15 December 2017

Last Closing: HK$ 5.63 Upside: +42% Target Price: HK$ 8.00 Gas Utilities Sector Tian Lun Gas (1600 HK) UP MP OP A gas utilities laggard to unleash M&A-driven growth potential

Initiation of coverage

Financial Highlights

Y/E 31 Dec 2015 2016 2017E 2018E 2019E Revenue (RMB m) 2,252 2,693 3,178 3,714 4,335 NEUTRAL YoY growth (%) 67.6 19.6 18.0 16.8 16.7 Net profit (RMB m) 284 313 390 477 569 EPS (RMB) 0.282 0.317 0.394 0.482 0.575 SELL EPS growth (%) 5.9 12.5 24.4 22.4 19.2 P/E (x) 16.9 15.1 12.1 9.9 8.3 BVPS (RMB) 2.326 2.457 2.760 3.131 3.573 P/B (x) 2.1 1.9 1.7 1.5 1.3

Dividend yield (%) 0.0 1.6 1.9 2.3 2.8 We initiate coverage on Tian Lun Source: Company data, BOCOM Int’l estimates Gas (TLG) with a Buy rating and More than tenfold increases in revenue and retail gas sales in 2010-16. Since its DCF-based TP of HK$8.00. founding in 2002, Tian Lun Gas (TLG) has been growing fast in terms of revenue and gas TLG’s management emphasized acquisition-driven growth ahead sales volume. From 2002 to 2007, TLG laid the foundation for future growth by gaining with prudent project selection. three projects in key cities in Province. After its listing in 2010, TLG started to We forecast TLG’s 3-year earnings expand quickly through a series of acquisitions. Since 2011, TLG has acquired 24 targets CAGR at 22.0%, with free cash flow with capex of ~RMB3.8bn. From 2010 to 2016, revenue, net profit and retail gas sales turning positive in 2019E. volume surged 14x, 6x and 20x, respectively, translating into 48%, 27% and 43% CAGRs YTD share performance of TLG has in the period. By 1H17, TLG had expanded its footprint into 13 provinces with a total of significantly underperformed peers’. We see re-rating potential 54 gas projects, 59 gas refilling stations, two LNG processing plants, and three operating for TLG once the company speeds long-haul pipelines. up acquisitions.

Steadfast on M&A strategy with highly-selective approach. TLG’s management has Stock data reaffirmed M&A will not slow and remains the key strategy to drive expansion. Among 52w high (HK$) 7.6 the small- to mid-sized privately-owned gas distribution companies, TLG targets to 52w low (HK$) 3.75 acquire those with limited financial resources for expansion or with earnings levels Market cap (HK$ m) 5,572 insufficient for a listing. We reckon TLG prefers mature projects with good operational Issued shares (m) 990 efficiency and will keep the historical P/E of potential deals lower than its own to Avg daily vol (m) 1.42 1-mth change (%) -1.1 ensure value-accretive acquisitions. TLG is now looking for M&A opportunities in SW YTD change (%) -21.3 and NW regions as projects there are expected to enjoy better gas supply. 50d MA (HK$) 5.69 200d MA (HK$) 5.28 Expect strong earnings CAGR of 22.0% in 2016-19; free cash flow to improve 14d RSI 48.01 continuously. We forecast TLG’s net profit to register a 22.0% CAGR during 2016-19 on Source: Bloomberg the back of a 26% CAGR in retail gas sales volume and slight improvement in dollar 1-year performance chart margin. We have factored in RMB500m capex per year for M&A in 2017-19E. With HSI 1600.HK persistent improvement in operational cash flow, we estimate TLG’s free cash flow to 40% 30% turn positive in 2019E. Net gearing, on the other hand, is estimated to come down from 20% 105% to 90% from 2017 to 2019. 10% 0% -10% Undemanding valuation; initiate coverage with Buy and TP of HK$8.00: We derive our -20% -30% TP of HK$8.00 from our DCF model, based on 8.6% WACC and 2.0% terminal growth. -40% Our TP translates into 14.0x 2018E P/E. TLG has been a laggard amid a strong year for Dec-16 Apr-17 Aug-17 Nov-17 the gas utilities sector. We believe investors have been impatient with TLG’s somewhat Source: Bloomberg

slower M&A progress after the Jintang acquisition in 2Q17. Current valuation at 10x Wallace Cheng 2018E P/E is at least ~30% discounted to those of major gas utilities names (ENN, CGH [email protected] and CRG). We expect such a discount to narrow when TLG further expedites its Tel: (852) 3766 1810 acquisitions. We initiate coverage on TLG with a Buy rating. Spencer Luo [email protected] Risk factors: (1) M&A progress may be slower than expected; (2) dollar margin and new Tel: (852) 3766 1853 connections may be lower than expected; and (3) relatively low liquidity of the stock.

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

TABLE OF CONTENT

Company Overview – Strong Growth Track since 2002 ...... 3 Steadfast on Highly-selective Acquisitions ...... 5 Operation to Stay on Track during 2017-19E ...... 7 Expect 22.0% Earnings CAGR in 2016-19E; Free Cash Flow to Improve Continuously ...... 10 Risk Factors ...... 12 Undemanding Valuation; Initiate Coverage with Buy Rating and TP of HK$8.00 ...... 13

TABLE OF CHARTS Figure 1: Summary of TLG’s major acquisitions after listing ...... 3 Figure 2: Revenue and net profit of TLG (2007-16) ...... 4 Figure 3: Retail gas sales volume of TLG (2007-16) ...... 4 Figure 4: Locations of TLG’s 3 projects before listing in 2010 ...... 4 Figure 5: Summary of TLG’s project in 1H17 ...... 4 Figure 6: Natural gas consumption volume and growth rate (2007-16) ...... 5 Figure 7: 1H17 operational data highlights ...... 7 Figure 8: Comparison of retail gas sales breakdown in 2017E ...... 7 Figure 9: Comparison of gas sales volume growth from gas stations (2017-19E) ...... 7 Figure 10: Key assumptions on gas sales volume...... 8 Figure 11: New connections per year and cumulative connections ...... 8 Figure 12: Key assumptions on dollar margin of retail gas sales ...... 9 Figure 13: Revenue, gross profit and GPM forecasts ...... 10 Figure 14: Revenue and gross profit forecasts ...... 10 Figure 15: Weighting of each segment in gross profit ...... 10 Figure 16: Net profit and EPS growth forecasts ...... 11 Figure 17: Free cash flow and net gearing forecasts ...... 11 Figure 18: WACC assumptions ...... 13 Figure 19: DCF Model ...... 13 Figure 20: DCF valuation sensitivity analysis ...... 13 Figure 21: 5- year P/E band of TLG (x) ...... 14 Figure 22: 5-year P/B band of TLG (x) ...... 14 Figure 23: YTD sector performance ...... 14 Figure 24: Valuation summary ...... 14

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Company Overview – Strong Growth Track since 2002 Since its founding in 2002, Tian Lun Gas (TLG) has been growing fast in terms of revenue and gas sales volume. Chairman and founder Mr Zhang Yingchen is a well-known entrepreneur in Henan. From 2002 to 2007, TLG gained three projects in key cities in Henan Province (namely , and ), laying the foundation for development. Before going public in HK, TLG’s annual gas sales volume came to only 24mcm in 2009, with total connections of ~110,000 and two CNG filling stations.

Figure 1: Revenue and net profit of TLG (2007-16) Figure 2: Retail gas sales volume of TLG (2007-16) Revenue Net profit (RMB m) (mcm) Total retail gas sales volume (mcm) 3,000 2,693 600 488 2,252

2,000 400 364 1,344 258 912 181 1,000 716 200 155 451 105 258 284 313 58 128 179 135 169 220 66 8 24 44 75 83 11 18 24 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Company data Source: Company data

Figure 3: Summary of TLG’s major acquisitions after listing Year Acqusitions Description Consideration (RMB m) 1 2011 Tian Lun City gas project in Puyang City in Henan Province 23 2 Henan Luyuan City gas project in Minquan City and CNG business in in Henan Province 33 3 Jilin Zhongji City gas and CNG business in Jilin Province. 153 4 Gansu Baiyin City gas, CNG distribution and gas pipeline connection in Gansu Province 100 5 Henan Songxian City gas project in Songxian County in Henan Province 33 6 2012 Xi’Na City gas projects in and in Henan Province 38 7 Caoxian Zhongtian City gas projects in Shandong Province 28 8 Shanxian Zhongtian City gas project in Shandong Province 33 9 Dongkou Senbo City gas project in Hunan Province 24 10 2013 Yunnan Datong City gas projects in 7 counties in Yunnan Province. 80 11 Dongming Wanji City gas project in Shandong 32 12 Heze Guanghe City gas project in Shandong 105 13 2014 Shantou Chenghai City gas project in Shantou City in Guangdong Province 207 14 Chaozhou Huamao City gas project in Chaozhou City of Guangdong Province 334 15 2015 Liquan Hongyuan City gas project in Liquan County, City, Shanxi Province 170 16 Qianxian Hongyuan City gas project in , Xianyang City, Shanxi Province 116 17 Hui Ji Energy Long-haul gas pipeline business, city gas projects in City of Henan 860

Province and Sanming City in Fujian Province 18 Jilin Qian’an City gas project in Qian’an County, Songyuan City, Jilin Province 23 19 Hunan Zhongyou City gas project in Fenghuang County, Hunan Province 50 20 Qian Hong Yuan & Li Quan Hong Yuan City gas projects in Qian County and Li Quan County in Province 286 21 2016 Mingsheng City gas projects in of , Sichuan Province 460 22 Xichuan Longcheng City gas projects in Xichuan, Nanyang, Henan Province 85 23 Lechang Anshunda City gas projects in Lechang, Guangdong Province 56 24 2017 Sichuan Jintang County Gas City gas projects in Jintang district in Chengdu City, Sichuan Province 500 Total 3,829

Source: Company data, BOCOM Int’l

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

After the listing in 2010, TLG started to expand quickly through a series of acquisitions. Since 2011, TLG acquired 24 targets with capex of ~RMB3.8bn. From 2010 to 2016, revenue, net profit and retail gas sales volume surged 14x, 6x and 20x, respectively, translating into 48%, 27% and 43% CAGRs during the period. By end-1H17, TLG had expanded its footprint into 13 provinces with a total of 54 gas projects, 59 gas refilling stations, two LNG processing plants, and three operating long-haul pipelines. Figure 4: Locations of TLG’s 3 projects before listing in 2010

Source: Company data, BOCOM Int’l

Figure 5: Summary of TLG’s project in 1H17

Source: Company data, BOCOM Int’l

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Steadfast on Highly-selective Acquisitions

Acquisition no longer a major focus for major gas utilities names nowadays. TLG’s expansion strategy seems to be quite different from those of major gas utilities names like ENN (2688 HK, Buy), Resources Gas (CRG, 1193 HK, Buy) and China Gas (CGH, 384 HK, Buy), which have put less emphasis on new project acquisitions in the recent 3-4 years. Thanks to the boom in natural gas consumption in the domestic market, the bigger players have garnered substantial gas distribution scales of >15bcm/year. We believe it will be difficult for the major gas utilities names to drive meaningful expansion simply through acquisitions for two reasons:

(1) The ownership of major gas distribution concessions with substantial annual gas sales volume in tier-1 or tier-2 cities has been generally stable in the recent 3-4 years;

(2) Acquiring gas distribution concessions of smaller scale does not look cost-efficient to major players.

Figure 6: Natural gas consumption volume and growth rate (2007-16) (bcm) Natural gas consumption (bcm) Natural gas consumption growth rate 250 30% 24.1% 205.8 23.0% 193.1 200 186.9 20.7% 170.5 149.7 20% 150 15.3% 134.1 13.9% 108.0 11.6% 89.5 100 81.3 9.6% 70.5 6.6% 10% 10.1% 50 3.3%

0 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: NBS, BOCOM Int’l Plenty of acquisition opportunities in TLG’s view. After achieving robust growth in terms of revenue, net profit and gas sales volume in the last 15 years, TLG’s management has indicated that acquisitions will not slow and remain the key strategy for expansion. In fact, management still sees plenty of potential acquisition targets in the market, especially small- to mid-sized privately-owned gas distribution companies with only one concession in a certain district/city. We identify two major reasons for TLG to target these companies as acquirees:

(1) Among this group of companies, some lack the financial muscle to acquire peers, while their current scale may render them ineligible for a listing in HK or China.

(2) Some mature projects may have project ROA exceeding the limit of 7% after years of depreciation of fixed assets. In our view, this kind of small players require an ambitious management team with both financing and eagerness to further invest in fixed assets for expansion, which could in turn bring down project ROA to 7%.

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

TLG maintains selective approach to acquisitions. We believe the company will remain selective on acquisitions, while management also confirmed several criteria in place for project selection:

Mature projects with good operational efficiency, given their high utilization rate and stable cash flow;

Consideration of the potential deals to be kept at a relatively low historical P/E compared to TLG’s to ensure value-accretive acquisitions;

Projects in southwestern and northwestern regions, as management sees better gas supply there due to relative proximity to the gas fields in Xinjiang and Sichuan, as well as better coal-to-gas conversion potential.

Projects in Jiangsu and Zhejiang provinces due to their strong economic and urban development outlook.

Hitherto, TLG has mainly financed its acquisitions via bank loans, barring bigger acquirees like Hui Ji Energy acquired back in 2015 for RMB860m in a single deal financed by share placement to IFC. A series of loan-driven M&As partially explains its high net gearing of >100% in recent years. Looking ahead, we do not rule out the possibility that TLG may exploit more diversified financing methods in the future, should any sizable attractive projects come on TLG’s radar.

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Operation to Stay on Track during 2017-19E 1H17 operation recap: 28.8% YoY growth in retail gas sales volume. TLG showed strong growth in gas sales in 1H17, with retail gas sales volume and total gas sales volume up 28.8% YoY and 22.4% YoY respectively. Residential and C&I gas sales registered 19.8% and 31.9% YoY growth, thanks to full-year contributions from new projects acquired in 2016 and the strong gas consumption growth driven by coal-to-gas conversion nationwide. After six more gas stations started operation, gas sales to gas stations also jumped 33.5% YoY. Noteworthy is that the newly-acquired Jintang project was not consolidated in 1H17. In terms of new connections, 1H17 C&I new connections surged 66.8% YoY to 839 units from a low base in 1H16; residential new connections remained stable with ~96k new households added, up 2.2% YoY.

Figure 7: 1H17 operational data highlights Y/E 31 Dec 1H16 2H16 1H17 YoY (%) Natural gas sales volume (mcm)

Residential 69 82 83 19.8 C&I 110 104 146 31.9 Gas stations 57 65 76 33.5 Total retail gas 236 252 304 28.8 Long-haul pipeline 205 225 197 -3.9 Wholesale 347 434 394 13.8 Total gas sales 820 937 1,003 22.4 New connections

Residential 93,663 110,730 95,691 2.2 C&I 503 723 839 66.8 Source: Company data, BOCOM Int’l estimates Lifting C&I gas sales in retail gas sales mix. Under our estimation, we still expect TLG to acquire 1-2 new projects per year during 2018-19E, with retail gas sales scale per project reaching 30-50mcm/year. Compared to the major gas utilities names with >60% estimated gas sales to C&I users in 2017E, TLG is estimated to have a relatively low base in gas sales to C&I users (at 46% only in 2017E). We expect TLG to emphasize development in C&I gas sales, especially in new C&I coal-to-gas conversion in tier-3 cities. Under our forecast, TLG’s C&I gas sales volume will maintain ~30% YoY growth in 2018/19E; the weighting of gas sales to C&I users is estimated to reach 51% in total retail gas sales in 2019E. Figure 8: Comparison of retail gas sales breakdown in Figure 9: Comparison of gas sales volume growth from gas 2017E stations (2017-19E) Residential C&I Gas stations 50% China Gas CR Gas ENN TLG

100% 40% 11.1% 9.0% 9.5% 31.1% 25.5% 80% 30% 19.3% 60% 20% 15.5% 65.6% 64.6% 74.6% 45.8% 10% 5.0% 5.0% 5.0% 40% 4.4% 5.0% 5.0% 2.0% 2.0% 0% 20% 23.3% 26.4% 28.7% 2017E 2018E 2019E 15.9% -10% 0% -10.0% CGH CR Gas ENN TLG -20% Source: Company data, BOCOM Int’l estimates Source: Company data, BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Gas sales from gas stations to achieve higher growth than peers. Meanwhile, we expect TLG to maintain robust growth in gas sales volume from gas stations with 21.8% CAGR in 2016-19E, which looks aggressive compared to single-digit or no growth in gas station sales of major gas utilities names. We believe TLG’s advantage still lies in the growth potential of vehicular gas sales in tier-3 cities. Management continues to see strong demand for CNG/LNG-fueled vehicles for commercial use and E-hailing vehicles in Henan. We expect TLG to add around 10 gas stations per year, lifting total gas stations in operation from 55 by 2017E to 73 by 2019E.

Overall retail gas YoY growth to be sustained at >23% in 2018-19E. We estimate TLG’s YoY growth in retail gas sales volume in 2017 to be maintained at 29.2%, followed by 25.6% and 23.7% YoY growth in 2018-19E. Meanwhile, TLG still has three more long-haul pipelines which are expected to commence operation in 2018-20. We conservatively forecast long-haul pipeline gas sales volume to increase at a 4.4% CAGR in 2016-19 as TLG will be selective on choosing end users in order to maintain dollar margin. Overall, we estimate TLG’s total gas sales volume to grow 14.9% in 2016-19.

Figure 10: Key assumptions on gas sales volume Y/E 31 Dec 2015 2016 2017E 2018E 2019E Natural gas sales volume (mcm)

- Residential 101 151 181 217 261 YoY (%) 46.4 49.6 20.0 20.0 20.0 - C&I 150 215 289 384 498 YoY (%) 35.6 42.9 34.6 32.6 29.9 - Gas stations 113 122 161 192 221 YoY (%) 45.1 8.3 31.1 19.3 15.5 Total retail gas 364 488 631 792 980 YoY (%) 41.4 34.0 29.2 25.6 23.7

-Long-haul pipeline 256 429 425 452 488 YoY (%) NA 67.5 -1.2 6.6 7.9 - Wholesale 615 780 898 1,005 1,106 YoY (%) NA 26.9 15.0 12.0 10.0 Total gas sales 1,235 1,698 1,953 2,250 2,574 YoY (%) 379.6 37.4 15.0 15.2 14.4 Source: Company data, BOCOM Int’l estimates Higher growth of new C&I connections than residential. In terms of new connections per year, we forecast new C&I connections will stay strong with 36%/32%/28% YoY growth in each of 2017/18/19, in line with TLG’s focus on accelerating C&I gas sales growth. In contrast, we estimate moderate growth of 5-6% YoY for new residential connections.

Figure 11: New connections per year and cumulative connections Y/E 31 Dec 2015 2016 2017E 2018E 2019E New connections (‘000)

Residential 202.3 204.4 214.6 227.5 241.1 YoY (%) 2.8 1.0 5.0 6.0 6.0 C&I 1.4 1.2 1.7 2.2 2.8 YoY (%) 35.5 -12.2 35.5 32.0 28.2 Cumulative connections (‘000)

Residential 1,016 1,325 1,540 1,767 2,009 C&I 6 9 11 13 16 Total 1,022 1,334 1,551 1,780 2,024 Source: Company data, BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Figure 12: Key assumptions on dollar margin of retail gas sales Y/E 31 Dec 2015 2016 2017E 2018E 2019E (RMB/m3)

Retail gas tariff

- Residential 2.19 2.22 2.20 2.21 2.22 - C&I 2.65 2.33 2.40 2.40 2.41 - Gas stations 2.93 2.51 2.64 2.64 2.64 Average retail gas tariff 2.61 2.34 2.40 2.41 2.41 Unit cost of retail gas 2.21 1.92 2.01 2.00 2.00 Retail gas dollar margin 0.40 0.42 0.40 0.40 0.41 Source: Company data, BOCOM Int’l estimates Slight improvement in retail gas dollar margin expected during 2017-19. In terms of dollar margin, we expect TLG’s average retail gas dollar margin to gradually improve from RMB0.40/m3 to RMB0.41/m3 from 2017E to 2019E. We expect newly-acquired projects to have better dollar margins on residential and C&I gas sales. Taking Jintang as an example, its current average dollar margin of >RMB0.8/m3 is well ahead of TLG’s RMB0.40/m3. Regarding the winter cost hike, we expect this to cause ~RMB0.02/m3 contraction in 2H17 compared to 1H17.

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Expect 22.0% Earnings CAGR in 2016-19E; Free Cash Flow to Improve Continuously

Figure 13: Revenue, gross profit and GPM forecasts Y/E 31 Dec (RMB m) 2015 2016 2017E 2018E 2019E Revenue

Sales of gas 975 1,136 1,517 1,907 2,360 Gas pipeline connections 571 589 660 721 788 Long-haul pipeline 676 927 939 1,017 1,111 Others 30 41 62 68 75 Total revenue 2,252 2,693 3,178 3,714 4,335

Gross profit

Sales of gas 166 206 250 320 403 Gas pipeline connections 358 372 412 449 489 Long-haul pipeline 70 97 92 111 131 Others 15 17 25 28 31 Total gross profit 609 692 781 908 1,054

Gross margin (%)

Sales of gas 17.0 18.2 16.5 16.8 17.1 Gas pipeline connections 62.7 63.1 62.5 62.2 62.0 Long-haul pipeline 10.3 10.5 9.8 11.0 11.8 Others 49.2 40.9 40.9 40.9 40.9 Overall GPM 27.0 25.7 24.6 24.5 24.3 Source: Company data, BOCOM Int’l estimates Gas sales’ weighting in gross profit to increase. We expect TLG to achieve a 17.2% CAGR in revenue from 2016 to 2019. Gas sales segment is expected to be the major growth driver with a 27.6% CAGR during the period, while connection income should grow moderately at a 10% CAGR during the period. In terms of gross margin, we estimate gas sales gross margin to improve from 16.5% to17.1% from 2017 to 2019, in step with the improvement in dollar margin. Given the increase in weighting of gas sales within gross profit, we expect overall gross margin to inch down from 24.6% to 24.3% from 2017 to 2019. Overall, we forecast TLG’s net profit will increase at a 22.0% CAGR during 2016-19.

Figure 14: Revenue and gross profit forecasts Figure 15: Weighting of each segment in gross profit

(RMB m) Revenue Gross profit Gas sales Gas connections Long-haul pipeline gas Others 2.4% 2.5% 3.3% 3.1% 2.9% 5,000 4,335 100% 11.5% 14.0% 11.8% 12.3% 12.4% 4,000 3,714 80% 3,178 2,693 3,000 60% 52.8% 49.4% 46.4% 2,252 58.8% 53.7% 2,000 40% 1,054 781 908 1,000 609 692 20% 38.3% 27.3% 29.8% 32.1% 35.3% 0 0% 2015 2016 2017E 2018E 2019E 2015 2016 2017E 2018E 2019E Source: Company data, BOCOM Int’l estimates Source: Company data, BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Free cash flow to further improve in 2019E. We expect TLG’s capex to reach RMB950m/750m/750m in 2017-19E, mainly composed of recurring capex of RMB250m per year and acquisition capex of RMB500m per year. With operational cash flow to improve from RMB586m to RMB753m from 2017E to 2019E, we expect free cash flow to turn positive to RMB3m in 2019E. Meanwhile, we estimate TLG will further tame its net gearing. The recently-obtained HK$1.25bn 5-year bank loan is mainly used to refinance its short-term loan. We expect TLG to lower its short-term loan from the end-2017 level of RMB1.5bn to RMB0.9bn by end-2018. Along with the improvement in free cash flow, we estimate net gearing of TLG to drop from 105% in 2017E to 90% in 2019E.

Figure 16: Net profit and EPS growth forecasts Figure 17: Free cash flow and net gearing forecasts

(RMB m) Net profit EPS growth (%) (RMB m) Free cash flow Net gearing

1,000 30% 500 150% 24.4% 22.4% 25% -1,179 -199 -364 3 750 19.2% 0 -109 20% 2015 2016 2017E 2018E 2019E 100% 500 12.5% 15% 113.6% 99.0% -500 105.1% 89.7% 10% 75.7% 5.9% 569 50% 250 477 390 -1,000 284 313 5% 0 0% -1,500 0% 2015 2016 2017E 2018E 2019E

Source: Company data, BOCOM Int’l estimates Source: Company data, BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Risk Factors

Acquisition progress may be slower than expected. Project selection may take longer than expected due to negotiations with the seller of the project, especially regarding the consideration of the deal. This would eventually drag both gas sales volume and profit growth.

Dollar margin may disappoint. Change in sales mix or inefficient control on purchasing cost of natural gas could, in turn, compress dollar margin. Also, the average dollar margin from newly-acquired projects may be at a similar level to TLG’s current dollar margin, thus failing to drive increments in dollar margin after the acquisition.

New connection number could be lower than expected. Low incentive for coal-boiler users to convert to natural gas boilers could slow down new connections from C&I users. Residential connections may be a disappointment due to direct competition from electric heaters or stoves. Meanwhile, newly-acquired projects may see little room for new connections given the high penetration rate of natural gas in the cities.

Relatively-low liquidity of the stock: As 3-month average daily turnover comes to only ~HK$7m or ~1.5m shares, liquidity seems on the low side. Any sudden increase in buying or selling volume could cause high volatility in share price.

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Undemanding Valuation; Initiate Coverage with Buy Rating and TP of HK$8.00 We derive our TP of HK$8.00 from the DCF model, based on 8.6% WACC and 2.0% terminal growth. Our TP translates into 14.0x 2018E P/E. TLG has been a laggard in a strong year for the gas utilities sector. We believe investors have been impatient with TLG’s somewhat slower M&A progress after the Jintang acquisition in 2Q17. Current valuation at 10x 2018E P/E is at least ~30% discounted to those of major gas utilities names (ENN, CGH and CRG). We expect such a discount to narrow when TLG further expedites its acquisition plan. We initiate coverage on TLG with a Buy rating.

Figure 18: WACC assumptions Key assumptions Value Risk-free rate (%) 3.5 Market risk premium (%) 10.0 Beta 0.90 Cost of equity (%) 12.3 Pre-tax cost of debt (%) 5.0 Effective tax rate (%) 25.0 After-tax cost of debt (%) 3.8 Estimated debt-to-capital ratio (%) 45.0 WACC (%) 8.6 Source: BOCOM Int’l estimates

Figure 19: DCF Model (RMB m) / Y/E 31 Dec 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E Year 1 2 3 4 5 6 7 8 9 10 Cash from operations 641 753 806 896 998 1,034 1,065 1,098 1,134 1,173 Less: Capex (750) (750) (700) (700) (150) (150) (150) (150) (150) (150) Free cash flow (109) 3 106 196 848 884 915 948 984 1,023

Terminal growth rate (%) 2.0

Sum of PV of FCF 3,153

Terminal value 6,985

Less: Net debt (2018E) (3,066)

Less: MI (2018E) (365)

Equity value (RMB m) 6,707

Total no. of shares (m) 990

Equity value per share (RMB) 6.78

Equity value per share (HK$) 8.00

Source: BOCOM Int’l estimates

Figure 20: DCF valuation sensitivity analysis g / WACC 7.6% 8.1% 8.6% 9.1% 9.6% 1.0% 8.98 7.82 6.83 5.96 5.19 1.5% 9.77 8.48 7.37 6.41 5.58 2.0% 10.71 9.24 8.00 6.94 6.02 2.5% 11.83 10.14 8.73 7.54 6.52 3.0% 13.20 11.21 9.59 8.24 7.10

Source: BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Figure 21: 5- year P/E band of TLG (x) Figure 22: 5-year P/B band of TLG (x) 30.0 5.0 +2 SD +2 SD 25.0 4.0 +1 SD +1 SD 20.0 3.0 Mean Mean 15.0 2.0 -1 SD -1 SD 10.0 1.0 -2 SD -2 SD 5.0 0.0 01/12 12/12 11/13 10/14 09/15 08/16 07/17 01/12 12/12 11/13 10/14 09/15 08/16 07/17

Source: Bloomberg, BOCOM Int’l Source: Bloomberg, BOCOM Int’l

Figure 23: YTD sector performance CGH (384 HK) ENN (2688 HK) TGC (1083 HK) CRG (1193 HK) (%) KE (135 HK) BEH (392 HK) TLG (1600 HK) Average 140 120 110.1 100 80 69.0 56.6 60 41.1 40 31.4 22.9 19.0 20 0 -20 -40 -21.3

Source: Bloomberg, BOCOM Int’l

Figure 24: Valuation summary Company Stock Rating TP CP Reporting ––––– EPS ––––– EPS consensus –––––– P/E –––––– –––––– P/B –––––– Yield name ticker currency FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E FY17E (x) (x) (x) (x) (%) HK/H shares (HK$) (HK$) China Gas (*) 384 HK Buy 30.00 22.10 HK$ 1.280 1.540 1.219 1.467 17.3 14.4 4.4 3.6 1.6 ENN Energy 2688 HK Buy 67.70 53.90 RMB 3.170 3.579 3.168 3.635 14.4 12.7 2.8 2.4 2.5 CR Gas 1193 HK Buy 32.60 28.65 HK$ 1.772 2.029 1.753 1.968 16.2 14.1 3.1 2.7 1.9 Tian Lun Gas 1600 HK Buy 8.00 5.63 RMB 0.394 0.482 0.340 0.395 12.1 9.9 1.7 1.5 1.9 Towngas China 1083 HK NA NA 6.23 HK$ NA NA 0.443 0.489 14.1 12.7 1.3 1.2 1.9 Beijing Enterprises 392 HK NA NA 43.60 HK$ NA NA 5.219 5.656 8.4 7.7 1.0 0.9 2.2 Kunlun Energy 135 HK NA NA 7.13 RMB NA NA 0.530 0.580 11.4 10.4 1.3 1.3 1.1 Average 14.3 12.0 2.2 1.9 1.6 Source: Bloomberg, BOCOM Int’l estimates for covered stocks (*) End-March FY18-19E figures used instead

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

Company background

Beijing Tian Lun Investment Group (1600 HK) was listed on Hong Kong Exchange in November 2010. Main businesses for the Group include: city gas operation, LNG/CNG gas station, LNG processing plants, long-haul pipeline gas business and direct supply to industrial customers. As at 30 June 2017, the company owned a total of 54 urban gas projects in 13 provinces, 59 gas refilling stations, 2 LNG processing plants, and 3 operating long-haul pipelines with 3 others under construction.

Tian Lun Gas (1600 HK): Financial Statements Profit & loss (RMB m) Cash flow (RMB m) Year ended 31 Dec 2015 2016 2017E 2018E 2019E Year ended 31 Dec 2015 2016 2017E 2018E 2019E Turnover 2,252 2,693 3,178 3,714 4,335 Pre-tax profit 429 445 547 668 797 COGS (1,643) (2,001) (2,398) (2,805) (3,281) Tax paid (108) (110) (135) (165) (197) Gross profit 609 692 781 908 1,054 Dep and amort. 142 173 233 262 290 SD&A expenses (133) (141) (159) (182) (208) Shared results of asso & jce (0) (21) (44) (83) (97) Other income 12 12 5 5 5 Change in working capital (109) 9 27 12 15 Other gains, net 38 44 2 0 0 Others (119) (61) (42) (53) (54) Operating profit 526 608 628 731 850 Cash from operations 234 434 586 641 753 Net finance costs (97) (184) (125) (146) (150) Capital expenditure (1,414) (634) (950) (750) (750) Shared results of asso & jce 0 21 44 83 97 Others (90) (17) 347 22 23 Pre-tax profit 429 445 547 668 797 Cash from investing (1,503) (651) (603) (728) (727) Income tax expense (111) (110) (137) (167) (199) Change in bank borrowings 770 715 1,539 (461) 140 After tax profit 318 334 410 501 598 Proceeds from shares issued 916 0 0 0 0 Minority interest (34) (21) (21) (24) (29) Others (90) (389) (90) (110) (131) Net profit 284 313 390 477 569 Cash from financing 1,597 326 1,449 (571) 9 FX change 18 36 0 0 0 Net change in cash 346 146 1,431 (658) 35

Balance sheet (RMB m) Financial ratios Year ended 31 Dec 2015 2016 2017E 2018E 2019E Year ended 31 Dec 2015 2016 2017E 2018E 2019E Cash and cash equivalents 609 755 2,187 1,528 1,563 Gross margin (%) 27.0 25.7 24.6 24.5 24.3 Inventories 61 42 53 61 72 EBIT margin (%) 23.4 22.6 19.8 19.7 19.6 Trade and other receivables 593 603 705 824 962 Net margin (%) 12.6 11.6 12.3 12.8 13.1 Other current assets 352 413 78 78 78 ROA (%) 4.3 4.1 4.0 4.9 5.4 Total current assets 1,615 1,814 3,023 2,492 2,675 ROE (%) 10.2 11.4 12.7 13.8 14.5 Property, plant & equipment 1,944 2,124 2,440 2,740 3,019 Net gearing (%) 75.7 113.6 105.1 99.0 89.7 Intangible assets 2,479 2,999 3,201 3,390 3,573 Interest coverage (x) 5.4 3.3 5.0 5.0 5.7 Interest in asso. & jce 51 272 515 598 695 Current ratio 1.0 1.1 1.2 1.3 1.2 Other non-current assets 590 425 455 485 515 Total non-current assets 5,063 5,820 6,611 7,213 7,801 Short-term borrowings 850 848 1,527 886 912 Trade and other payables 506 530 624 730 854 Other current liabilities 202 254 302 337 378 Total current liabilities 1,557 1,633 2,453 1,953 2,145 Long-term borrowings 1,887 2,740 3,600 3,780 3,893 Other non-current liabilities 451 508 508 508 508 Total non-current liabilities 2,339 3,248 4,108 4,288 4,402 Share capital 9 8 8 8 8 Reserves 2,340 2,423 2,723 3,090 3,528 Equity attri. to shareholders 2,348 2,431 2,731 3,098 3,536 Minority interests 434 321 341 365 394 Total equity 2,782 2,752 3,072 3,463 3,930

Source: Company data, BOCOM Int’l estimates

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

BOCOM International 10/F., Man Yee Building, 68 Des Voeux Road Central, Hong Kong Main: + 852 3766 1899 Fax: + 852 2107 4662 www.bocomgroup.com

Rating System Analyst Stock Ratings: Analyst Industry Views: Buy: The stock's total return is expected to exceed that of the Outperform: The analyst expects the industry coverage universe to corresponding industry over the next 12 months. be attractive relative to the relevant broad market benchmark over the next 12 months. Neutral: The stock's total return is expected to be in line with that of the corresponding industry over the next 12 months. Market perform: The analyst expects the industry coverage universe to be in line with the relevant broad market benchmark Sell: The stock's total return is expected to be below that of the over the next 12 months. corresponding industry over the next 12 months. Underperform: The analyst expects the industry coverage universe Not-Rated: The analyst does not have conviction regarding the to be unattractive relative to the relevant broad market benchmark outlook of the stock's total return relative to that of the over the next 12 months. corresponding industry over the next 12 months. Broad market benchmark for Hong Kong is the Hang Seng Trading Buy: The stock's absolute return is expected to be very Composite Index, for China A-shares is the MSCI China A Index, for attractive in the near term. This rating can be different from the US-listed Chinese companies is S&P US Listed China 50 (USD) Index. rating with a view over the next 12 months. Trading Sell: The stock's absolute return is expected to be very unattractive in the near term. This rating can be different from the rating with a view over the next 12 months.

Research Team

Head of Research @bocomgroup.com Deputy Head of Research @bocomgroup.com Hao HONG, CFA (852) 3766 1802 hao.hong Geoffrey CHENG, CFA (852) 3766 1809 geoffrey.cheng

Macro-Strategy Internet Hao HONG, CFA (852) 3766 1802 hao.hong Yuan MA, PhD (86) 10 8800 9788 - 8039 yuan.ma Karen TAN (852) 3766 1825 karen.tan Connie GU, CPA (86) 10 8800 9788 - 8045 connie.gu Grace HUA, CFA (852) 3766 1837 Grace.hua Mengqi SUN (86) 10 8800 9788 - 8048 mengqi.sun Zhe ZHOU (86) 10 8800 9788 - 8041 zhe.zhou Shan Ying (86) 10 8800 9788 - 8044 ying.shan

Banks/ Non-Bank Financials Property Li WAN, CFA, FRM (86) 10 8800 9788 - 8051 wanli Alfred LAU, CFA, FRM (852) 3766 1807 alfred.lau Hannah HAN (852) 3766 1858 hannah.han Philip TSE, CFA, FRM (852) 3766 1815 philip.tse Jennifer ZHANG (852) 3766 1850 yufan.zhang Carmen WONG (852) 3766 1830 carmen.wong

Consumer Renewable Energy Summer WANG, CFA (852) 3766 1808 summer.wang Louis SUN (86) 21 6065 3606 louis.sun

Environmental Services Technology Wallace CHENG (852) 3766 1810 wallace.cheng Chris YIM (852) 3766 1803 christopher.yim

Gaming & Leisure Transportation & Industrials Alfred LAU, CFA, FRM (852) 3766 1807 alfred.lau Geoffrey CHENG, CFA (852) 3766 1809 geoffrey.cheng Fay ZHOU (852) 3766 1816 fay.zhou

Healthcare Automobile & Defense Lilian WAN (852) 3766 1849 lilian.wan Angus CHAN (86) 21 6065 3601 angus.chan Grace ZHAO (86) 21 6065 3611 grace.zhao

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Tian Lun Gas (1600 HK)  Gas Utilities Sector 15 December 2017

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