 43.8 22.2 29.7 15.7 18.8 Net profit (YoY) 241.7 91.8 68.2 60.8 22.5 8.3 12.4 32.0 Core EPS (fully-diluted) (YoY) 241.7 91.7 48.8 12.0 22.5 8.3 (2.0) 32.0 Gross-profit margin 24.6 28.1 29.5 28.8 33.5 36.2 33.0 30.5 EBITDA margin 27.9 36.9 37.6 39.2 41.5 40.2 36.4 33.4 Operating-profit margin 20.9 26.9 27.1 27.5 28.8 29.5 26.5 24.2 Net profit margin 8.5 10.9 12.5 14.2 14.8 12.7 11.1 11.2 ROAE 11.4 14.3 9.1 9.0 10.2 10.2 10.1 11.7 ROAA 2.9 3.4 3.2 3.5 3.7 3.6 3.5 4.0 ROCE 8.2 9.6 7.9 7.5 7.9 9.0 9.0 9.6 ROIC 8.1 9.7 8.5 7.7 8.4 7.9 7.9 8.2 Net debt to equity 204.4 199.4 52.9 112.0 121.1 135.7 125.0 129.2 Effective tax rate 6.2 6.1 11.9 11.7 0.9 17.0 18.0 18.9 Accounts receivable (days) 12.5 15.3 22.3 33.7 61.1 62.8 50.4 45.2 Current ratio (x) 0.6 0.3 1.1 1.1 1.1 1.3 1.0 1.1 Net interest cover (x) 4.1 3.9 3.6 3.6 3.0 3.5 3.3 3.6 Net dividend payout 0.0 101.8 36.1 41.8 11.8 12.8 13.8 14.8 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile China Suntien Green Energy is a clean-energy enterprise controlled by the Hebei Construction & Investment Group Co. Its main business include the investment, construction and operation of wind farms, transmission and distribution of natural gas and CNG.

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A play on cutting air pollution in Hebei, China’s most polluted province

Initiation: clean-energy In the near term, we believe CSG is on the right track in terms of it targeting to raise it total gas-sales volume in appeal in Hebei Hebei, the most air-polluted province in China. Hebei targets to cut its coal consumption by 14%, from 300m tonnes to 260m tonnes by 2017, partly by replacing its Initiate with an Outperform rating. coal-fired power plants and boilers with gas-fired ones in order to provide centralised urban heating. In addition, we believe there will be significant Company background development in the adoption of natural gas vehicles in Hebei, according to the government’s clean-energy CSG is a clean-energy enterprise controlled by the policies. provincially owned Hebei Construction & Investment Group Co (HECIC, not listed). Its main businesses are  CSG: natural-gas sales volume forecasts the investment, construction and operation of wind (m m3) Gas: 16% 2012-15E CAGR farms, and the transmission and distribution of natural 2,500 35% gas and CNG. The company owns long-distance gas- 30% 2,000 transmission pipelines with a total length of around 25% 550km and 19 city-gas concessions in Hebei Province. 1,500 20% As at the end of 1H13, CSG had 1.35GW of consolidated wind-power capacity mainly in Hebei Province (93% of 1,000 15% 10% total capacity in the province). 500 5%  CSG: organisational chart 0 0% 2009 2010 2011 2012 2013E 2014E 2015E Hebei Provincial SASAC Total gas sales (LHS) YoY Total gas sales volume growth (RHS)

100% Source: Company, Daiwa forecasts Hebei Construction & Investment Group Co., Ltd. Public (H shares) (HECIC) In 2014, we believe the commissioning of CSG’s coal- 50.5% 49.5% bed methane (CBM) pipeline, as well as PetroChina China Suntien Green LNG-receiving terminal in Caofeidian, Tianjin, will Energy Corporation Ltd. help mitigate the ongoing gas-shortage situation in Hebei.

Wind Power Business Natural Gas Business The ROE for CSG’s wind-power business improved 100% 55% from 3.6% in 2009 to 7.7% for 1H13 (peers ROE: 2.7- 9.2% for 1H13) due to: 1) its new wind-power plants in 45% Hong Kong & HECIC New-energy Hebei Natural Gas China Gas (3 HK) Hebei over 2009-1H13 with guaranteed grid

Source: Company connectivity, and 2) a low curtailment rate of about 7% (national rate is: 3-22%). CSG operates in a province that is rich in both wind resources and power demand.

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expanding its city-gas operation within Hebei – it has Natural gas – widespread use to managed to expand its city-gas operation threefold, replace coal for power/heating from 5 city-gas projects in 2010 to 18 in 2012.

Of the 40m-tonne cut in coal consumption being  China: air pollution index targeted by the Hebei Government, we expect the majority to come from the aggressive national plan to switch from coal to gas for power and heating by 2017. According to management, HECIC, CSG’s parent, is considering investing in new gas-fired co-generation plants in the near term, which could boost CSG’s gas sales volume.

Among the 19 ongoing city-gas projects, CSG owns two, which are in the nation’s top-1o most polluted cities (namely, Handan and Baoding – both in Hebei). CSG’s 361km Zhuozhou -to-Handan provincial gas- transmission pipeline supplies gas to all of the country’s most polluted cities, such as Shijiazhuang and Xingtai. As CSG’s owns two important provincial gas pipelines, we believe it will benefit from further

CSG: natural-gas operation in Hebei

Source: Company

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Gas shortage should ease Focusing on industrial-gas sales to expand Hebei has been consuming less natural gas than its the unit-dollar margin neighbours, Beijing and Tianjin, in terms of per GDP CSG is focusing on increasing industrial-gas sales to gas consumption. Hebei’s current natural-gas boost its unit-dollar margin, given that CSG earns an consumption is 30% of Beijing’s and 60% of Tianjin’s. average dollar margin of CNY0.55-0.65/m3 from its Hebei’s low gas utilisation is mainly because the central industrial customers, about 50-60% higher than the government has made it a priority to supply gas to fixed CNY0.25/m3 dollar margin earned from its Beijing and the Tianjin Municipality (which borders wholesale gas sales delivered through its long-distance Hebei Province and Beijing). This has resulted in a gas transmission pipeline. shortage in Hebei for a long time. In addition, CSG plans to focus on building vehicular  Total and per-GDP gas consumption in BHT region CNG/LNG primary stations in Chengde, Baoding and (m m3)(CNY/m3) Shahe to boost its NGV gas sales, which have a current 8,000 10 unit-dollar margin of about 0.5-0.6/m3. 6,000 8 6 4,000 In conclusion, we forecast the unit-dollar margin of 4 CSG’s gas business to increase from CNY0.40/m3 in 2,000 2 2012 to CNY0.48/m3 in 2016, even accounting for a 0 0 potential squeeze on the industrial-gas sales margin 2005 2006 2007 2008 2009 2010 2011 that we see for 2015-16. Beijing gas volume consumption (LHS) Tianjin gas volume consumption (LHS) Hebei gas volume consumption (LHS)  CSG: unit-dollar margin for gas sales earned for each Beijing per GDP gas consumption (RHS) customer (2012) Tianjin per GDP gas consumption (RHS) Hebei per GDP gas consumption (RHS) (CNY/m3) Source: CEIC 0.60

According to CSG’s management, the current 0.50 utilisation reading for its Zhuozhou-to-Handan 0.40 provincial pipeline is around only 50%, due to the insufficient supply of gas from the upstream Shaanxi- 0.30 Beijing pipelines (which is being diverted to Beijing). 0.20 However, we believe the forthcoming increase in gas supply (end-2013 to 2016) from the 100% CSG-owned 0.10 CBM pipeline, 51% HECIC-owned pipeline, and 20%- 0.00 owned Tangshan Caofeidian LNG-receiving terminal Wholesale C&I Residential CNG will increase the long-term gas supply by about 10bcm Source: Company, Daiwa to Hebei Province (Hebei’s 2012 gas consumption: 3.6bcm), representing a potential three-fold increase  CSG: unit-dollar margin trends and gas-sales volume growth between 2012 and 2017 (10bcm). for each customer (CNY/m3)  CSG: future gas supply to Hebei Province 0.50 120% Year of CSG's 100% Source Capacity completion stake JV parties 0.40 80% CBM pipeline (from Shanxi) 0.49 bcm End-2013E 100% n.a. 60% BEH: 29%; 40% Caofeidian LNG receiving terminal (1) 4.00 bcm 2014E 20% CNPC: 51% 0.30 20% CNPC's pipeline connecting Datang's 0% 0.20 bcm End-2014E 0% n.a. Keqi coal-to-gas plant 0.20 (20%) HECIC: 51%; 2011 2012 2013E 2014E 2015E 2016E Sinopec's pipelines 8.00 bcm End-2016E 0% Sinopec: 49% Unit dollar margin of total gas-sales (LHS) Additional gas supply to Hebei and YoY growth of wholesale gas-sales volume (RHS) Tianjin 12.69 bcm YoY growth of industrial gas-sales volume (RHS) Additional gas supply to Hebei 10.00 bcm YoY growth of residential gas-sales volume (RHS) Source: Company, Daiwa YoY growth of CNG gas-sales volume (RHS) Note: we assume 2.69bcm of gas from the Caofeidian LNG-receiving terminal will be used Source: Company, Daiwa forecasts to supply Tianjin.

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 Natural gas discount/premium to competing fuel for vehicular Impact of city-gate tariff hike gas and industrial gas (2015E) 50% As CSG aims to increase its industrial-gas sales to boost 40% 30% its unit-dollar margin, we believe CSG could see its 20% overall dollar margin squeezed if it is not able to pass 10% on the CNY0.88/m3 city-gate tariff hike on base 0% volume in 2015. (10%) (20%) On 28 June 2013, the NDRC increased the city-gate (30%) Anhui Hubei non-residential natural-gas price for Hebei Province by Hebei Gansu Hunan Tianjin Beijing Jiangsu 3 Sichuan Shanghai an average of CNY0.43/m , effective 10 July 2013. Shandong Chongqing Shengyang Guangzhou Heilongjiang NG discount for industrial usage NG discount for vehicular usage This is part of a bigger plan that will allow a substantial one-off price rise and under which China will adopt a Natural gas price discount for Natural gas price discount ladder-like pricing mechanism for incremental natural industrial use (end-2015) for vehicular use (end-2015) gas, which the NDRC expects to account for 9% of the Beijing 10% 20% total piped gas supply for 2013. The plan also provides Tianjin 9% 29% a grace period, until 2015, for the price of the 2012 base Hebei 15% 36% Shengyang -5% 33% volume (91% of piped-gas supply for 2013) to be linked Heilongjiang -3% 25% to competing fuels, such as heating oil and LPG, with a Shanghai 4% 26% 15% discount. Jiangsu 8% 26% Anhui 1% 32%  CSG: city-gate hike for non-residential gas in Hebei Province Shandong -11% 22% Hubei -10% 25% 3 (CNY/m ) Hunan 4% 24% 4.00 Guangzhou -21% 10% 3.12 Chongqing 20% 38% Sichuan 18% 34% 3.00 Gansu 18% 45% 2.24 Simple average 4% 28% 2.00 Source: Provincial DRCs, Daiwa

1.00 In conclusion, we believe the price of natural gas is still competitive compared with alternative fuels in Hebei, even accounting for the CNY0.88/m3 city-gate hike due 0.00 Base volume Incremental volume in 2015.

Remarks: By end-2015E, the city-gate price of non-residential gas will reach CNY3.12/m3 Source: Provincial NDRC, Company, Daiwa Sensitivity analysis of margin squeeze for industrial gas sales Cost pass-through to industrial customers We have conducted analysis to gauge the sensitivity of should be effective CSG’s NAV, 2016E earnings and 2016E ROE to Our calculations show that, if we assume that 100% of different percentages of the hike in 2015 that would not the city-gate price hike is passed on in 2015, the be passed on to industrial-gas customers in 2016. discount in terms of the price of CSG’s industrial  CSG: sensitivity of NAV, net profit and ROE to different levels natural gas compared with competing fuels would drop of industrial gas hike pass-through in 2016 from 27% currently to 15% at the end-2015. % of hike not able to be passed 2016E net 2016E 2016E Industrial on NAV profit ROE tariff We believe CSG is very likely to pass on most of the Base case 3.20 1,150 13.6% 3.33 city-gate hike without seeing a squeeze on its unit- -5% 3.03 1,135 13.4% 3.31 -10% 2.87 1,120 13.3% 3.28 dollar margin. In addition, about 70% of the company’s -15% 2.70 1,105 13.1% 3.25 industrial customers make carbon black and glass, Source: Daiwa forecasts which are less sensitive to the price of natural gas.

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 CSG: degree of sensitivity of NAV, net profit and ROE to Aggressive wind capacity expansion plan different levels of industrial gas hike pass-through relative to base case CSG targets to almost double its consolidated installed NAV 2016E net profit 2016E ROE 2016E industrial tariff capacity from 1,346MW in 2012 to 2,500MW in 2015. -5.1% -1.3% -0.18ppt -0.8% Management has guided to add 250MW in new -10.3% -2.6% -0.31ppt -1.7% capacity for 2013, amounting to 450MW in new -15.4% -3.7% -0.46ppt -2.5% capacity for both 2014 and 2015. We assume a more Source: Daiwa forecasts prudent consolidated capacity of about 2,300MW for Our base case assumes that CSG will be able to pass on 2015. 93% of the 2015 city-gate price hike to non-residential customers. As at the end of 2012, CSG had 2,751MW of preliminary approved projects under consideration. In terms of wind-power resources, CSG had a capacity of Wind power – good quality and a 19.8GW as at the end of 2012, with only 21% of this in Hebei. To diversify its geographical risk, CSG targets to lower curtailment rate reduce its total consolidated installed capacity in Hebei from 93% in 2012 to about 80% in 2015. The profitability of CSG’s wind-power business continues to improve, with its average utilisation rising  CSG: consolidated installed wind-power capacity to 4% for 1H13, due to the business’s low curtailment Wind: 20% 2012-15E CAGR rate of about 7% (peers: 13.5-18.9% for the same 2,500 120% period). This is because 935MW of CSG’s capacity is in 2,000 100% Hebei, the second-largest wind-power market in China, 80% where there is a well-developed power-grid 1,500 60% infrastructure and there are huge consumption centres 1,000 (Beijing and Tianjin) nearby. 40% 500 20%  China wind IPPs: 1H13 utilisation hours and curtailment rate 0 0% (hours) 2009 2010 2011 2012 2013E 2014E 2015E 1,400 20% Total consolidated wind power year-end capacity (MW) (LHS) 18% YoY consolidated wind power year-end capacity growth (RHS) 1,300 16% Source: Company, Daiwa forecasts 14% 1,200 12%

1,100 10% 8% 1,000 6% China Suntien Green Datang Renewables Longyuan Power Energy Utilisation hours (LHS) Curtailment rate (RHS) Source: Companies

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 CSG: wind-power operation

Remarks: As at the end of 2012, 93% of CSG’s consolidated wind-power capacity was in Hebei Source: Company

Renewable-energy surcharge hike could improve the cash position CDM income should bottom out On 30 August 2013, the NDRC announced that the For 1H13, CSG’s CDM business accounted for only renewable-energy surcharge for non-residential and 0.3% of pre-tax earnings, from 13% for 1H12 (6% for non-agricultural users would increase from 2012), because at that time the value of CER units CNY0.008/kWh to CNY0.015/kWh, effective 25 (certified emission reductions) declined by 98% YoY, September 2013. We believe this will effectively due to the expiry of the first commitment period under support China’s renewable-energy development fund, the Kyoto Protocol. Regarding CSG’s CDM income, which saw a shortfall of CNY20bn in 1H13. This could 100% of its CDM contracts are on a floating basis, widen to CNY33bn by 2015 based on the previous driven by the spot price of CER. insufficient surcharge (CNY0.008/kWh), according to NDRC forecasts. We have not factored the CDM income into our model given the unclear outlook for Europe’s economy for Based on our research, most wind IPPs seem confident 2014 and the potential establishment of a carbon- of being able to collect their tariff-premium receivables trading exchange in China. Thus, any turnaround in the before the end of 2013. CSG’s tariff-premium spot price of CER and CDM income could result in receivables amounted to CNY200m in 2012, upside to our earnings forecasts for 2014. representing 24% of its total trade and bills receivables  (CNY843m). We believe such receivables could be reduced to CNY100m by the end of 2013, which could further improve the company's cash position.

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 Carbon-credit spot price on 23 October 2013, with the completion date targeted (EUR/Co2tonne) for 1Q14. 40 35 We believe the placement would remove the share- 30 price overhang as further placements would then be 25 unlikely in the long term (HECIC aims to have a 20 controlling stake in CSG). We expect CSG to raise 15 about CNY1bn to support further investment in wind 10 and city-gas projects. 5 0 Apr-08 Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Apr-12 Dec-12 Aug-13 Potential asset injections by CER EUA parent could lead to upside Source: Bloomberg

 China wind power: CDM income as a proportion of profit Parent HECIC could inject clean-energy assets, such as before tax its joint-venture pipeline with Sinopec and other gas-

25% fired utilities, which are still at the planning stage, into CSG over long-term. We believe these would be EPS- 20% accretive.

15%  CSG: HECIC’s stake in CSG before and after the proposed placement 10% 60% 5% 57.90% 58%

0% 56% 2009 2010 2011 2012 1H13 54% China Longyuan China Suntien Green Energy 52% Source: Company 50.50% 50% 48% Valuation 46% Before proposed placement After proposed placement

As CSG’s natural-gas and wind-power businesses have Source: Company different risk profiles, we use an SOTP methodology to value each business. Our SOTP-based valuation leads Risks to a fair value of HKD3.20, implying a 14x 2014E PER.

 CSG: SOTP valuation Apart from the margin squeeze and equity-dilution Business segment Valuation Stake ownership HKD/share % value risks that we discussed previously, other risks to our Natural gas DCF at 6.8% 100.0% 4.05 79% call would include slower-than-expected gas sales Wind power DCF at 8.3% 100.0% 1.06 21% growth in Hebei over 2014-15, due to gas being Corporate value 5.11 100% diverted to Beijing and Tianjin. Net Cash / (Debt) (1.91) Price Target 3.20 Source: Bloomberg, Daiwa forecasts In addition, management has revised down its 2013 wind-power capacity target, to 250MW currently from 400MW originally. We would see any further cuts in Share-price overhang removed guidance as a risk. after private share placement A further slowdown in new wind-power capacity into 2014 could slow the company’s earnings contribution In August 2013, CSG proposed a plan to place 477m from its wind-power segment. new shares privately, which would represent 12.8% of the company’s enlarged capital. HECIC’s stake in CSG would drop from 57.9% to 50.5% post the placement. The proposed placement was passed during the EGM - 91 - China Gas Sector 11 November 2013

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Industrials / China 392 HK Industrials / China 11 November 2013

Beijing Enterprises

Beijing Enterprises Target (HKD): 70.00 Upside: 12.1% 392 HK 7 Nov price (HKD): 62.45

Initiation: accelerated growth with margin risks well mitigated 1 Buy 2 Outperform (initiation) • We forecast a 21% CAGR in gas distribution volume over 2012- 3 Hold 16 driven by the capacity ramp-ups by gas-fired utilities 4 Underperform • Co-operation with China Gas should expand the geographical 5 Sell footprints of company’s gas and environmental utilities • Margins could rise due to NGV gas sales; initiating coverage with an Outperform (2) rating and target price of HKD70

How do we justify our view?

growth. We forecast gas- ■ Risks transmission volume sales to rise The key downside risks include from 0.7% YoY for 1H13 to a 10% warm weather in Beijing, which CAGR over 2013-15, as the tariff could slow gas sales for heating, hike in June 2013 narrowed the slower-than-expected development Dennis Ip, CFA discount of Beijing and Hebei city- of the NGV market or loss of market (852) 2848 4068 gate tariffs to that of Guangdong. share to competitors. [email protected] The rise has increased the incentive for PetroChina to supply gas to Gary Zhou Hebei, which has a high PM2.5 (852) 2773 8535 respirable particulates reduction [email protected] Share price performance target of 25% (other regions: 15- 20%) by 2017. (HKD) (%) 70 135 ■ Investment case 64 125 Impact of tariff hikes should be We initiate coverage of Beijing 58 115 Enterprises (BEH), which is engaged offset. A potential gross-profit 51 105 in city-gas distribution in Beijing margin squeeze on BEH’s gas sales 45 95 and gas transmission in north to utilities as a result of city-gate Nov-12 Feb-13 May-13 Aug-13 Nov-13 China, with an Outperform (2) tariff hikes should be offset by B'Jing Ent (LHS) Relative to HSI (RHS) rating. We expect the company to increases in NGV gas sales, which continue to see strong gas have a higher gross-profit margin. 12-month range 48.75-65.05 distribution and transmission sales- Market cap (USDbn) 9.23 volume growth, on the back of ■ Catalysts 3m avg daily turnover (USDm) 8.73 Near-term catalysts include cold Shares outstanding (m) 1,146 recent policies to mitigate air Major shareholder Beijing Enterprises Group (57.9%) pollution. weather in Beijing, and a further diversion of gas supplies to north Financial summary (HKD) Ambitious plans for fuel China. Year to 31 Dec 13E 14E 15E conversion of utilities should Revenue (m) 43,340 56,236 73,462 underpin gas-distribution ■ Valuation Operating profit (m) 3,779 4,515 5,204 We have a six-month SOTP-based Net profit (m) 3,853 4,827 5,977 volume growth. For 2012-15, we Core EPS (fully-diluted) 3.244 4.064 5.033 forecast a gas-distribution sales target price of HKD70, representing EPS change (%) 17.8 25.3 23.8 volume CAGR of 21%, on the back of a 2014E PER of 17x, in line with the Daiwa vs Cons. EPS (%) (0.3) 1.7 4.3 ambitious plans to convert the fuel stock’s past-five-year average. We PER (x) 19.2 15.4 12.4 of its power plants and boilers for believe our target PER is attractive Dividend yield (%) 1.4 1.8 2.2 given the accelerated net-profit DPS 0.866 1.105 1.394 urban heating from coal to gas. PBR (x) 1.7 1.6 1.4 growth of 18-24% YoY we forecast EV/EBITDA (x) 12.9 10.9 9.5 Recent tariff hike encourages over 2013-15, compared with 5-18% ROE (%) 9.4 10.9 12.4 transmission gas sales-volume YoY over 2009-12. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

th  Growth outlook  China: 12 Five-Year Plan – natural-gas consumption

We forecast a gas sales-volume CAGR (downstream (bcm) business) of 21% for BEH over 2013-15, driven largely 16 15 18% 2010-15 CAGR by the rapid ramp-up of gas-fired cogeneration power 14 plants and boilers for centralised urban heating in 12 Beijing. 10

According to the air-pollution mitigation plan 8 6.5 announced recently by the State Council, Beijing, 6 Tianjin, and Hebei will need to reduce their coal 4 consumption by 20% over 2012-17. This should support 2 gas sales-volume growth (midstream pipeline business), 0 which we forecast to rise at a CAGR of 10% over 2013- 2010 2015E 15. Source: 12th Five-Year Plan of the NDRC

 Valuation  BEH: 12-month forward PER history The stock is trading currently at a 2014 PER of 15.4x (x) based on our EPS forecast, 0.5 SD below its past-five- 25 year average 12-month forward PER of 17.0x. 23 23.3x Avg+2SD 21 20.1x Avg+1SD We believe the recent derating of the stock has been due 19 to concern about cost pass-through for distributed gas, 17 17.0x Avg particularly from cogeneration power plants and boilers 15 13.9x Avg-1SD for centralised urban heating, given the city-gate tariff 13 hikes planned over 2014-15. 11 10.7x Avg-2SD 9 7 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Bloomberg, Daiwa forecasts

 Earnings revisions  BEH: consensus EPS-forecast revisions The Bloomberg-consensus 2013-14E EPS forecasts for (HKD) BEH have been cut by 3-4% since January 2013, as a 4.40 result of disappointing gas-transmission volume sales 4.20 and concerns about the cost pass-through of its 4.00 distributed gas following the city-gate tariff hike in July. 3.80 3.60 BEH said it had completed passing through costs to all 3.40 non-resident customers on 23 August 2013, and this 3.20 should ease investors’ concerns. Future gross-profit 3.00 margin risk for distributed gas sales should be offset by Jul-12 Jul-13 Apr-12 Apr-13 Oct-12 Oct-13 Jan-12 Jun-12 Jan-13 Jun-13 Feb-12 Mar-12 Feb-13 Mar-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 high-margin NGV gas sales. We do not expect either gas May-12 May-13 distribution or transmission volume growth to be 2013E EPS 2014E EPS affected, due to a clear coal-consumption reduction Source: Bloomberg target, supported by rising gas consumption, by 2017E.

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas distribution sales volume 4.89 5.69 6.46 6.47 7.94 9.53 11.53 14.07 (bcm) Gas ASP, incl tax (CNY/m3) 2.02 1.89 1.92 2.09 2.06 2.31 2.71 3.11 Gas purchase cost, incl tax (CNY/m3) 1.73 1.61 1.64 1.82 1.80 2.01 2.37 2.75 Natural gas transmission sales 12.20 14.39 17.24 20.30 23.72 25.00 27.83 30.17 volume (bcm) Proportion of net earnings from 65 76 74 82 85 89 86 85 natural gas operations (%)

 Profit and loss (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Piped gas operation 10,152 11,943 14,119 16,460 20,645 27,712 39,305 55,093 Brewery operation 8,473 9,758 10,545 13,373 14,443 15,386 16,635 17,986 Other Revenue 1,079 2,508 2,949 638 482 242 295 383 Total Revenue 19,704 24,208 27,613 30,472 35,570 43,340 56,236 73,462 Other income 986 546 593 873 1,485 1,427 2,340 3,625 COGS (15,199) (18,390) (21,214) (23,738) (28,208) (34,449) (45,617) (60,905) SG&A (2,601) (3,154) (3,771) (4,642) (5,393) (6,539) (8,444) (10,977) Other op.expenses (1,515) (1,737) (1,910) (1,517) (2,168) (2,555) (2,979) (3,316) Operating profit 2,697 2,885 2,804 3,222 3,149 3,779 4,515 5,204 Net-interest inc./(exp.) (407) (364) (374) (647) (997) (997) (879) (1,027) Assoc/forex/extraord./others 766 1,084 1,365 1,674 2,049 2,551 2,907 3,824 Pre-tax profit 3,056 3,605 3,795 4,249 4,202 5,333 6,543 8,001 Tax (359) (559) (685) (583) (569) (776) (937) (1,214) Min. int./pref. div./others (414) (648) (470) (889) (363) (705) (779) (810) Net profit (reported) 2,282 2,399 2,639 2,776 3,270 3,853 4,827 5,977 Net profit (adjusted) 2,282 2,399 2,639 2,776 3,270 3,853 4,827 5,977 EPS (reported)(HKD) 2.005 2.110 2.321 2.440 2.875 3.362 4.212 5.216 EPS (adjusted)(HKD) 2.005 2.110 2.321 2.440 2.875 3.362 4.212 5.216 EPS (adjusted fully-diluted)(HKD) 2.004 2.057 2.222 2.337 2.754 3.244 4.064 5.033 DPS (HKD) 0.649 0.634 0.670 0.671 0.721 0.866 1.105 1.394 EBIT 2,697 2,885 2,804 3,222 3,149 3,779 4,515 5,204 EBITDA 4,018 4,296 4,296 4,996 5,013 6,334 7,494 8,520

 Cash flow (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 3,056 3,605 3,795 4,249 4,202 5,333 6,543 8,001 Depreciation and amortisation n.a. 1,411 1,492 1,774 1,863 2,555 2,979 3,316 Tax paid n.a. (559) (158) (316) (479) (467) (688) (815) Change in working capital n.a. 765 (30) 292 (1,215) 578 349 579 Other operational CF items n.a. (2,129) 1,843 (6,925) 1,009 (2,796) (2,568) (3,846) Cash flow from operations n.a. 3,093 6,942 (926) 5,381 5,203 6,615 7,236 Capex n.a. (2,317) (3,867) (4,346) (8,234) (8,000) (7,295) (6,750) Net (acquisitions)/disposals n.a. (718) (3,649) (3,262) (2,320) 0 0 0 Other investing CF items n.a. (1,192) (1,319) 776 1,185000 Cash flow from investing n.a. (4,228) (8,835) (6,833) (9,370) (8,000) (7,295) (6,750) Change in debt n.a. 971 6,727 7,596 6,560 4,765 2,573 1,903 Net share issues/(repurchases) n.a. 5 0 (1) 0000 Dividends paid n.a. (942) (1,263) (1,179) (1,149) (1,484) (1,894) (2,389) Other financing CF items n.a. 2,671 753 (566) (984) 0 0 0 Cash flow from financing n.a. 2,705 6,217 5,851 4,427 3,281 679 (486) Forex effect/others n.a.0000000 Change in cash n.a. 1,571 4,324 (1,908) 438 484 (0) 0 Free cash flow n.a. 776 3,075 (5,272) (2,853) (2,797) (680) 486 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (HKDm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 6,731 9,604 14,573 12,616 12,298 12,783 12,782 12,782 Inventory 3,067 2,995 3,727 5,286 5,914 7,222 9,564 12,769 Accounts receivable 1,639 1,812 2,250 2,636 3,427 4,836 5,638 7,078 Other current assets 1,518 1,765 1,231 2,960 4,268 5,140 6,588 8,521 Total current assets 12,956 16,177 21,780 23,498 25,907 29,981 34,572 41,150 Fixed assets 17,988 19,045 22,244 26,317 32,805 38,259 42,579 46,016 Goodwill & intangibles 8,553 8,676 7,260 7,477 7,569 7,569 7,569 7,569 Other non-current assets 12,200 15,207 15,745 20,063 23,227 25,183 28,619 33,341 Total assets 51,697 59,105 67,029 77,355 89,508 100,991 113,338 128,076 Short-term debt 3,173 3,038 2,320 5,705 6,277 6,277 6,277 6,277 Accounts payable 1,190 1,408 4,554 1,905 2,616 3,195 4,231 5,649 Other current liabilities 5,617 6,439 7,917 8,677 11,293 13,826 18,227 24,251 Total current liabilities 9,979 10,885 14,791 16,287 20,187 23,298 28,735 36,178 Long-term debt 4,411 7,986 10,170 14,543 20,347 25,565 28,149 30,052 Other non-current liabilities 996 1,218 1,132 1,329 1,334 959 993 1,253 Total liabilities 15,386 20,088 26,093 32,159 41,868 49,823 57,877 67,482 Share capital 114 114 114 114 114 114 114 114 Reserves/R.E./others 29,518 31,191 34,154 37,496 39,496 42,320 45,834 50,156 Shareholders' equity 29,632 31,305 34,268 37,610 39,609 42,434 45,948 50,269 Minority interests 6,679 7,712 6,668 7,587 8,030 8,735 9,514 10,324 Total equity & liabilities 51,697 59,105 67,029 77,355 89,508 100,991 113,338 128,076 EV 73,788 74,402 66,941 74,001 78,667 81,554 82,009 80,899 Net debt/(cash) 853 1,419 (2,082) 7,632 14,326 19,059 21,643 23,546 BVPS (HKD) 26.038 27.533 30.129 33.063 34.819 37.028 40.094 43.865

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) n.a. 22.9 14.1 10.4 16.7 21.8 29.8 30.6 EBITDA (YoY) n.a. 6.9 0.0 16.3 0.3 26.4 18.3 13.7 Operating profit (YoY) n.a. 7.0 (2.8) 14.9 (2.2) 20.0 19.5 15.3 Net profit (YoY) n.a. 5.1 10.0 5.2 17.8 17.8 25.3 23.8 Core EPS (fully-diluted) (YoY) n.a. 2.6 8.0 5.2 17.8 17.8 25.3 23.8 Gross-profit margin 22.9 24.0 23.2 22.1 20.7 20.5 18.9 17.1 EBITDA margin 20.4 17.7 15.6 16.4 14.1 14.6 13.3 11.6 Operating-profit margin 13.7 11.9 10.2 10.6 8.9 8.7 8.0 7.1 Net profit margin 11.6 9.9 9.6 9.1 9.2 8.9 8.6 8.1 ROAE 15.4 7.9 8.0 7.7 8.5 9.4 10.9 12.4 ROAA 8.8 4.3 4.2 3.8 3.9 4.0 4.5 5.0 ROCE n.a. 11.5 5.4 5.4 4.5 4.8 5.2 5.6 ROIC n.a. 12.1 5.8 6.1 4.7 4.9 5.3 5.5 Net debt to equity 2.9 4.5 net cash 20.3 36.2 44.9 47.1 46.8 Effective tax rate 11.8 15.5 18.0 13.7 13.5 14.5 14.3 15.2 Accounts receivable (days) 15.2 26.0 26.8 29.3 31.1 34.8 34.0 31.6 Current ratio (x) 1.3 1.5 1.5 1.4 1.3 1.3 1.2 1.1 Net interest cover (x) 6.6 7.9 7.5 5.0 3.2 3.8 5.1 5.1 Net dividend payout 32.4 30.0 28.9 27.5 25.1 25.8 26.2 26.7 Free cash flow yield n.a. 1.1 4.3 n.a. n.a. n.a. n.a. 0.7 Source: FactSet, Daiwa forecasts

 Company profile Found in 1997, Beijing Enterprises Holdings Limited (BEH) is involved mainly in the following gas and environmental control utilities such as city-gas distribution mainly in Beijing, gas pipeline transmission through Shaanxi-Beijing pipelines, coal-to-gas plants in Inner Mongolia and LNG terminal in Tianjin, construction and operation of sewage, water supply, water-treatment plants and waste-to-energy plants. BEH also produces and distributes beer in Beijing and other provinces in China.

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 BEH: corporate structure

Initiation: accelerated growth with margin risks well mitigated

Initiating with an Outperform (2) rating

Company background

BEH is a flagship conglomerate in Beijing. The biggest shareholder, with a 57.9% stake, is Beijing Enterprises Group, which is owned by the Beijing Municipal Government. For 2012, 85% of the company’s net Source: Company profit came from the gas operations with the remainder from its brewery business and water utilities. BEH has three major utilities businesses: piped natural gas, sewage treatment, and water treatment. In 2012, BEH started its NGV-gas-refuelling businesses. It currently has 20 refuelling stations in Beijing.

Unlike the other major gas distributors in China, such as ENN Energy (2688 HK, HKD44.05, Buy [1]), China Resources Gas (1193 HK, HKD19.82, Hold [3]), and TCCL (1083 HK, HKD7.47, Outperform [2]), BEH owns a significant stake in a cross-province gas transmission pipeline – the Shaanxi-Beijing pipelines – which it uses to supply its service region of Beijing. The ownership of these strategic midstream pipelines not only strengthens the company’s gas-supply security, but also gives it an advantage in negotiations on acquiring city-gas distribution concessions along the route of the pipelines.

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the 20-22% YoY total distributed gas sales volume A major air-pollution reduction growth we forecast for BEH), and forecast this to play in the capital and Hebei account for 77% of BEH’s total distributed gas volume for 2015E (2013E: 73%). Over the near term, BEH looks likely to increase its city-gas sales volume in Beijing as the capital is aiming Power – 8.4m tonnes of coal due to be to close all coal-fired boilers and power plants by 2015 replaced with 5.0bcm of gas by 2016 and 2016, respectively, in order to reduce coal According to the Beijing Development and Reform consumption from 23m tonnes for 2012 to 15m tonnes Commission (Beijing DRC), the capital aims to convert for 2015, and 10m tonnes for 2017. Meanwhile, Hebei all coal-fired power plants to gas-fired cogeneration Province is aiming to reduce coal consumption by 14% power plants by 2016 in order to reduce coal by 2017, according to China Suntien Green Energy (956 consumption from the 2012 level by 8.4m tonnes. The HK, HKD2.82, Outperform [2]), which should be Beijing DRC plans to have a total capacity of 8GW positive for the transmission gas-sales volume in the (2010: 2GW) of gas-fired cogeneration power plants Shaanxi-Beijing pipelines, which are owned by BEH. located at the four heating-power centres in the city, consuming 7.4bcm of natural gas in 2016 (43% of total  BEH: natural gas distribution and transmission sales-volume gas 2016 volume), a three-fold increase from the forecasts 2.4bcm for 2012. (bcm) 40 25%  Beijing: four heating-power cogeneration centres 20% 30 15% 20 10% 10 5%

0 0% 2011 2012 2013E 2014E 2015E North east North west cogeneration Natural gas distribution sales (Beijing) - LHS cogeneration centre Natural gas transmission sales - LHS centre YoY growth of natural gas distribution sales - RHS YoY growth of natural gas transmission sales - RHS Source: Company, Daiwa forecasts South east South west cogeneration cogeneration centre The commissioning of the Datang coal-to-gas project centre and CNPC’s LNG receiving terminal in Caofeidian, Tianjin, supports our net-profit CAGR forecast of 20% over 2013-15. 2012 2013 2014E 2014E 2015E 2015E Plant owner Huaneng Jingneng Datang Jingneng Jingneng Huaneng Shijingshan In addition to growth in natural-gas sales in Beijing Plant location Gaobeidian Caoqiao Shijingshan Jingxi Gaoantuan Gaobeidian and Hebei, we believe BEH’s recent accumulation of South east South west North west North west North east South east Plant Area Beijing Beijing Beijing Beijing Beijing Beijing shares in and co-operation with China Gas (384 HK, New HKD8.77, Outperform [2]) will provide natural-gas commissioned utility and environmental-control (water and waste-to- capacity (MW) 923 838 1,380 1,308 845 923 Total capacity energy) growth opportunities outside Beijing. (MW) 2,891 3,729 5,109 6,417 7,262 8,185 Additional gas sales, bcm 0.50 1.22 1.35 1.10 Gas distribution – Beijing power Total gas sales, bcm 2.26 3.49 4.83 5.94 and heating utilities to stop using Source: Beijing DRC, Daiwa forecasts coal as a fuel by 2016 Heating – 2.4m tonnes of coal due to be Of the 13m tonnes of coal consumption due to be cut in replaced by 1.4bcm of gas by 2015 Beijing by 2017, we expect about 85% (10.8m tonnes) One of the major reasons for the severe PM2.5 air to come from an ambitious coal-to-gas fuel conversion pollution during the winter in Beijing is the use of coal- plan for power and heat-generation plants. We assume fired boilers for centralised urban heating. Unlike a 20-26% YoY rise in distributed gas sales volume for power plants, which can be built in rural areas, boilers power and heat in Beijing over 2013-15 (higher than for heating need to be built near town centres to

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minimise heat loss. In 2012, Beijing converted 60% of ones, as they generate power, heat, and cool air at the the city’s boilers to gas-fired ones, with all coal-fired same time. We expect these projects to boost long-term boilers within the third-ring roads decommissioned. gas-distribution consumption growth in Beijing over the coming years. According to the Beijing DRC, Beijing also aims to convert all coal-fired boilers for centralised urban New town expansion in Beijing heating into gas-fired ones by 2015, in order to reduce In addition to a city-gas presence within Beijing’s 6th coal consumption by 2.4m tonnes from the 2012 level. Ring Road, BEH has been expanding its city-gas We estimate that 40% of the boilers in Beijing city, distribution coverage to rural Beijing along with its which produce 4,900 tonnes/year of steam (137 40%-owned midstream Shaanxi-Beijing pipelines. The boilers), are yet to be converted. Steam produced by company currently has operations in Huairou, Miyun, small coal boilers (4,000 tonnes/year of steam and Changping districts, in the rural areas of Beijing. generated at less than 20 tonnes/hour) in rural areas of As air pollution is a regional issue, we believe the Beijing are due to be converted to gas-fired boilers Beijing government will promote natural-gas from 2014-17, representing an additional cut in coal utilisation outside the 6th Ring Road of the city. consumption of 2m tonnes over that period.  BEH: city-gas exposure to Beijing’s new districts  Beijing: coal-to-gas conversion schedule for boilers used for centralised heating

Year Coal-fired boilers to be converted (tonnes/yr) Areas without coal-fired boilers 2013 2,100 Within the 4th Ring Road 2014 2,200 Within the 5th Ring Road 2015 600 Within the 6th Ring Road Source: Beijing DRC

Distributed-energy projects Source: Company, Daiwa In addition to centralised cogeneration power plants and heating centres, BEH also participates in a number BEH supplies all of Beijing’s gas of distributed-energy projects (see following As BEH owns equity stakes in all the midstream paragraph), mainly tri-generation (cooling-power- companies supplying gas to Beijing, such as a 40% heating) ones, in industrial parks and large commercial interest in the Shaanxi-Beijing pipelines, a 34% stake buildings – such as the grid control centre of Beijing in the Keqi coal-to-gas plant, and a 29% stake in the Gas, the No.9 building of the Beijing Conventional Tangshan Caofeidian LNG terminal, the company is Centre, and Beijing South Rail Station. well-placed to expand its city-gas operation to nearby new towns in Beijing municipality. The central government has been encouraging the adoption of distributed energy projects, with the aim of  Gas supply sources to Beijing BEH's diversifying primary energy consumption from coal- Gas supply sources to Beijing Other stakeholders fired electricity to natural gas, supported by renewable stake Shaanxi-Beijing pipelines 40% Kunlun Energy sources such as wind, solar and geothermal power. Datang International Power, Datang Group, Keqi coal-to-gas plant 34% These projects are more energy efficient than Tianjin Jinneng Investment conventional coal-fired power or coal-fired heating Tangshan Caofeidian LNG Terminal 29% Kunlun Energy, China Suntien Green Energy Source: Companies - 99 - China Gas Sector 11 November 2013

policy relating to how much of city-gas costs can be City-gate tariff hike – margin passed through to power and heating utilities. squeeze on utilities gas should be  BEH: breakdown of gas distribution sales volume offset by NGV gas sales 100%

BEH’s share price fell by 7% in July this year due to 80% concerns that the company would not be able to pass 60% on all of the city-gate tariff hike to its customers. On 28 June 2013, the National Development and Reform 40% Commission (NDRC) announced an increase in the 20% city-gate for non-residential natural-gas price in Beijing by 15% (or CNY0.35/m3), to CNY2.40/m3, with 0% 2012 2013E 2014E 2015E effect from 10 July 2013. This was the first step in a Heating & Cooling Cogeneration Power Plant plan that will see China adopt a ladder-like pricing Residential users and commercial Public sector structure for natural gas. This allows substantial price Industries Vehicles increases one at a time for incremental gas supplies, Source: Company, Daiwa forecasts which we forecast to account for 17% of piped gas supply for 2013. The plan also provides a grace period, In its announcement on gas tariffs in June this year, until 2015, for the price of the 2012 base volume (which the NDRC said that either preferential gas tariffs or we forecast to account for 83% of piped-gas supply for local government subsidies should be provided to gas- 2013) to be linked to competing fuels, such as heating fired power plants and heating centres. If the oil and LPG, in Beijing with a 15% discount. government decides to adopt a preferential gas tariff, BEH might not be able to pass through the entire cost A CNY0.74/m3 rise in non-residential gas hike from the city-gate, of CNY0.74/m3, and face a prices (base volume) nationwide is due gross-profit margin squeeze. We believe this scenario is over 2013-15 highly likely as we forecast gas consumption from gas- fired utilities in Beijing to more than double from Under the city-gate tariff-hike schedule, the NDRC 5.8bcm for 2012 to 12.8bcm for 2016. plans to raise the city-gate price by 39% in Beijing by 3 2015, to CNY3.14/m . As a result, the total tariff rise for  BEH: gas distribution sales to gas-fired power and heating city-gate non-residential customers from the level of utilities 3 June 2013 would be CNY1.09/m . (bcm) 14 12.76  Beijing: average city-gate price for non-residential gas over 2013-15 12 22% 2012-16 CAGR (CNY/m3) 10 3.50 3.14 8 3.00 5.80 2.40 6 2.50 2.05 2.00 4

1.50 2 1.00 0 0.50 2012 2016E 0.00 Source: Company, Daiwa forecasts Average city-gate price, Average city-gate price, Average city-gate price, CNY/m³ (before July-2013) CNY/m³ (after July-2013) CNY/m³ (as of July-2015E) Source: NDRC, Daiwa In our forecasts, we assume that BEH can only pass through the city-gate price rise (of CNY0.37/m3) on 88% Ability to pass on costs fully to power- of gas sales to utilities in 2015. generation and heating customers could be low … … but should be offset by NGV gas sales As we forecast gas sales from utilities to continue to However, we are not too pessimistic about the gross- account for about 75% of total distributed gas sales for profit margin on BEH’s distributed-gas sales over the BEH over the medium term, the company’s future next few years, as we expect there to be a rise in NGV dollar margin on distributed gas sales will be highly gas sales, which should not only offset the margin dependent on the Beijing municipal government’s

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squeeze from utilities gas sales, but could lead to an  BEH: gas sales volume and gross-profit contribution from gas expansion in the dollar margin. for NGVs 70% Given that the ASP of NGV gas (CNY5.12/m3) is almost 60% double that of gas for utilities (CNY2.67/m3), the dollar 50% margin on NGV gas is 3-4x that of utilities gas, even 40% accounting for the fee to convert natural gas to CNG 30% and LNG of CNY0.8/m3. 20%

 BEH: current ASP and dollar spread of natural gas sales in 10% Beijing 0% (CNY/m3) 2014E 2015E 2016E 6.00 Gas sales volume contribution from NGV gas 5.00 4.00 Gross profit contribution from NGV gas 3.00 Source: Daiwa forecasts 2.00 1.00  0.00  BEH: gross-profit forecasts for various distributed-gas customers (CNYm) Vehicles Industries 10,000 80% Public sector Plant 8,000

commercial 60% Heating & CoolingHeating & 6,000 Cogeneration Power Power Cogeneration Residential users and 4,000 40% Dollar margin of various gas customers in Beijing 2,000 ASP of various gas customers in Beijing 20% Premium / Premium / 0 (discount) (discount) (2,000) 0% ASP over Unit dollar over 2014E 2015E 2016E 2017E (CNY/m3) utilities gas spread (CNY/ m3) utilities gas Utilties gas sales - LHS Other gas sales - LHS Heating & cooling 2.67 0% 0.29 0% Public sector gas sales - LHS Cogeneration power plants 2.67 0% 0.29 0% Industrial gas sales - LHS Residential users and commercial 2.31 -13% 0.12 -59% vehicles gas sales - LHS GP proportion of distributed gas sales from utilities - RHS Public sector 3.23 21% 0.85 193% GP proportion of distributed gas sales from vehicles - RHS Industries 3.23 21% 0.85 193% Source: Daiwa forecasts Vehicles 5.12 92% 1.36 367% Source: Company, Daiwa Dollar margin could expand on back of

In 2012, BEH developed 1,000 NGVs with 20 refuelling NGV gas sales stations in a joint venture with Sinopec. The company’s In conclusion, even if we assume BEH can only pass goal of developing 10,000 new NGVs supported by 35 through 88% of city-gate costs to power and heating new CNG/LNG refuelling stations in 2013 is on track, utilities in 2015, the dollar margin would still increase according to management. It also aims to boost NGV due to NGV gas sales. gas sales to 3bcm (equivalent to about 150,000 NGVs, based on our calculation) in Beijing from 2012 over the  BEH: dollar margin of distributed-gas sales next few years. The most recent document on air- (CNY/m3) pollution mitigation from the State Council has a target 0.45 of 60% of new public buses, in the three major air- pollution-control regions (including Beijing, Tianjin, 0.40 and Hebei), using clean energies immediately. Beijing Public Transport had about 28,000 buses as at the end 0.35 of 2011, while Beijing has about 66,000 taxis that are due to be converted to CNG gradually. 0.30 Assuming BEH accounts for a 55% share of this 3bcm NGV gas market by 2017 (the company’s target is 60- 0.25 70%), we forecast NGV gas to make up 47% of the gross 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E profit of distributed-gas sales, despite accounting for Source: Company, Daiwa forecasts just 9% gas-sales volume in 2015E, due to its lucrative gross-profit margin.

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Given this, we are more concerned about the prospects for BEH’s natural-gas refuelling business, as the gross- profit margin on NGV gas sales is 3-4x higher than that of utilities gas. Downside risks for BEH in this business would be a significant loss of market share in the NGV refuelling business to major nationwide operators such as Kunlun Energy, Sinopec, and CNOOC.

Impact of city-gate tariff hikes We have undertaken a sensitivity analysis of BEH’s NAV, 2016E earnings, and 2016E ROE from the company’s ability to pass through costs for gas to utilities at the end of 2015.

 BEH: sensitivity of NAV, net profit, and ROE to different levels of utility gas hike pass-through in 2016E % of hike not able to be 2016 net 2016 2016 utilities gas tariff passed through NAV profit ROE (CNY/m3)) Base case 70.00 6,759 12.8% 3.12 -5% 65.11 6,448 12.3% 3.10 -10% 60.21 6,137 11.8% 3.07 -15% 55.30 5,826 11.2% 3.05 Source: Daiwa forecasts

 BEH: degree of sensitivity of NAV, net profit, ROE to different levels of utility gas hike pass-through relative to base case (2016E) NAV 2016 net profit 2016 ROE 2016 utilities gas tariff (CNY/m3) -7.0% -4.6% -.53pp -0.8% -14.0% -9.2% -1.07pp -1.7% -21.0% -13.8% -1.61pp -2.5% Source: Daiwa forecasts Note: Changes correspond to the respective 5%, 10% and 15% hike pass-through percentages shown in the first table

In our model, we assume that BEH is only able to pass through 88% of the city-gate price rise to cogeneration power plants and heating companies.

Our analysis suggests that every 5% of the city-gas price hike that BEH is not able to pass through to its utilities customers would result in a 4.6% drop in the 2016E net profit and a 0.53pp drop in the 2016E ROE.

BEH passed through all non-residential gas costs from city-gate price hike in August On 23 August 2013, BEH said it had passed through fully the non-residential city-gate price hike to all customers, with a prices rising by CNY0.39/m3. The tariff hike was backdated to 10 July 2013.

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Risks in 2H13 and 1H14 Gas transmission: 20% coal reduction consumption targeted BEH’s YoY gas sales-volume growth in the city-gas distribution business has a high correlation to YoY in Hebei by 2017 temperature changes, as 45% of gas sales volume (2012) comes from heating. For 2012, heating gas-sales On 10 September this year, the State Council published volume grew by 25% YoY, and was the main driver of an action plan to cut air pollution with a target of the 23% YoY increase in total gas sales, due to the reducing the PM2.5 pollutant level by 25% over 2012- exceptionally low temperatures (it was -16oC on 24 17, through the closure of coal-fired boilers and power December 2012, the lowest daily temperature in Beijing plants. China Suntien Green Energy estimates that a for 20 years). For 2H13 and 1H14, we forecast gas 17% reduction in coal consumption in Hebei, Beijing, demand from heating to increase at a lower rate of and Tianjin, from 375m tonnes for 2012 to 310m about 10% YoY, despite the conversion of more coal- tonnes for 2017. We estimate that additional fired boilers within the area of the 4th Ring Road. This consumption of 30bcm of natural gas would be needed is because winter temperatures in Beijing this year are to replace the reduction in coal, mainly supported by likely to be higher than last year, with temperatures the Shaanxi-Beijing pipelines, in which BEH has a 40% reverting to their long term mean following the stake. exceptionally cold winter last year. We calculate that the correlation between Beijing’s daily temperature  Coal-consumption reduction targets for areas in which BEH has pipelines (2012-17) during heating season (from 16 November to 15 March) (m tonnes) 2012 2017E Reduction was -0.65 from 2009-12. Beijing 23 10 57% Hebei 302 260 14%  Beijing: YoY difference in average daily temperatures Tianjin 50 40 20% (℃) Beijing-Tianjin-Hebei 375 310 17% 15 2012/13 winter was the coldest in Beijing for 20 years, and we expect 2013/14 winter to be warmer Source: State Council 10 Visible demand for gas for coal-conversion 5 projects in Beijing, Tianjin, and Hebei 0 For 2012-17, we forecast 33bcm of additional gas (5) demand (as a result of a reduction in the use of coal to generate power and heat) from the Beijing, Tianjin, and (10) Hebei areas. Based on the announced supply pipelines, (15) we forecast the utilisation rates for the company’s Shaanxi-Beijing pipelines to increase from 78% for Jul-13 Apr-13 Oct-12 Jun-13 Jan-13 Feb-13 Mar-13 Aug-13 Nov-12 Dec-12 May-13 2013 to 85% over 2015-17. According to management, Source: Bloomberg the Shaanxi-Beijing Pipeline No.4 is due to be commissioned by the end of 2015, which would raise Risk of losing market share in the transmission capacity of the Shaanxi-Beijing pipelines from 35bcm to 55bcm. NGV gas market in Beijing  Gas demand and supply balance for areas in which BEH has In addition to gas sales for heating, BEH’s prospects pipelines 2012-17E Gas demand and supply balance over 2012-17E will depend on NGV gas sales, given the lucrative A) Additional gas demand Proportion dollar-margin premium of about 350% over gas for Coal-to-gas fuel conversion of power plants and boilers 23.0 bcm 70% utilities. Unlike city gas, there is no monopoly in NGV Non-utilities gas demand from Beijing 2.1 bcm 6% gas, as the oil majors, such as CNPC, can build stations Non-utilities gas demand from Tianjin 1.8 bcm 5% after receiving government approval. Therefore, BEH Non-utilities gas demand from Hebei 6.1 bcm 18% Additional gas demand from Beijing-Tianjin-Hebei 33.0 bcm 100% could lose share in the NGV gas market in Beijing. We assume the company accounts for only 70% of NGV gas B) Additional gas supply Proportion sales in Beijing over the long term. BEH/Kunlun's Shannxi-Beijing pipelines 15.2 bcm 46% BEH/Datang's coal-to-gas production plant in Keqi 4.0 bcm 12% BEH/Kunlun's Tangshan LNG receiving terminal in Tangshan 4.0 bcm 12%

Other sources (1) 9.8 bcm 30% Additional gas supply from Beijing-Tianjin-Hebei 33.0 bcm 100% Note (1): China Suntien Green Energy has formed a JV with Sinopec to supply 8bcm of gas to Hebei Province Source: Company, Daiwa forecasts

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 BEH: gas-transmission volume forecasts for Shaanxi-Beijing pipelines Other gas projects – coal-to-gas (bcm) plants, LNG terminals, and city- 35 90% 30 gas projects in other provinces 25 85% 20 In addition to the Shaanxi-Beijing pipelines, BEH owns 80% 15 stakes in other upstream/midstream natural-gas 10 infrastructure supplying to the Beijing-Tianjin- 75% regions. 5

0 70% 2008 2009 2010 2011 2012 2013E 2014E 2015E Keqi’s coal-to-gas plant due to be Gas transmission volume of SBJ pipelines - LHS commissioned by end-2013 Utilisation of SBJ pipelines - RHS Phase 1 of Keqi’s coal-to-gas project is due to be Source: Company, Daiwa forecasts commissioned by the end of 2013. BEH owns a 34% Recent slowdown of pipeline transmission stake while Datang International Power (Not rated) owns 51%. The CNY25.7bn project is divided into three sales not a concern phases, and will have a combined coal-to-gas For 1H13, BEH’s natural-gas transmission volume was production capacity of 4bcm/year. According to flat (up 0.7% YoY) compared with a rise of 24% YoY for management, the coal-to-gas project will mainly supply 1H12. Management said reduced demand in the gas to Beijing at a price of CNY2.7-2.75/bcm. CNPC northeast region and the commissioning of Dalian LNG will buy the gas from the Keqi plant and sell it to BEH receiving terminal were the main reasons for the at a fixed city-gate price (CNY2.05/m3 for residential slowdown in transmission volume. We believe another gas, and CNY3.14/ m3 for non-residential gas). We reason was the diversion of more gas sales to estimate the project IRR will be 8%. Guangdong, where the city-gate tariff was about CNY0.7/m3 higher than in the Hebei and Beijing areas, Pipeline connecting Tangshan LNG following the completion of the Guangdong section of receiving terminal to Beijing in 2014 West-East Pipeline II. Management expects the construction of ancillary However, with the city-gate tariff hike announced in pipelines for the Tangshan LNG receiving terminal to June 2013, we forecast the discount on the city-gate be completed in 2013, and be ready to carry gas in price in Beijing, Tianjin, and Hebei to narrow from 2014. Management expects a 10-12% project IRR. BEH about 18% for 2013 to about 5% for 2015, which would owns a 29% stake in the Tangshan LNG terminal, while provide CNPC with an incentive to supply gas to CNPC owns 51%, and China Suntien Green Energy Beijing, Tianjin, and Hebei in the future. Therefore, we owns 20%. see the recent city-gate price reform and air-pollution  Beijing: transmission of gas supplies mitigation policy supporting our forecast of a 10% Pipeline connecting Keqi’s coal-to- gas production plant CAGR in gas transmission volume for BEH over 2012- (to be commissioned in end-2013) Shaanxi-Beijing Pipeline #4 15. (to be commissioned in end-2015)

Legends  City-gate price premium of Guangdong over Beijing, Tianjin, Cogeneration and Hebei heating centres 25%

20% Pipeline connecting Tangshan LNG receiving terminal 15% (to be commissioned in 2014) Shaanxi-Beijing Pipeline #1, 2, 3 (in operation) 10%

5% Source: Provincial NDRC

0% Beijing Tianjin Hebei 2013E 2015E Source: NDRC

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Other city-gas projects We see the co-operation with BEH has more than 10 city-gas projects outside Beijing, mostly located in the north of the country, such as China Gas, and potential share Xinjiang, Shandong, Liaoning, Hebei, and Inner injection, as positive Mongolia. Since 2012, BEH’s parent, Beijing Enterprises Group  BEH: City-gas exposure outside Beijing (BEG) (Not listed), has accumulated a 22.01% stake in China Gas (CGHL) in the open market at prices ranging from HKD3-8/share. BEG is currently the largest shareholder in CGHL and appointed Zhou Si, the CEO of BEH, as chairman of CGHL’s board. BEH and CGHL have signed a co-operation agreement on: 1) co- developing CNG refuelling and distributed-energy projects in CGHL’s concession areas (about 200 locations nationwide), 2) jointly bidding on city-gas projects outside the Beijing area, and 3) exploring business opportunities in environmental utilities, such as water supply, wastewater treatment (WWT), and waste- Source: Company to-energy (WTE) projects, in CGHL’s concession areas.

   China Gas: city-gas operating concession areas in China

Source: Company

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We believe that BEH’s co-operation with CGHL will: 1) prevent competition between the two in city-gas No more toll roads: focus now on operations, 2) broaden the geographical exposure of environmental projects, such as the company’s city-gas operations beyond Beijing, and 3) enlarge its environmental-project market share in wastewater treatment and waste- China, given a solid relationship with CGHL and the to-energy municipal governments in the 21 provinces where it has concessions. BEH would also benefit from the 28% In 2012, BEH disposed of its loss-making toll-road total gas sales-volume CAGR we forecast for CGHL businesses and is now focusing on four major over 2013-16. businesses – natural gas, breweries, water utilities and waste-to-energy. Of these four, we prefer the gas, water Pending share injection of stake in CGHL and waste businesses, given their higher ROEs, of 8- into BEH should be value-accretive 11%, compared with the brewery’s 3%. In late July this year, BEG announced a plan to inject  BEH: ROE of various business segments in 2012 all of its 22.01% stake (which became 20.9% after 15% 10.9% CGHL acquired Fortune Gas through a combination of 9.4% cash and share in August) in CGHL to BEH for a 10% 7.6% consideration of HKD7.4bn (or HKD7.02/share for 5% 3.2% China Gas). The proposed share injection would be 0% settled by HKD2bn cash and 98.1m newly issued shares in BEH, at an issue price of HKD55/share. The 98.1m (5%) new shares in BEH would enlarge the diluted share (10%) -8.2% capital by 8.4% to 1,265m. The share injection proposal was passed by independent shareholders on 8 November 2013, and BEH targets to complete this by Waste-to-energy road operations

the end of 2013. Upon completion, BEG’s share in BEH Brewery operation Sewage and water treatment operation would rise to 61.13% from 57.86% currently. Piped gas operation Expressway and toll Source: Company

We believe the planned share injection would be value- BEW – water supply and WWT platform accretive to BEH’s shareholders given that we forecast EPS to rise by 3.4% YoY for 2014 and 1.2% YoY for As at the end of 1H13, Beijing Enterprises Water 2015. Should it go through, our SOTP NAV forecast for (BEW) (Not rated), BEH’s 48.97%-owned associate, BEH would rise from HKD70/share to HKD74.5/share, had 204 water plants, either in operation or under based on our EPS forecasts for CGHL for FY15-16. construction, and a total design capacity of 12.63mt/day.  BEH: EPS enhancement from potential CGHL stake injection (HKDm) 2014E 2015E Beijing Development – a future WTE CGHL's net profit 2,753 3,009 Before share injection platform BEH's net profit 4,827 5,977 According to management, BEH had commissioned BEH's number of diluted shares (m) 1,188 1,188 four solid waste-treatment projects in Wuhan, BEH's diluted EPS (HKD) 4.06 5.03 After share injection Henyang, Harbin, and Hainan by the end of 1H13. The BEH's share of CGHL's net profit 575 629 total treatment capacity was 10.7ktpd as of 1H13. Additional after-tax finance cost -6 -6 Additional no. of BEH's shares issued 98.1 98.1 Apart from organic growth, Beijing Development (Not Total BEH's net profit 5,396 6,600 rated), BEH’s 54.71%-owned subsidiary, has BEH's number of shares (m) 1,286 1,286 BEH's diluted EPS (HKD) 4.20 5.13 announced plans to acquire a stake in China Green EPS enhancement 3.3% 2.0% Energy (CGE) (Not listed), a leading WTE player based Source: Daiwa forecasts in Hangzhou that has 14 WTE projects and a total treatment capacity of 27ktpd (currently operating or According to management, BEH has to obtain approval being constructed). The total consideration for the CGE from independent shareholders, the listing committee stake acquisition would be HKD4.1-4.2bn, and would of the Hong Kong Stock Exchange, and CGHL. It be paid for with a combination of new shares and expects the share injection to be completed by convertible bonds. December this year.

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Upon completion of the stake acquisition, BEH plans to inject HKD3bn in cash and WTE assets currently held Valuation by BEH, into BED in exchange for the new shares, which would raise its ownership to about 50%. The As BEH is a utilities conglomerate engaged in different combined WTE assets under BEH and CGE would be businesses with different risk profiles, we employ an 1.6x bigger than those of the other leading listed WTE SOTP methodology to value the business, which we player, China Everbright International (Not rated). divide into five parts: 1) piped-gas operations, 2) the Similar to BEW, which is the listed investment vehicle water-treatment operation under BEW, 3) the brewery for BEH’s water utility, BED would be the listed business under Yanjing Brewery (Not rated), 4) Beijing investment vehicle for BEH’s future WTE projects. Development (Not rated), and 5) Biosino Bio-Tech (Not rated).  BEH: daily WTE capacity of the major China players (1H13) BEH CGE CEI CGE+BEH Our SOTP valuation yields a fair value of HKD70.0, (ktpd) (as of 1H13) (as of end-2012) BEH+CGE (as of 1H13) over CEI implying a 2014E PER of 17x, in line with the stock’s Existing capacity 10.73 18.00 28.73 9.65 3.0x Secured capacity past-five-year average. We believe our target PER is under pipeline - 9.00 9.00 13.45 .7x attractive, given the accelerated net-profit growth of Total capacity 10.73 27.00 37.73 23.10 1.6x 18-24% YoY we forecast over 2013-15, compared with Source: Company, Daiwa 5-18% YoY over 2009-12.

 BEH: acquisition of CGE by BED  BEH: SOTP valuation Current no. of shares of BJD (m) 854.46 Stake HKD/ % BEH's stake ownership 54.71% Business segment Valuation ownership share value Min Max Piped-gas operation DCF at 7.6% 100.0% 70.08 79% Acquisition price (HKDm) 4,134 4,173 (distribution and transmission) Shares/CB issuance price (HKD/share) 1.13 1.13 Listed water treatment operation - Market value 49.8% 12.70 14% No. of new shares issuance 3,658 3,693 371.HK Total no. of shares of BJD after CGE's acquisition 4,513 4,547 Listed brewery business - 000729 SS Market value of A-share- 45.2% 5.16 6% listed comparable Dilution 81.1% 81.2% Tsingtao Brewery BEH's stake ownership 10.36% 10.28% (with 5% discount) CGE's stake ownership 81.07% 81.21% Beijing Development (154 HK) Market value 53.6% 0.85 1% Biosino Bio-Tech (8247 HK) Market value 20.8% 0.06 0% Capital to be injected by BEH through ‘Standby CBs’ (HKDm) 3,000 Corporate value 88.84 100% Standby CB issuance price (HKD/share) 1.13 Net cash/(debt) (18.83) No. of new shares issued 2,655 Price target 70.00 Min Max Source: Bloomberg, Daiwa forecasts Total no. of shares after BEH’s capital injection and CGE’s acquisition 7,168 7,202 Dilution 37.0% 36.9% BEH’s stake ownership 43.6% 43.4% CGE’s stake ownership 51.0% 51.3% Source: Company, Daiwa

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- 108 -

Utilities / China 1193 HK Utilities / China 11 November 2013

China Resources Gas

China Resources Gas Target (HKD): 20.50 Upside: 3.4% 1193 HK 7 Nov price (HKD): 19.82

Initiation: margin risks likely to outweigh benefits from M&A 1 Buy 2 Outperform • Less focus on NGV gas sales could lead to lower gas sales gross 3 Hold (initiation) margin under a further city-gate tariff hike in 2014-15E 4 Underperform • Further M&A for big cities could take more time 5 Sell • Valuation premium seems unjustified; initiating with Hold rating

How do we justify our view?

established city-gas distribution ■ Risks joint venture in Tianjin accounted Key downside risks include a for just 3% of CRG’s 1H13 net profit turnaround in earnings at the Tianjin despite a gas sale of 800m m3 (13% joint venture and green-field projects contribution of CRG’s gas sales). taking more time than we expect to Dennis Ip, CFA break even. Key upside risks are (852) 2848 4068 Impact of tariff hike. Unlike ENN better-than-expected profit margins [email protected] and CGHL, CRG focuses on and gas sales from new projects. acquiring new city-gas projects Gary Zhou rather than gaining NGV market (852) 2773 8535 share. A lack of NGV gas sales could [email protected] Share price performance mean the company faces increased risk of a margin squeeze in C&I gas (HKD) (%) 23 135 ■ Investment case under a planned CNY0.85/m3 hike in city-gate gas tariff for base 21 123 We initiate coverage of CRG, one of 19 110 China’s leading city-gas distributors, volume over 2014-15. 17 98 with a Hold (3) rating. We expect 15 85 earnings growth to continue to be ■ Catalysts Nov-12 Feb-13 May-13 Aug-13 Nov-13 boosted by acquisitions, but it will Near-term catalysts include Ch Res Gas (LHS) Relative to HSI (RHS) take time for these to flow through potential value-accretive M&A, to profit, while the gross-profit which we see as unlikely given that 12-month range 15.92-22.60 margin on big-city projects should municipal governments are aware of Market cap (USDbn) 5.69 take time to rise. Meanwhile, a lack the value of city-gas projects 3m avg daily turnover (USDm) 8.50 following ENN/Sinopec’s failed Shares outstanding (m) 2,224 of NGV gas sales should see a fall in Major shareholder China Resources Group (70.5%) the gross-profit margin for 2015. attempted takeover of China Gas in 2012. Financial summary (HKD) Strong M&A pipeline but profit Year to 31 Dec 13E 14E 15E contribution far off. In 2012, ■ Valuation Revenue (m) 22,088 25,791 30,610 CRG acquired 78 city-gas projects, We have a DCF-based target price of Operating profit (m) 3,617 3,956 4,162 HKD20.5. The stock is trading Net profit (m) 2,168 2,642 2,950 doubling its portfolio to 158. Core EPS (fully-diluted) 0.975 1.188 1.326 However, the number of green-field currently at 2014E PER of 17x, at the EPS change (%) 19.0 21.8 11.7 projects was increased by 25 to a top of the range of its China peers’ Daiwa vs Cons. EPS (%) 0.5 (0.6) (8.5) total of 39 in 1H13, leading to a total 14-17x. Our target price excludes a PER (x) 20.3 16.7 14.9 50 loss-making projects at the end of further HKD8bn in acquisitions Dividend yield (%) 1.0 1.2 1.3 planed by management over 2013-15 DPS 0.195 0.238 0.265 1H13. While we see the strong M&A PBR (x) 3.3 2.8 2.5 growth as positive, we are concerned due to the lack of certainty and EV/EBITDA (x) 10.7 9.7 8.9 that ROIC could fall over the near information. ROE (%) 17.2 18.2 17.6 term. For example, the recently Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 121 China Gas Sector 11 November 2013

1 Buy How do we justify our view? 2 Outperform

3 Hold (initiation)  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CRG: total gas sales volume forecasts We forecast a total gas-sales volume CAGR for CRG of (Unit: bcm) 26% for 2012-15, largely supported by the acquisition of 20,000 160% 79 city-gas projects in 2012, the establishment of a joint 140% venture city-gas project in Tianjin with Tianjin Gas 15,000 120% completed in January 2013, and the planned 100% establishment of a city-gas distribution joint venture in 10,000 80% Ningbo in 2014. Our total gas-sales forecast for 2015 of 60% 18.7bcm is below the company’s guidance of 20bcm. 5,000 40% This is because we do not factor in a further HKD8bn in 20% planned acquisitions, due to a lack of clarity on the 0 0% timeline. 2009 2010 2011 2012 2013E 2014E 2015E Total gas sales volume (LHS) Total gas sales volume YoY growth (RHS) Source: Company, Daiwa forecasts

 Valuation  CRG: 12-month-forward PER

Based on our 2013E EPS forecast, the stock is trading (x) 23 currently at 0.1 SD above its past-four-year average PER 22.1x Avg+2SD of 16.4x. For our DCF valuation, we use a WACC of 7.2% 21 and a terminal growth rate of 2%. 19 19.3x Avg+1SD 17 16.4x Avg 15 We believe the valuation premium to its peers over 13 13.5x Avg-1SD 2010-12 was due to the injection of several value- 11 10.7x Avg-2SD accretive assets from the company’s parent, China 9 Resources Holdings (CRH). However, we understand 7 that no further asset injections are planned. We believe 5 that the recent M&A deals will take more time than Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 usual to complete and turn around. Therefore, we Source: Bloomberg, Daiwa forecasts believe a valuation premium to the stock’s past-five-year level is no longer justified.

 Earnings revisions  CRG: consensus earnings-forecast revisions

The Bloomberg-consensus 2013-14 EPS forecasts were (HKD) raised in 2012, when CRG completed the acquisitions of 1.25 a large number of city-gas projects, and have been little 1.20 changed since then. 1.15 1.10 1.05 However, we are cautious on the outlook for the 1.00 company as it will take time for management to make 0.95 the projects profitable, with the same true for future 0.90 M&A. 0.85 0.80 Jul-12 Jul-13 Apr-12 Apr-13 Oct-12 Oct-13 Jan-12 Jun-12 Jan-13 Jun-13 Feb-12 Mar-12 Feb-13 Mar-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 May-12 May-13 2013E EPS 2014E EPS Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Natural gas sales volume (mn m3) 1,415 2,214 5,574 7,216 9,268 13,547 16,194 18,773 Gas ASP, incl tax (HKD/m3) 2.04 2.15 2.55 2.73 3.06 3.49 3.73 4.02 Gas purchase cost, incl tax (HKD/m3) 1.55 1.62 2.04 2.15 2.37 2.55 2.89 3.31 Residential gas connection ('000 361 595 926 1,005 1,129 1,215 1,234 1,256 houesholds) Gross profit contribution - connection 29 41 48 42 42 37 34 31 fee (%)

 Profit and loss (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales of gas 1,903 3,096 7,175 11,254 15,541 17,896 21,474 26,205 Gas connection 622 1,014 2,157 2,954 4,050 4,192 4,317 4,404 Other Revenue 842000000(0) Total Revenue 3,367 4,110 9,332 14,208 19,591 22,088 25,791 30,610 Other income 102 165 226 459 573 646 754 895 COGS (2,359) (2,858) (6,594) (10,043) (13,572) (15,013) (17,875) (21,839) SG&A (617) (740) (1,531) (2,520) (3,581) (4,103) (4,714) (5,503) Other op.expenses (218) (192) (430) (561) (753) (1,032) (1,287) (1,455) Operating profit 437 677 1,434 2,103 3,011 3,617 3,956 4,162 Net-interest inc./(exp.) (31) (40) (82) (88) (334) (565) (541) (512) Assoc/forex/extraord./others 3 7 16 119 125 1,012 1,360 1,562 Pre-tax profit 409 644 1,367 2,135 2,803 4,065 4,775 5,212 Tax (65) (85) (329) (563) (768) (1,101) (1,279) (1,381) Min. int./pref. div./others (47) (99) (252) (396) (384) (795) (854) (881) Net profit (reported) 297 460 787 1,176 1,651 2,168 2,642 2,950 Net profit (adjusted) 297 460 787 1,176 1,651 2,168 2,642 2,950 EPS (reported)(HKD) 0.621 0.343 0.545 0.612 0.819 0.975 1.188 1.326 EPS (adjusted)(HKD) 0.621 0.343 0.545 0.612 0.819 0.975 1.188 1.326 EPS (adjusted fully-diluted)(HKD) 0.620 0.343 0.545 0.612 0.819 0.975 1.188 1.326 DPS (HKD) 5.711 0.063 0.064 0.091 0.119 0.195 0.238 0.265 EBIT 437 677 1,434 2,103 3,011 3,617 3,956 4,162 EBITDA 599 869 1,863 2,664 3,764 4,649 5,243 5,618

 Cash flow (HKDm) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Profit before tax 409 644 1,367 2,135 2,803 4,065 4,775 5,212 Depreciation and amortisation 162 192 430 561 753 1,032 1,287 1,455 Tax paid (65) (85) (329) (563) (768) (1,101) (1,279) (1,381) Change in working capital 891 653 1,219 768 2,143 163 1,239 1,771 Other operational CF items (660) (397) (1,007) (889) 113 (1,012) (1,360) (1,562) Cash flow from operations 737 1,007 1,680 2,012 5,043 3,146 4,661 5,495 Capex (665) (628) (1,966) (1,954) (3,776) (2,860) (2,860) (2,860) Net (acquisitions)/disposals (331) (760) 63 (1,097) (2,273) (4,000) (2,000) 0 Other investing CF items 294 (531) 7 232 (253) (188) (188) (188) Cash flow from investing (702) (1,919) (1,896) (2,819) (6,302) (7,048) (5,048) (3,048) Change in debt (133) 2,443 1,109 736 3,946000 Net share issues/(repurchases) 875 (254) 2,473 0 2,712000 Dividends paid (18) (139) (136) (187) (428) (240) (434) (528) Other financing CF items (1,246) 113 287 (303) 192000 Cash flow from financing (522) 2,163 3,732 245 6,422 (240) (434) (528) Forex effect/others 00000000 Change in cash (487) 1,250 3,516 (562) 5,163 (4,143) (821) 1,918 Free cash flow 72 379 (286) 58 1,267 286 1,801 2,635 Source: FactSet, Daiwa forecasts

- 111 - China Gas Sector 11 November 2013

Financial summary continued …

 Balance sheet (HKDm) As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Cash & short-term investment 1,348 2,691 6,722 7,178 12,381 8,238 7,418 9,336 Inventory 51 160 269 464 747 804 817 831 Accounts receivable 328 668 1,771 3,095 4,366 3,408 4,089 4,990 Other current assets 235 550 536 757 912 701 841 1,084 Total current assets 1,962 4,070 9,298 11,494 18,406 13,152 13,165 16,241 Fixed assets 1,642 4,080 9,101 12,395 17,712 23,577 27,187 28,631 Goodwill & intangibles 679 829 1,244 1,968 2,532 2,394 2,386 2,378 Other non-current assets 244 1,738 1,137 2,981 3,749 3,288 3,576 5,026 Total assets 4,527 10,717 20,779 28,838 42,399 42,410 46,314 52,276 Short-term debt 108 1,340 534 1,677 239 239 107 107 Accounts payable 1,175 2,004 3,667 4,473 6,239 5,925 7,054 8,619 Other current liabilities 449 833 2,789 4,900 8,449 6,559 6,337 7,390 Total current liabilities 1,732 4,176 6,990 11,050 14,928 12,723 13,499 16,116 Long-term debt 39 1,392 5,156 5,014 11,622 11,622 11,622 11,622 Other non-current liabilities 216 1,991 649 908 1,045 732 893 997 Total liabilities 1,988 7,559 12,795 16,972 27,595 25,076 26,014 28,735 Share capital 141 141 183 199 222 222 222 222 Reserves/R.E./others 2,087 2,283 5,648 9,119 11,482 13,216 15,330 17,690 Shareholders' equity 2,229 2,425 5,832 9,319 11,704 13,439 15,552 17,912 Minority interests 311 733 2,152 2,547 3,100 3,895 4,748 5,630 Total equity & liabilities 4,527 10,717 20,779 28,838 42,399 42,410 46,314 52,276 EV 43,180 44,831 45,115 44,445 44,798 49,605 51,010 49,829 Net debt/(cash) (1,200) 40 (1,032) (486) (520) 3,623 4,311 2,393 BVPS (HKD) 1.576 1.714 3.185 4.677 5.263 6.043 6.993 8.054

 Key ratios (%) Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015E Sales (YoY) (45.4) 22.1 127.0 52.3 37.9 12.7 16.8 18.7 EBITDA (YoY) (3.5) 45.0 114.4 43.0 41.3 23.5 12.8 7.1 Operating profit (YoY) (29.7) 55.0 111.7 46.7 43.1 20.1 9.4 5.2 Net profit (YoY) (25.7) 54.9 71.3 49.4 40.4 31.3 21.8 11.7 Core EPS (fully-diluted) (YoY) (56.2) (44.7) 58.9 12.3 33.8 19.0 21.8 11.7 Gross-profit margin 29.9 30.5 29.3 29.3 30.7 32.0 30.7 28.7 EBITDA margin 17.8 21.1 20.0 18.8 19.2 21.0 20.3 18.4 Operating-profit margin 13.0 16.5 15.4 14.8 15.4 16.4 15.3 13.6 Net profit margin 8.8 11.2 8.4 8.3 8.4 9.8 10.2 9.6 ROAE 26.6 19.8 19.1 15.5 15.7 17.2 18.2 17.6 ROAA 13.1 6.0 5.0 4.7 4.6 5.1 6.0 6.0 ROCE n.a. 23.0 14.7 13.1 13.3 13.0 12.9 12.4 ROIC n.a. 36.7 21.5 16.9 17.0 15.0 12.7 12.1 Net debt to equity net cash 1.7 net cash net cash net cash 27.0 27.7 13.4 Effective tax rate 16.0 13.3 24.0 26.4 27.4 27.1 26.8 26.5 Accounts receivable (days) 17.8 44.3 47.7 62.5 69.5 64.2 53.1 54.1 Current ratio (x) 1.1 1.0 1.3 1.0 1.2 1.0 1.0 1.0 Net interest cover (x) 14.0 16.8 17.6 24.0 9.0 6.4 7.3 8.1 Net dividend payout 919.2 18.5 11.7 14.8 14.6 20.0 20.0 20.0 Free cash flow yield 0.2 0.9 n.a. 0.1 2.9 0.6 4.1 6.0 Source: FactSet, Daiwa forecasts

 Company profile China Resources Gas is one of the leading city-gas distributors in China, owning 159 projects (as of June 2013) with geographical focus on economically developed and densely populated city

- 112 - China Gas Sector 11 November 2013

 CRG: location of regional operation, and design and construction centres

Margin risks likely to outweigh benefits from M&A

Initiating coverage with a Hold rating

Company background

Source: Company CRG is one of the Big-4 Mainland city-gas distributors in terms of the number of its city-gas distribution concessions (159 as at the end of June 2013). With the M&A no longer worth a premium support of conglomerate parent CRH, the company has valuation been the biggest acquirer of large city-gas projects since 2008, with projects in 11 provincial capitals and Since the company’s transformation into a city-gas three municipalities in its city-gas project portfolio distribution utility in 2H08 (prior to that, it was currently. engaged in the microelectronic business), CRG has

 CRG: geographical footprint been trading at a PER premium to its peers given the expectation that its parent, CRH, would continue to inject city-gas assets into the company at a discount. We believe this valuation premium will now narrow as: 1) CRH finished injecting all its assets into CRG in August 2012, 2) external project acquisitions could be pricey, 3) the M&A of large projects take long periods to complete, 4) a significant number of green-field projects are likely to remain loss-making over the near term, and 5) newly-acquired big projects, such as the one in Tianjin, will take time to turn around.

 China gas distribution: forward-PER valuation comparison (x) 30

25 Source: Company 20

5 -12 -13 -12 -13 y y p p Jul-10 Jul-11 Jul-12 Jul-13 Jan-10 Jan-11 Jan-12 Jan-13 Mar-10 Mar-11 Mar-12 Mar-13 Sep-10 Nov-10 Sep-11 Nov-11 Se Se Nov-12 May-10 May-11 Ma Ma

ENN BEH CR Gas China Gas Towngas Kunlun Source: Bloomberg, Daiwa

 China gas distribution: forward PER since 2010 ENN BEH CRG CGHL TCCL Kunlun Average PER since 2012 16.6x 17.0x 17.4x 13.7x 14.0x 13.5x Source: Bloomberg, Daiwa

- 113 - China Gas Sector 11 November 2013

Unlike its peers, ENN and CGHL, CRG is focused on these projects to continue to make losses and have no M&A and turning around its Tianjin joint venture significant gas sales at least until 2016. rather than expanding into the NGV refuelling business. We believe the company faces increased risk Meanwhile, we believe the acquisition of external of a profit-margin squeeze from a planned tariff hike of projects in the future will be at high valuations, as the CNY0.85/m3 in the non-residential city-gate gas price market realised the value of city-gas assets after over 2014-15. Sinopec/ENN’s failed attempt at a hostile takeover of China Gas in 2012. Value-accretive injection story now over  CRG: number of green-field projects to total projects Following the last round of asset injections in August 160 25% 2012, there are no more city-gas projects available for 140 CRH to inject into CRG at a discount. As a result, 120 20% CRG’s future inorganic growth has become less visible. 100  CRG: past asset injections 80 15% CRG’s 60 Stakes Target PER PER at Discount 40 10% Date Project acquired Consideration of project the time to CRG 20 Injection from parent Aug 7 city-gas projects 36-100% HKD3.8bn 15x 18x 15% 0 5% 2008 (Chengdu, Wuxi, 2008 1H09 2009 1H10 2010 1H11 2011 1H12 2012 1H13 Suzhou, Nanjing, Total operating projects (LHS) Total green-field projects (LHS) Fuyang, Huaibei, Linhai) Green-field projects ratio (RHS) Sep 7 city-gas projects 49-100% HKD1.6bn 13x 24x 46% Source: Company, Daiwa 2009 (Zhenjiang, Zibo, Xiangfan, Datong, Yangquan, Yicheng, Large new projects take time to acquire: Qianjiang) Tianjin and Ningbo case studies Sep 9 city-gas projects 49-100% HKD2.0bn 20x 22x 12% 2010 (Xiamen, Jining, One of the major reasons for CRG’s PER premium to Suining, Tengzhou, its peers is the company’s ability to acquire city-gas Shifang, Kunshan, Qidong, Gucheng, projects in major cities, such as Chengdu, Chongqing, Hangzhouwan) Zhengzhou, Tianjin, and Ningbo. However, it has taken Jul 7 city-gas projects 40-100% HKD1.71bn 17x 17x -3% more time than it expected to set up joint ventures in 2011 (Yueyang, Zhongshan, Jingdezhen, Anyang, these cities. Huizhou Dayawan, Dandong, Dalian Huayuankou) For example, it took CRG 2.5 years to complete the Aug 16 city-gas projects 49-100% HKD2.42bn 47x 18x -157% Tianjin JV with Tianjin Gas (Not listed) after the 2012 (Fuzhou, Nanchang, parties entered into a co-operation agreement in June Jiangmen, Dongying, Taizhou, Heyuan, 2010. The establishment of a joint venture in Ningbo, Fuzhou LPG, announced in December 2011, is due to be completed Nanzhang, Guixi, Haicheng, Fenghua, by the end of 2014. Given these cases, we believe it will Tonghua, Yunnan take CRG at least two years to set up any large city-gas Pipeline, Jinzhou, joint venture, meaning that no profit contribution from Wannian) them would be likely over the near term. Source: Company, Daiwa

New green-field projects should continue to makes losses over the near term CRG has completed the acquisition of 86 city-gas projects since January 2012. About 29% of those are green-field projects, which could take at least three years to be ramped up in order to break even, assuming that a supply of gas is available for these new projects. For example, TCCL’s management usually expect gas sales only five years after a new green-field project has been established. Our research shows that the proportion of green-field projects in CRG’s portfolio rose from 9% for 1H11 to 25% for 1H13. We expect

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 CRG: number of green-field projects to total projects According to CRG’s management, the Tianjin JV CR Gas Signed Co-operation Signed the JV Contract, JV proposal completed accounts for a small net profit currently given a net Tianjin Agreement with the Supplement approved by cash The JV was margin of about 3% (it is typically 11-12% for city-gas Tianjin Gas for the Agreement, and the Ministry of injection to officially proposed JV Articles of Association Commerce the JV established projects), even though it achieved gas sales of 800m m3 (13% of the total for CRG). CRG’s management said June 2010 Nov 2011 Nov 2012 Jan 2013 Apr 2013 that the joint venture needed time to improve its operations and to invest in a new pipeline in Binhai to 2.5 years boost both gas sales volume and the net margin. It said Signed Co-operation Agreement with Ningbo Official it expected the joint venture to contribute a material Urban Construction and establishment Ningbo Ningbo Xingguang Gas for of JV profit in 2015 or 2016. the proposed JV (expected)  Tianjin JV: total gas sales and net-margin forecasts Dec 2011 2014 (expected) (Unit: bcm) 2-3 years 7 12% 6 Source: Company, Daiwa 10% 5 8% Tianjin takes time to contribute 4 6% This year, CRG completed the establishment of a city- 3 4% gas joint venture with Tianjin Gas. CRG has paid 2 CNY2.45bn in cash for a 49% stake, while Tianjin Gas 1 2% has injected CNY2.55bn worth of city-gas assets, 0 0% mainly in the Tianjin suburbs and the new Binhai area. 2012 2016E Tianjin Tianlian (Not rated), a gas operator under Total gas sales for Tianjin JV (LHS) Net margin of Tianjin JV (RHS) Tianjin Gas, owns the gas concessions in the centre of Source: Company, Daiwa forecasts Tianjin city. CRG expects gas sales for the joint venture to increase four-fold, from 1.6bcm for 2012 to 6.4bcm for 2016, mainly supported by new industrial customers in Binhai, and demand from gas-fired Impact of city-gate tariff hikes cogeneration plants and heating centres in Tianjin’s suburbs. CRG’s share price fell by 15% between the end of June 2013 and the end of August, due to concerns about a  Map of Tianjin showing the Binhai area city-gate tariff hike. With effect from 10 July 2013, the NDRC increased the city-gate non-residential natural gas price by 15%, to CNY1.95/m3 from CNY1.69/m3. This is part of a bigger plan that will allow a substantial one-off price rise and under which China will adopt a ladder-like pricing mechanism for incremental natural gas, which the NDRC expects to account for 9% of total piped gas supply for 2013. The plan also provides a grace period, until 2015, for the price of the 2012 base volume (91% of piped-gas supply for 2013) to be linked to competing fuels, such as heating oil and LPG, with a 15% discount.

Another rise in non-residential gas (base volume) price nationwide likely between 2013-15 Under the planned city-gate tariff-hike schedule, there will be a 42% price rise (nationwide) at the city gate, to CNY2.77/m3 from CNY1.95/m3, by 2015. This would mean the total tariff rise from the level of June 2013 for

Source: Daiwa city-gate non-residential customers would be CNY1.08/m3.

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 Average city-gate price for non-residential gas in 2013-15E Based on our analysis, we believe city-gas operators (CNY/m3) will see profit-margin compression in C&I gas sales 3.00 2.77 over the next few years. This is because natural gas is

2.50 likely to have a price premium to competing fuels, 1.95 leading to demand destruction when the price rise 2.00 1.69 under the NDRC’s plan, of CNY0.88/m3 (national 1.50 average) on base volume over 2013-15, has to be passed through fully to customers. NGV gas, however, would 1.00 still be priced at a 28% (39% currently) discount to 0.50 competing fuels – petrol and diesel – even if 100% of the city-gate tariff hike of CNY0.88/m3 were passed on 0.00 Average city-gate price, Average city-gate price, Average city-gate price, fully in 2015. Therefore, city-gas operators should be CNY/m³ (before July-2013) CNY/m³ (after July-2013) CNY/m³ (as of July-2015E) able to pass through the city-gate hike completely to Source: NDRC, Daiwa NGV customers.

 Discount/premium to competing fuels for NGV gas and Lack of NGV gas sales could leave industrial gas (2015) 50% CRG open to a potential margin 40% squeeze from non-residential 30% 20% city-gate tariff hikes 10% 0% According to management, CRG aims to have 300 NGV (10%) refuelling stations (mostly CNG) by 2015, far below (20%) those of its peers, ENN and CGHL, of 800 and 600, (30%) respectively. The company sees the non-exclusive Anhui Hebei Hubei Hunan Tianjin Gansu Beijing Jiangsu Sichuan nature of the NGV refuelling business and its lack of Shanghai Shandong Chongqing Shengyang Guangzhou LNG resources as reasons for it not focusing too much Heilongjiang on developing its NGV refuelling operation. So rather NG discount for industrial usage NG discount for vehicular usage than develop its LNG business by itself, CRG recently Source: Provincial NDRCs, Daiwa entered into a joint venture with Sinopec in Wuxi to build LNG refuelling stations for vehicles and river Given that NGV gas sales account for 14% of CRG’s vessels. This joint venture has 25 LNG/L-CNG total sales, compared with 15-21% for its peers, we see refuelling stations in operation. Nevertheless, we the company as being more likely to face a profit- believe expanding NGV gas sales could raise the gross margin squeeze in 2015. margin, as the unit dollar margin on NGV gas is 56%  China gas distribution: number of NGV refuelling stations higher than that of C&I gas, and 226% higher than that 900 of residential gas for CRG. 800 700  CRG: unit dollar margin of C&I and NGV gas (2012) 600 (CNY/m3) 500 1.2 400 1.0 300 200 0.8 100 0.6 0 2011 2012 2013E 2014E 2015E 0.4 CRG China Gas ENN 0.2 Source: Companies, Daiwa forecasts

0.0 Residential C&I Vehicular Source: Provincial NDRCs, Daiwa

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 China gas distribution: NGV gas sales contribution forecasts In our model, we assume that CRG will only able to 25% pass through 96% of the planned rise in city-gate price to C&I customers, which results in our 2015 earnings 20% forecast being lower than that of the consensus.

15% Our analysis suggests that for every 5% of the city-gas price hike that CRG is not able to pass through to its utilities customers, it would see a 3% fall in 2016E 10% earnings and a 0.45pp fall in 2016E ROE.

5% CRG has passed through 80% of the July 2011 2012 2013E 2014E 2015E incremental piped-gas cost rise CRG China Gas ENN Source: Companies, Daiwa forecasts According to management, as at the end of September 2013, CRG had passed through 80% of the non- Based on our assumptions for C&I’s gross-profit residential gas-volume tariff rise that came into effect margin and CNG volume growth, we forecast the gross in July. It expects all of the rise to be passed through by margin on CRG’s gas sales to drop from 25.0% for 2013 the end of this year. to 22.7% for 2016.

 CRG: gross-profit margin on piped gas sales Valuation 25.5% We value CRG using a DCF methodology, as we think 25.0% this best reflects the stable long-term income we expect based on our gas-sales volume and residential- 24.5% connection forecasts. We use a WACC of 7.2% and a

24.0% terminal growth rate of 2%. Our DCF-based valuation yields a fair value of HKD20.5, implying a 17x 2014E 23.5% PER.

23.0% The stock is trading currently at a 2014E PER of 17x,

22.5% which is at the top of the range of its China peers’ 14- 2013E 2014E 2015E 2016E 17x. Source: Daiwa forecasts

Impact of city-gate tariff hikes We assess the sensitivity of CRG’s NAV, 2016E earnings, and 2016E ROE to different pass-through levels for C&I gas sales at the end of 2015.

 CRG: sensitivity of NAV, net profit, and ROE to different levels of industrial gas hike pass-through in 2016E % of hike not able to be passed 2016 net 2016 Industrial through NAV profit 2016 ROE tariff Base case 20.52 3,417 17.8% 4.18 -5% 19.78 3,316 17.3% 4.16 -10% 19.05 3,216 16.9% 4.13 -15% 18.34 3,119 16.5% 4.11 Source: Daiwa estimates

 CRG: degree of sensitivity of NAV, net profit, ROE to different levels of industrial gas hike pass-through relative to base case (2016E) NAV 2016 net profit 2016 ROE 2016 industrial tariff -3.6% -3.0% -.45pp -0.6% -7.1% -5.9% -.90pp -1.2% -10.6% -8.7% -1.35pp -1.8% Source: Daiwa estimates Note: Changes correspond to the respective 5%, 10% and 15% hike pass-through percentages shown in the first table

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 CRG: DCF valuation 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Risks Year 0 0 1 2 3 4 5 6 Net income 2,168 2,642 2,950 3,417 4,013 4,644 3,035 3,527 Interest x (1-tax) 412 396 376 361 345 329 309 293 The key downside risks to our view include CRG taking Depreciation 1,032 1,287 1,445 1,580 1,705 1,830 1,955 2,000 a prolonged period to achieve a net-margin of about Change in working 10% (normal level for a city-gas project) for the Tianjin capital 163 1,239 1,771 1,753 1,174 1,006 754 454 JV and more time than we expect for the green-field Capex (6,860) (4,860) (2,860) (2,860) (2,860) (2,860) (2,860) (2,860) FCF (3,086) 704 3,692 4,250 4,377 4,449 3,194 3,495 projects to break even, which we have discussed in the Discount factor previous section. We see the likelihood of both these (base 2013) 1.00 1.00 0.93 0.87 0.81 0.76 0.71 0.66 risks materialising as high. PV cash flow (base 2013) (3,280) 704 3,446 3,702 3,588 3,755 2,261 2,309 Terminal growth rate 2.0% Key upside risks would be a better-than-expected net margin and gas-sales contributions from new projects, Sum PV cash flow and CRG expediting the business-integration process (to 2020) 19,733 PV of terminal value to achieve operational synergies and bulk material (from 2021) 30,205 purchases co-ordinated by its regional operation, and Minus net debt on design and construction centres. We see the likelihood balance sheet (4,311) of both these risks materialising as low. Equity value (CNY) 45,627 Exchange rate (HKD/CNY) 1.26 NPV/share (HKD) 20.5 Valuation assumption China risk free rate 3.5% Market risk premium 9.0% Beta 0.69 Cost of equity 9.7% Yr n-1 debt/capitalisation 35.0% Pre-tax cost of debt 3.2% After-tax cost of debt 2.4% WACC 7.2% Source: Daiwa forecasts

 CRG: DCF sensitivity over WACC and terminal growth rate WACC 6.0% 6.5% 7.2% 7.5% 8.0% 3.0% 34.1 28.8 24.0 21.9 19.6 Terminal 2.5% 30.1 26.0 22.0 20.4 18.3 growth rate 2.0% 27.2 23.8 20.5 19.1 17.3 1.5% 24.9 22.1 19.3 18.0 16.5 1.0% 23.0 20.7 18.2 17.1 15.7 Source: Daiwa estimates

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Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Daiwa’sRegional Deputy Asia Head Pacific of Asia Pacific Research Research Directory Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Rohan DALZIELL (852) 2848 4938 [email protected] Shipbuilding; Steel Regional Head of Product Management Jun Yong BANG (82) 2 787 9168 [email protected] Kevin LAI (852) 2848 4926 [email protected] Tyres; Chemicals Deputy Head of Regional Economics; Macro Economics (Regional) Mike OH (82) 2 787 9179 [email protected] Christie CHIEN (852) 2848 4482 [email protected] Capital Goods (Construction and Machinery) Macro Economics (Taiwan) Sang Hee PARK (82) 2 787 9165 [email protected] Jonas KAN (852) 2848 4439 [email protected] Consumer/Retail Head of Hong Kong Research; Head of Hong Kong and China Property Jae H LEE (82) 2 787 9173 [email protected] Jeff CHUNG (852) 2773 8783 [email protected] IT/Electronics (Tech Hardware and Memory Chips) Automobiles and Components (China) Joshua OH (82) 2 787 9176 [email protected] Grace WU (852) 2532 4383 [email protected] IT/Electronics (Handset Components) Head of Greater China FIG; Banking (Hong Kong, China) Thomas Y KWON (82) 2 787 9181 [email protected] Jerry YANG (852) 2773 8842 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Banking (Taiwan); Insurance (Taiwan and China) Leon QI (852) 2532 4381 [email protected] TAIWAN Banking (Hong Kong, China); Broker (China) Mark CHANG (886) 2 8758 6245 [email protected] Winston CAO (852) 2848 4469 [email protected] Head of Taiwan Research Capital Goods – Machinery (China) Steven TSENG (886) 2 8758 6252 [email protected] Eric CHEN (852) 2773 8702 [email protected] IT/Technology Hardware (PC Hardware) Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Christine WANG (886) 2 8758 6249 [email protected] Felix LAM (852) 2532 4341 [email protected] IT/Technology Hardware (Automation); Cement; Consumer Head of Materials (Hong Kong, China); Cement and Building Materials (China, Kylie HUANG (886) 2 8758 6248 [email protected] Taiwan); Property (China) IT/Technology Hardware (Handsets and Components) Dennis IP (852) 2848 4068 [email protected] Lynn CHENG (886) 2 8758 6253 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China) IT/Electronics (Semiconductor) John CHOI (852) 2773 8730 [email protected]

Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China) INDIA Joey CHEN (852) 2848 4483 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Steel (China) Head of India Research; Strategy; Banking/Finance Kelvin LAU (852) 2848 4467 [email protected] Navin MATTA (91) 22 6622 8411 [email protected] Head of Transportation (Hong Kong, China); Transportation (Regional) Automobiles and Components Jibo MA (852) 2848 4489 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group; Custom Products Group Capital Goods; Utilities Thomas HO (852) 2773 8716 [email protected] Mihir SHAH (91) 22 6622 1020 [email protected] Custom Products Group FMCG/Consumer

Deepak PODDAR (91) 22 6622 1016 [email protected] PHILIPPINES Materials Norman H PENA (63) 2 813 7344 [email protected] ext 301 Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] Banking/Property Oil and Gas; Utilities Michael David (63) 2 813 7344 [email protected] MONTEMAYOR ext 293 SINGAPORE Consumer/Retail Adrian LOH (65) 6499 6548 [email protected] Patricia PALANCA (63) 2 813 7344 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and ext 408 China); Capital Goods (Singapore) Utilities/Mining David LUM (65) 6329 2102 [email protected] Property and REITs Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)

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- 121 - China Gas Sector 11 November 2013

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The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months.

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