Towngas China (1083 HK) Towng As C Hina

Hong Kong Utilities 21 April 2016

Towngas China (1083 HK) Towng as C hina

Target price: HKD5.00 (from HKD7.50)

Share price (20 Apr): HKD4.40 | Up/downside: +13.6%

Would now be a good time to privatise? Dennis Ip, CFA (852) 2848 4068  Weak 2016E guidance and greenfield projects lag expectations [email protected]  But current trough valuation may be a privatisation opportunity Marco Lai (852) 2848 4465  Cutting TP to HKD5.0 and downgrading to Outperform (2) [email protected]

What's new: We believe Towngas China’s (TCCL) greenfield projects pose Forecast revisions (%) a risk to its gas sales volume growth, and that the company’s annual Year to 31 Dec 16E 17E 18E incremental 4.5bcm gas sales volume target for its 2010-15 greenfield Revenue change (17.2) (20.9) n.a. projects may be hard to achieve. At the same time, we think the stock’s Net profit change (6.8) (11.3) n.a. Core EPS (FD) change (7.7) (12.1) n.a. valuations (9.2x 2016E PER, 0.8x PBR) could make the case for a Source: Daiwa forecasts privatisation, which TCCL has said it could consider at the right price. Share price performance What's the impact: Greenfield projects lacking growth momentum. (HKD) (%) TCCL missed its gas sales volume targets for its greenfield projects by over 9 105 80% in 2013-15, and we estimate that around 40% of the projects acquired 8 94 over 2010-15 are loss-making. As TCCL’s greenfield projects focus on new 6 83 industrial demand, we expect the ongoing slowdown in new industrial park 5 71 3 60 expansion to hinder their sales volume growth. Apr-15 Jul-15 Oct-15 Jan-16 Apr-16

Towngas Ch (LHS) Relative to HSI (RHS) Widespread regulatory margin cut unlikely. The impact of Zhejiang’s proposed 20% distribution tariff cut will be small, on our estimates, as Zhejiang 12-month range 3.48-8.73 accounts for only 5% of TCCL’s total project investment. While we believe the Market cap (USDbn) 1.51 proposed cut is unlikely to be copied nationwide, we do see some provinces 3m avg daily turnover (USDm) 2.56 having a higher chance of adopting a similar tariff cut, which we estimate Shares outstanding (m) 2,665 Major shareholder The Hong Kong and China Gas (60.8%) altogether would reduce TCCL’s 2017E gross profit by 4.3%. Financial summary (HKD) Possible case for privatisation. TCCL is currently trading at an attractive Year to 31 Dec 16E 17E 18E 9.2x 2016E PER, a 58% discount to the 22x PER of parent Hong Kong and Revenue (m) 7,518 8,345 9,372 China Gas (HKCG; 3 HK, not rated). It is also trading at 0.8x 2016E PBR Operating profit (m) 1,258 1,311 1,410 Net profit (m) 1,279 1,342 1,412 vs. 2.8x for HKCG. We can see grounds for HKCG to consider privatising Core EPS (fully-diluted) 0.480 0.504 0.530 TCCL at a 30-50% premium to TCCL’s current share price, as we attribute EPS change (%) 6.3 4.9 5.2 its valuation discount to peers (at 12-15x 2016E PER) to the immaturity of Daiwa vs Cons. EPS (%) (3.8) (0.9) 2.3 PER (x) 9.2 8.7 8.3 its newly acquired projects, which saw flat YoY gas sales volume growth in Dividend yield (%) 3.7 3.9 4.2 2015, vs. 2% YoY for HKCG. It may take a few years for TCCL to realise DPS 0.161 0.172 0.184 the value of its 2010-15 city-gas projects, as the projects do not yet have PBR (x) 0.8 0.8 0.7 EV/EBITDA (x) 7.5 6.7 5.7 the requisite economies of scale. Thus, we expect TCCL to remain cheap ROE (%) 9.2 9.1 9.0 compared with peers ENN (2688 HK, HKD41.85, Buy [1]) and CR Gas Source: FactSet, Daiwa forecasts (1193 HK, HKD21.80, Buy [1]). Moreover, an asset injection from HKCG to TCCL seems unlikely due to the wide valuation gap between the two.

What we recommend: We trim our 2016-17E revenue and EPS by 17-21% and 8-12%, respectively, after adjusting for its weak gas sales volume in 2015, the Nov 2015 tariff cut, and our expectation of weak industrial gas sales for new projects. We cut our 12-month DCF-derived TP (basis unchanged) from HKD7.5 to HKD5.0 and downgrade TCCL from Buy (1) to Outperform (2).

How we differ: Our 2016-17E EPS forecasts are 1-4% below the consensus on our more conservative gas sales growth assumptions.

See important disclosures, including any required research certifications, beginning on page 18

Towngas China (1083 HK): 21 April 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook TCCL: gas sales, connection, revenue and profit growth rates We forecast TCCL’s gas sales volume growth to be stable 60% for 2016-18E (11-14% YoY). Although we forecast 0.4-0.5m 50% new connections a year for 2016-18E, we expect 40% connection fee revenue to decline by a 1% CAGR due to 30% declining connection margins (42% in 2015 vs. 34-39% in 20% 2016-18E). Our forecasts call for recurring net profit to see a 5% CAGR over 2016-18, supported by gas sales volume 10% growth. 0% (10%) 2011 2012 2013 2014 2015 2016E 2017E 2018E

Gas sales volume YoY% New connection YoY% Total revenue YoY% Recurring net profit YoY% Source: Company, Daiwa forecasts

Valuation TCCL: 12-month forward PER

TCCL is currently trading at 9.2x 2016E PER, 1.5SD below (x) its past-7-year 12-month forward PER average of 16.3x 30 and well below the 11-15x range of its pure city-gas 25.7x Avg+2SD 25 distributor peers. At these levels, we can see the grounds 21.0x Avg+1SD for HKCG to privatise TCCL, since TCCL’s PER discount to 20 HKCG stands at a high of 58%. 16.3x Avg 15 11.7x Avg-1SD 10 7.0x Avg-2SD

Jul-11

Apr-10 Oct-12 Apr-15

Jan-09 Jun-09 Jan-14 Jun-14

Feb-11 Mar-13 Feb-16

Nov-09 Dec-11 Nov-14

Sep-10 Aug-13 Sep-15 May-12 Source: Bloomberg, Daiwa forecasts

Earnings revisions TCCL: Bloomberg consensus EPS forecast

The Bloomberg consensus for TCCL’s 2016-17E EPS has (HKD) steadily declined over the past 2 years, likely due to the 0.75 low gas sales volume achieved by its newly acquired 0.70 projects against the backdrop of the oil-price slump and the 0.65 industrial production slowdown in 2015. 0.60

Our 2016-17E EPS forecasts are 1-4% lower than the 0.55 consensus forecasts, due to our more conservative gas 0.50 sales growth assumptions, especially for industrial gas 0.45

sales from TCCL’s greenfield projects.

Jul-14 Jul-15

Jan-14 Jan-15 Jan-16

Mar-14 Mar-15 Mar-16

Sep-15 Sep-14 Nov-14 Nov-15

May-14 May-15 2016E EPS 2017E EPS

Source: Bloomberg

Towngas China (1083 HK): 21 April 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Total gas sales volume (mn m3) 4,670 5,320 5,945 6,511 6,562 7,016 7,647 8,419 Subsidary gas sales volume (mn m3) 1,200 1,310 1,570 1,726 1,719 1,908 2,156 2,458 Gas ASP, incl tax (HKD/m3) 2.74 3.03 3.35 3.60 3.50 2.99 2.99 3.00 Gas purchase cost, incl tax (HKD/m3) 2.55 2.80 3.08 3.32 3.23 2.73 2.73 2.73 Segment profit contribution - connection 66 64 60 61 61 59 55 50 fee (%)

Profit and loss (HKDm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales of gas 3,288 3,972 5,265 6,205 6,011 5,702 6,444 7,382 Gas connection 1,034 1,211 1,451 1,677 1,708 1,816 1,901 1,989 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 4,321 5,183 6,716 7,882 7,719 7,518 8,345 9,372 Other income 195 160 246 14 (162) 200 203 206 COGS (3,634) (4,324) (5,650) (6,664) (6,549) (6,320) (7,089) (8,011) SG&A 0 0 0 0 0 0 0 0 Other op.expenses (101) (116) (140) (151) (152) (140) (147) (156) Operating profit 782 904 1,171 1,080 856 1,258 1,311 1,410 Net-interest inc./(exp.) (142) (148) (164) (174) (181) (181) (135) (126) Assoc/forex/extraord./others 394 480 601 625 593 680 683 691 Pre-tax profit 1,034 1,236 1,609 1,531 1,269 1,757 1,860 1,975 Tax (257) (299) (383) (350) (344) (351) (387) (427) Min. int./pref. div./others (68) (95) (120) (127) (117) (127) (131) (136) Net profit (reported) 709 841 1,106 1,054 808 1,279 1,342 1,412 Net profit (adjusted) 592 796 946 1,195 1,203 1,279 1,342 1,412 EPS (reported)(HKD) 0.289 0.342 0.424 0.402 0.305 0.480 0.504 0.530 EPS (adjusted)(HKD) 0.241 0.323 0.363 0.456 0.454 0.480 0.504 0.530 EPS (adjusted fully-diluted)(HKD) 0.241 0.323 0.362 0.454 0.451 0.480 0.504 0.530 DPS (HKD) 0.050 0.064 0.080 0.100 0.100 0.161 0.172 0.184 EBIT 782 904 1,171 1,080 856 1,258 1,311 1,410 EBITDA 1,019 1,179 1,502 1,482 1,295 1,722 1,800 1,922

Cash flow (HKDm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 1,034 1,236 1,609 1,531 1,269 1,757 1,860 1,975 Depreciation and amortisation 237 276 331 402 439 464 488 512 Tax paid (257) (299) (383) (350) (344) (351) (387) (427) Change in working capital 48 524 436 (201) 312 (316) 266 318 Other operational CF items (433) (661) (942) (124) (177) (680) (683) (691) Cash flow from operations 628 1,075 1,051 1,258 1,500 874 1,544 1,687 Capex (894) (1,610) (1,685) (2,005) (800) (770) (740) (710) Net (acquisitions)/disposals (170) (136) (317) (318) (130) 0 0 0 Other investing CF items 33 96 (981) (272) (836) 0 0 0 Cash flow from investing (1,031) (1,651) (2,983) (2,595) (1,766) (770) (740) (710) Change in debt 1,044 670 788 681 1,217 (400) (400) (400) Net share issues/(repurchases) 40 0 940 10 0 0 0 0 Dividends paid (97) (147) (191) (121) (263) (267) (430) (459) Other financing CF items 37 567 70 73 0 0 0 0 Cash flow from financing 1,025 1,089 1,607 643 953 (667) (830) (859) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 622 513 (326) (694) 687 (562) (25) 118 Free cash flow (266) (536) (634) (746) 700 104 804 977 Source: FactSet, Daiwa forecasts

Towngas China (1083 HK): 21 April 2016

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 2,071 2,699 2,605 1,797 2,376 1,814 1,788 1,907 Inventory 388 395 588 566 558 620 664 711 Accounts receivable 852 1,057 1,580 1,788 1,507 1,605 1,781 2,000 Other current assets 187 196 274 225 217 127 48 213 Total current assets 3,498 4,346 5,047 4,376 4,658 4,165 4,281 4,831 Fixed assets 6,128 7,652 9,355 11,026 12,055 11,714 11,976 12,185 Goodwill & intangibles 4,031 4,462 5,972 6,499 6,293 5,867 5,856 5,846 Other non-current assets 4,526 4,795 5,254 5,449 5,866 6,536 7,209 7,889 Total assets 18,183 21,255 25,629 27,350 28,871 28,282 29,323 30,751 Short-term debt 1,513 1,946 2,419 2,483 3,183 3,183 3,183 3,183 Accounts payable 2,263 2,998 4,152 4,136 4,160 4,003 4,490 5,074 Other current liabilities 516 629 812 770 806 806 806 806 Total current liabilities 4,291 5,574 7,383 7,389 8,149 7,992 8,479 9,063 Long-term debt 2,902 3,145 3,488 4,075 4,591 4,191 3,791 3,391 Other non-current liabilities 691 1,249 1,280 1,441 1,431 422 362 549 Total liabilities 7,884 9,968 12,150 12,906 14,171 12,606 12,632 13,004 Share capital 246 246 261 263 267 267 267 267 Reserves/R.E./others 9,369 10,236 12,270 12,991 13,212 14,061 14,944 15,865 Shareholders' equity 9,615 10,482 12,531 13,254 13,478 14,328 15,211 16,131 Minority interests 684 805 947 1,191 1,222 1,348 1,479 1,616 Total equity & liabilities 18,183 21,255 25,629 27,350 28,871 28,282 29,323 30,751 EV 11,029 10,853 11,378 12,906 13,335 12,944 12,017 10,944 Net debt/(cash) 2,344 2,393 3,302 4,761 5,398 5,561 5,186 4,668 BVPS (HKD) 3.908 4.261 4.796 5.035 5.057 5.376 5.707 6.053

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 44.9 20.0 29.6 17.4 (2.1) (2.6) 11.0 12.3 EBITDA (YoY) 52.9 15.8 27.3 (1.3) (12.6) 32.9 4.5 6.8 Operating profit (YoY) 66.8 15.6 29.6 (7.8) (20.7) 46.8 4.3 7.5 Net profit (YoY) 59.6 34.5 18.9 26.3 0.6 6.4 4.9 5.2 Core EPS (fully-diluted) (YoY) 42.0 34.0 12.2 25.5 (0.7) 6.3 4.9 5.2 Gross-profit margin 15.9 16.6 15.9 15.4 15.2 15.9 15.0 14.5 EBITDA margin 23.6 22.8 22.4 18.8 16.8 22.9 21.6 20.5 Operating-profit margin 18.1 17.4 17.4 13.7 11.1 16.7 15.7 15.0 Net profit margin 13.7 15.4 14.1 15.2 15.6 17.0 16.1 15.1 ROAE 6.5 7.9 8.2 9.3 9.0 9.2 9.1 9.0 ROAA 3.6 4.0 4.0 4.5 4.3 4.5 4.7 4.7 ROCE 5.8 5.8 6.5 5.3 3.9 5.5 5.6 5.9 ROIC 5.0 5.2 5.9 4.6 3.2 4.9 4.8 5.0 Net debt to equity 24.4 22.8 26.4 35.9 40.1 38.8 34.1 28.9 Effective tax rate 24.9 24.2 23.8 22.9 27.1 20.0 20.8 21.6 Accounts receivable (days) 58.4 67.2 71.7 78.0 77.9 75.5 74.0 73.6 Current ratio (x) 0.8 0.8 0.7 0.6 0.6 0.5 0.5 0.5 Net interest cover (x) 5.5 6.1 7.2 6.2 4.7 7.0 9.7 11.2 Net dividend payout 17.3 18.6 18.8 24.9 32.8 33.6 34.2 34.8 Free cash flow yield n.a. n.a. n.a. n.a. 6.0 0.9 6.9 8.3 Source: FactSet, Daiwa forecasts

Company profile

Towngas China is one of the leading city-gas distributors in China, owning 100 projects (as of December 2015) with a geographical focus on Sichuan, Shandong and Liaoning provinces. In 2015, the company sold 1.9bcm of natural gas (at the subsidiary level).

Towngas China (1083 HK): 21 April 2016

Less visibility on medium-term growth

We believe TCCL is likely TCCL’s consolidated gas sales volume was flat YoY in 2015, at 1.7bcm, as a slump in to miss its 4.5bcm competing fuel prices led to its industrial gas sales volume declining by 5% YoY, despite a annual incremental gas 12% YoY rise in its residential gas sales volume growth. We think it is unlikely that the sales target for its company will be able to meet its incremental gas sales target of 4.5bcm a year for the next greenfield projects 5 years from its greenfield projects.

Also, TCCL’s profit is heavily reliant upon connection fees, which we believe adds uncertainty to its medium-term profit growth prospects beyond 2018E, since new connection volumes decline as penetration rates increase.

Gas sales volume: tariff cut impact offset by slow volume growth in greenfield projects After the CNY0.7/m3 city-gate tariff cut in November 2015, TCCL’s management stated that the company’s 2M16 gas sales volume growth had recovered to the high-single-digit level, vs. zero growth in 2015.

However, we believe TCCL’s industrial gas sales may still face pressure given lower-than- expected gas sales for its greenfield projects. On our estimates, the gas sales volume of TCCL’s greenfield projects fell short of the company’s volume forecast by c.80% each year over the 2013-16 period. The large gap between actual and expected gas sales volume, in our view, is attributable to the slowdown in industrial production in China, as well as TCCL’s over-ambitious targets. We believe that around 40% of its greenfield projects acquired during 2010-15 are currently loss-making.

TCCL greenfield project gas sales volume target vs. actual (mcm) 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 'New' Projects New budget volume (mcm), subsidiary, in 5-years 2010 cohort, 8 projects (exclude the injection from HKCG) 500 500 500 500 500 500 500 505 510 515 2011 cohort, 5 projects 450 - 450 450 450 450 450 450 455 459 2012 cohort, 8 projects 562 - - 562 562 562 562 562 562 568 2013 cohort, 14 projects 2,107 - - - 2,107 2,107 2,107 2,107 2,107 2,107 2014 cohort, 8 projects 785 - - - - 785 785 785 785 785 2015 cohort, 1 project as of June, end (2H15 onward not budgeted) 103 - - - - - 103 103 103 103 Total budgeted gas sales from greenfield projects (a) 500 950 1,512 3,619 4,404 4,507 4,512 4,522 4,537 Assumed yoy organic growth of legacy projects 7% 6% 5% 4% 3% 2% 1% 1% 1% Total gas sales volume (mcm) - Attributable consolidated (b) 987 1,200 1,310 1,570 1,726 1,719 1,908 2,156 2,458 Gas sales volume (pre-2010) (c) 813 862 905 941 970 989 999 1,009 1,019 Gas sales volume (after-2010 projects) (d) = (b) – (c) 174 338 405 629 756 730 909 1,147 1,439 Gas sales volume not realized (e) = (a) – (d) 326 612 1,107 2,990 3,648 3,777 3,603 3,374 3,098 Percentage of gas sales volume not realised (f) = (e) / (a) 65% 64% 73% 83% 83% 84% 80% 75% 68% Source: Company, Daiwa estimates and forecasts

High industrial mix causing cyclical slowdown Most of TCCL’s greenfield projects rely on industrial gas demand. Eight of the 44 city-gas projects that the company acquired during 2010-15 are industrial park projects. These industrial parks mainly engage in heavy industries, such as equipment manufacturing, ship-building, non-ferrous metal and chemical processing. Hence, gas demand in these projects is highly sensitive to macro-economic conditions and industrial production growth in China.

Towngas China (1083 HK): 21 April 2016

TCCL: gas sales vs. national gas sales TCCL: target industries’ industrial output 25% Industry output (in unit) 2010-13 2013-15 Difference CAGR CAGR (pp) 20% Rail track material 3.4% -11.0% (14.4) Iron ore 10.6% -2.4% (13.1) 15% Heavy machinery 8.1% -3.2% (11.3) Cement 8.9% -1.4% (10.3) 10% Ship building -2.8% -11.2% (8.4) Automobile 8.6% 1.3% (7.3) 5% Steel 7.5% 1.6% (5.9) Electric light sources 3.3% 0.0% (3.3) 0% Canned food 4.4% 7.6% 3.2 1H10 2010 1H11 2011 1H12 2012 1H13 2013 1H14 2014 1H15 2015 Non-ferrous metal 8.5% 12.4% 3.9 China YTD gas consumption growth (yoy%) Pharmaceutical and China YTD industrial output growth (yoy%) Medicine 7.0% 11.7% 4.7 TCCL YTD gas sales volume growth (yoy%) Electronic component 3.8% 18.8% 15.0

Source: Company, NDRC, CEIC Source: CEIC, Daiwa estimates

TCCL: target industries of city-gas projects acquired during 2010-15 Stake Province Date (%) Major industries in the operating area Anhui Jiangbei New District, Wuhu City 2H15 100% Non-ferrous metal smelting, down, shoes Hebei Anxin County, Baoding City 2H15 70% Manufacturing, electronic information Shandong Wulian 1H15 70% Automobile parts and accessories, machinery manufacturing and stone supply Sichuan Jiajiang County, Leshan City 1H14 70% Ceramics Zhejiang Songyang County, Lishui City 1H14 51% Manufacturing of stainless steel pipes and copper metallurgy Jilin Siping City 1H14 80% Manufacturing of machinery, special-purpose vehicles Guizhou Xingyi 1H14 70% Construction materials, pharmaceuticals and wine-making Inner Guyang County, Baotou City 1H14 85% Magnesium metal processing Mongolia Jiangsu Tongshan District, Xuzhou City 1H14 100% Equipment and automobile manufacturing Yunnan Luliang County, Qujing City 1H14 100% Chemical industry Shandong Yangxin County, Binzhou City 2H14 51% Oil and gas chemical industry, stainless steel products, deep-processed industrial aluminum extrusion products Shandong Shiheng Town, Feicheng City 1H13 100% Metallurgical smelting, food processing, equipment fabrication Shandong Economic Development Zone, Boxing County, 1H13 65% Steel coating Binzhou City Anhui Zhengpugang Xin Qu Modern Industrial Zone, 1H13 100% High-end equipment fabrication, automobile parts and accessories, iron and steel Maanshan City Sichuan Mianzhu City 1H13 80% Phosphorous chemicals, glass chemicals and building materials Guangdong Fengxi District, Chaozhou City 1H13 60% Ceramic necessities and ceramic arts Anhui Fanchang County, Wuhu City 1H13 50% New materials in construction, light textiles, metallurgical machinery and medication Anhui Bozhou-Wuhu Modern Industrial Zone, Bozhou City 1H13 49% Manufacturing of modern machinery and equipment, electronic information Jiangsu Dafeng City 1H13 51% Petrochemical industry, new materials, pharmaceutical chemistry, production of heavy machinery and equipment and papermaking Hebei Cang County, Cangzhou City 1H13 90% Chemical industry, equipment manufacturing, communications and electronic products manufacturing Hebei Mengcun Hui Autonomous County, Cangzhou City 1H13 90% Pipe fittings manufacturing Hebei Yanshan County, Cangzhou City 1H13 90% Piping manufacturing Liaoning Jianping County 2H13 80% Ceramics Hebei Shijiazhuang Southern Industrial Zone 2H13 45% Building ceramics, pharmaceutical chemicals, cement building materials Liaoning Wafangdian City, Dalian 1H12 60% Bearings, forging, machinery equipment Shandong Binhai Science and Technology Industrial Park, 1H12 100% Food, electronics, automobile accessories Zhaoyuan City Jiangxi Yifeng County, Yichun City 1H12 100% Ceramics, building materials Liaoning Xinqiu District, Fuxin City 2H12 100% Construction materials, energy development, foodstuff processing Fujian Changting County, Longyan City 2H12 90% Rare earth industry Shandong Pingyin County , Jinan City 2H12 83% Carbon industry Hebei Lingang Industrial Park, Shanhaiguan District, 2H12 51% Auxiliary industries for vessels, railway accessories, wind power equipment, nuclear power equipment, Qinhuangdao City precision processing of food Jiangxi Xiushui County, Jiujiang City 1H11 80% Mine processing, ceramics and quartz processing Jiangxi Wuning Industrial Park, Jiujiang City 1H11 100% Energy-saving lights, mine ore processing, pharmaceuticals and chemicals processing Hunan Miluo City 1H11 70% Precision processing of secondary copper, aluminum, stainless steel and plastics Anhui Bowang New District, Maanshan City 2H11 75% Cutting tools, machine tools manufacturing, auto parts and metallurgical pressing Liaoning Beipiao City 2H11 80% Powder metallurgy and metallurgical casting Shandong Linqu County, Weifang City 1H10 42% Processing of aluminium and stainless steel, metallurgical and chemical processing and processing of construction materials Liaoning New Industrial District, Anshan City 1H10 100% Manufacturing of equipment Liaoning Lvshun Economic Development Zone, Dalian City 1H10 100% Manufacturing of ships and equipment Guangxi Lingui New District, Guilin City 2H10 95% Metals processing and bio-pharmaceuticals Liaoning Kazuo County, Chaoyang City 2H10 100% Metallurgy, foundries and purple pottery Jiangxi Chengdong Harbour District, Jiujiang City 2H10 60% Petrochemical, manufacturing of ships, production of construction materials, processing of food and oil Jiangxi Fubei Industrial Park, Fuzhou City 2H10 40% Smelting and processing of non-ferrous metal, and production of construction materials Shandong Nanhai New District, Laiyang City 2H10 100% Advanced technology, food processing and manufacturing of machinery

Source: Company Note: Highlighted: industrial park projects

Towngas China (1083 HK): 21 April 2016

On our estimates, c.20% of TCCL’s total of 104 projects are loss-making. Given 51 of these projects were acquired during 2010-15, and assuming there are no loss-making legacy projects, we estimate that c.40% of TCCL’s newly acquired projects are loss-making as a result of the less attractive economics of the gas tariff under the weak oil price and slowing industrial activity.

TCCL: over half of new projects (ex. midstream/vehicle gas) are in northern industrial provinces 2010 2011 2012 2013 2014 2015 Total % Hebei - - 1 4 - 1 6 14% Inner Mongolia - - - - 1 - 1 2% Shandong 2 - 2 2 1 1 8 18% Liaoning 3 - 3 1 - - 7 16% Jilin - - - - 1 - 1 2% Heilongjiang ------0% Zhejiang - - - - 1 - 1 2% Jiangsu - - - 1 1 - 2 5% Anhui - 1 - 3 - 1 5 11% Fujian - - 1 - - - 1 2% Guangdong - - - 1 - - 1 2% Guangxi 1 - - - - - 1 2% Yunnan - - - - 1 - 1 2% Guizhou - - - - 1 - 1 2% Hunan - 1 - - - - 1 2% Jiangxi 2 2 1 - - - 5 11% Sichuan - - - 1 1 - 2 5% Regions N 2 - 3 6 2 2 15 34% NE 3 - 3 1 1 - 8 18% E - 1 1 4 2 1 9 20% S 1 - - 1 2 - 4 9% C 2 3 1 1 1 - 8 18% Total 8 4 8 13 8 3 44 100%

Source: Company

Reliance on connection fee dampens sustainability TCCL has the largest proportion of consolidated gross profit derived from connection fees among its peers, but it trails its peers in terms of growth in total connection fee revenue. Given this factor, together with the company’s low organic gas sales volume growth, we believe TCCL’s overall revenue and net profit growth face downside risks in view of the declining number of new city-gas projects available.

Gas peers: gross profit mix from connection fees Gas peers: growth in connection fee revenue 2011 2012 2013 2014 2015 2016E 2017E 2018E 2011 2012 2013 2014 2015 2016E 2017E 2018E Towngas China 66% 64% 60% 61% 61% 59% 55% 50% Towngas China 64% 21% 16% 17% -4% -2% -1% -2% ENN Energy 55% 47% 44% 46% 50% 37% 39% 39% ENN Energy 31% 7% 5% 17% 25% -15% 13% 8% China Gas 51% 49% 46% 44% 39% 34% 30% 24% China Gas 56% 14% 2% 32% 16% 6% 4% 5% China Resources Gas 42% 42% 42% 43% 42% 36% 35% 34% China Resources Gas 35% 1% 80% 17% 10% -6% 4% 7%

Source: Companies, Daiwa forecast Source: Companies, Daiwa forecast

TCCL’s earnings growth Despite seeing an increase in its connection volume as a result of its acquisition of could face further greenfield projects, TCCL’s connection margin narrowed in 2015, driving down its overall downside risks given its 2015 connection fee revenue. We expect this margin squeeze to continue, due mainly to a high reliance on decrease in the connection fee per household as TCCL shifts its focus to less-developed connection fees and the cities. Moreover, we expect the connection volume growth to slow given the sluggish state sluggish property of the property market in China, with total national residential real estate investment growth markets in the cities seen falling from 19.4% YoY for 2013 and 9.2% YoY for 2014 to a 2015-17E CAGR of where it operates 2.5%, on Daiwa’s forecasts. its project TCCL: connection margin 2011 2012 2013 2014 2015 2016E 2017E 2018E Consolidated new connection (m) 0.23 0.26 0.31 0.37 0.39 0.43 0.46 0.50 YoY % 24% 11% 19% 20% 4% 11% 7% 7% Connection fee per household (HKD) 4,400 4,659 4,681 4,495 4,391 4,205 4,108 4,013 YoY % 20% 6% 0% -4% -2% -2% -2% -2% Connection segment margin 44% 46% 44% 45% 42% 39% 37% 34%

Source: Company

Towngas China (1083 HK): 21 April 2016

Little impact from potential regulatory margin cut

We expect the Zhejiang The Zhejiang provincial government published a document on 6 April introducing measures distribution tariff cut to to cut the production costs of companies as part of the country’s broader supply-side have only a limited reform push. It suggested cutting the province’s non-residential city-gate gas tariff by impact on TCCL’s net CNY0.1/m3, reducing the gas distribution tariff by 20%, and setting a CNY3.4/m3 price earnings ceiling for retail gas tariffs.

Zhejiang: little impact on overall gross profit On our estimates, the unit dollar margin for city-gas distributors on Zhejiang projects will decline by only 10%. (For more on our view of the proposed policy, click here.)

Given only 5% of TCCL’s total project investment is in Zhejiang, and gas sales only account for c.40% of its total gross profit, the impact of the proposed policy on the company’s overall gross profit would likely be small, in our view. On our estimate, Zhejiang’s proposal alone would reduce TCCL’s 2017E gross profit by only 0.2%.

Implementation is still uncertain As retail gas tariffs are decided at the city level, ie, by city governments, we believe the implementation of the provincial guidance document is uncertain. In our view, the city-gas distributors may have to negotiate with various city governments regarding any change in city-gas distribution tariffs and retail tariffs for their projects.

Further margin cuts for other provinces unlikely The same document published by the Zhejiang government suggested over 20 other measures (including tax cuts and financing support) besides gas tariff cuts, with the goal of reducing production costs and boosting economic growth. Therefore, we believe the policies are not focused solely on reducing the margin of the city-gas distribution sector as a whole, and other provinces seeking to boost economic development may not necessarily adopt the same measures. Indeed, given varying economic characteristics and gas tariff patterns among provinces, we believe that a nationwide regulatory city-gas margin cut is unlikely.

Even if some provinces do follow Zhejiang’s proposed policy and do reduce the gas distribution tariff, we believe the impact on TCCL would be small. We have shortlisted 9 provinces with relatively higher chances of following Zhejiang ‘s proposal, given their low industrial GDP growth, high proportion of industrial GDP to total provincial GDP, or high gas T&D margin. Assuming all these 9 provinces, together with Zhejiang, cut their city-gate tariff by CNY0.1/m³ and reduce the tariff margin by 20%, the overall impact on TCCL’s 2017E gross profit would be only 4.3%, on our estimate.

Towngas China (1083 HK): 21 April 2016

Gross profit and RoE impact of potential distribution margin cuts on city-gas distributors ENN CRG CGHL TCCL Max. Max. non- Max. margin Non- residential Max. unit Max. unit margin squeeze 2015 Installed residential retail tariff dollar dollar squeeze if percentage industrial Industrial designed daily Industrial Project city-gate (provincial margin for distribution follow if follow GDP proportion capacity for C&I Number of customer investment tariff capital) T&D margin Zhejiang Zhejiang growth to GDP Proxies: customers % project % % % Beijing 2.00 3.16 1.16 0.85 0.13 11% 3.3% 21% 1% 0% 0% 0% Tianjin 2.00 2.77 0.77 0.46 0.05 7% 9.2% 49% 0% 0% 0% 0% Hebei 1.98 3.02 1.04 0.73 0.11 10% 4.7% 51% 12% 3% 7% 4% Shanxi 1.91 3.20 1.29 0.98 0.16 12% -1.1% 49% 0% 4% 0% 0% Xinjiang 1.15 2.39 1.24 0.93 0.15 12% 6.9% 43% 0% 0% 0% 0% Liaoning 1.98 3.20 1.22 0.91 0.14 12% -0.2% 50% 1% 7% 4% 21% Jilin 1.76 3.15 1.39 1.08 0.18 13% 5.6% 53% 0% 4% 0% 7% Heilongjiang 1.76 3.60 1.84 1.53 0.27 15% 1.1% 37% 0% 1% 3% 2% Shanghai 2.18 3.57 1.39 1.08 0.18 13% 1.2% 35% 0% 0% 0% 0% Jiangsu 2.16 3.10 0.94 0.63 0.09 9% 8.4% 47% 11% 7% 5% 2% Zhejiang 2.29 3.60 1.31 1.00 0.12 12% 5.4% 48% 8% 10% 6% 5% Anhui 2.09 3.30 1.21 0.90 0.14 12% 8.5% 53% 6% 5% 12% 10% Jiangxi 1.96 2.92 0.96 0.65 0.09 10% 9.4% 52% 0% 5% 0% 5% Shandong 1.98 3.70 1.72 1.41 0.24 14% 7.4% 48% 0% 9% 6% 21% Henan 2.01 2.90 0.89 0.58 0.08 9% 8.0% 51% 9% 6% 12% 0% Hubei 2.31 3.49 1.19 0.88 0.14 12% 8.3% 47% 0% 7% 10% 0% Hunan 1.96 3.18 1.22 0.91 0.14 12% 7.4% 46% 12% 5% 1% 2% Guangdong 2.18 4.36 2.18 1.87 0.34 15% 6.8% 46% 13% 12% 2% 5% Guangxi 2.01 4.18 2.17 1.86 0.33 15% 8.1% 47% 0% 0% 3% 2% Hainan 1.64 2.62 0.98 0.67 0.10 10% 6.5% 25% 0% 0% 0% 0% Chongqing 1.64 2.14 0.50 0.19 - 0% 11.3% 46% 0% 0% 1% 0% Sichuan 1.65 3.25 1.60 1.29 0.22 14% 7.8% 49% 0% 7% 0% 13% Guizhou 1.71 3.30 1.59 1.28 0.22 14% 11.4% 42% 0% 1% 0% 1% Yunnan 1.71 3.42 1.71 1.40 0.24 14% 8.6% 41% 0% 3% 0% 1% Shaanxi 1.34 2.39 1.05 0.74 0.11 10% 7.3% 54% 0% 0% 5% 0% Gansu 1.43 1.99 0.56 0.25 0.01 2% 7.4% 43% 0% 0% 0% 0% Ningxia 1.51 2.06 0.55 0.24 0.01 2% 8.5% 49% 0% 0% 0% 0% Qinghai 1.27 1.70 0.43 0.12 (0.01) -3% 8.4% 54% 0% 1% 0% 0% Inner Mongolia 1.34 2.67 1.33 1.02 0.17 12% 8.0% 51% 14% 0% 14% 1% Weighted average max. C&I dollar margin 1.14 1.38 1.16 1.43 % for high-risk provinces 36% 46% 41% 73% Max. negative impact on C&I unit dollar margin if: - No other provinces follow 0.6% 0.2% 0.2% 0.5% - High-risk provinces follow 4.3% 5.9% 5.8% 9.7% - All provinces follow 12.0% 12.5% 11.8% 12.9% 2017E gross profit % from gas sales (Assume residential gas sales contribute minimal GP) 57% 65% 38% 45% Max. estimated negative impact on 2017E gross profit if - No other provinces follow 0.3% 0.1% 0.1% 0.2% - High-risk provinces follow 2.4% 3.8% 2.2% 4.3% - All provinces follow 6.9% 8.1% 4.4% 5.8% 2017E RoE - No gas tariff cut at all 20.5% 17.7% 22.4% 9.1% - No other provinces follow 20.4% 17.7% 22.4% 9.1% - High-risk provinces follow 19.9% 16.7% 21.9% 8.7% - All provinces follow 18.8% 15.4% 21.3% 8.6%

Source: NDRC, companies, Daiwa estimates Note: (1) Grey-highlighted cell = higher-than-Zhejiang unit dollar margin / lower-than-Zhejiang industrial GDP growth / larger-than-Zhejiang industrial GDP proportion 2) Red-highlighted text = high risk provinces, which have at least 2 grey-highlighted cell, in terms of a) higher T&D tariff, b) lower industrial GDP growth, c) higher exposure of industrial contribution to provincial GDP, compared with Zhejiang (3) Different proxies are used due to data availability

Towngas China (1083 HK): 21 April 2016

Possible case for privatisation in 2016-17

We believe it makes Although we expect TCCL to see slow earnings growth for 2016-18E, we also see potential sense for HKCG to share-price upside if HKCG were to privatise TCCL. Our read is that HKCG may be consider privatising considering a privatisation for TCCL due to the subsidiary’s current low valuation (9.2x TCCL, due to the high 2016E PER) and concentrated ownership structure, as well as the parent’s current valuation gap between abundant cash balance (2015: HKD13.3bn, vs. TCCL’s market cap of HKD10.2bn as at 18 the two companies April 2016) and low net gearing (2015: 32%).

Given that TCCL is trading at such a cheap valuation, we think a privatisation would make sense and assign a 30-50% chance of it actually happening. If HKCG decides to propose the move, we would see a more than 80% chance of shareholders approving it. The following table shows some of the biggest privatisations proposed to the Hong Kong stock market (all based on low valuations) since 2008, and that the approval rate for these proposed privatisations has been high.

Select HKD5bn+ privatisation cases proposed in Hong Kong Did it pass PER on PBR on the 10-day the EGM the date of date of Final offer price share- Major announce- PER vs. announce- PBR vs. price change % holding Date Company Ticker Major shareholder(s) shareholding % ment parent ment parent premium after offer vote? Nov-08 PCCW 8 HK Pacific Century RD (PAC SP) 42.4%* 14.26x -14% 10.45x -77% 55% 17.2% Yes Jan-10 Hutchison Telecom Intl 2332 HK Hutchison Whampoa (13 HK) 54.4% Net loss n.a. 0.75x -3% 33% 29.7% Yes Aug-10 ICBC (Asia) 349 HK ICBC (1398 HK) 59.7% 6.66x 298% 1.51x -39% 28% 24.3% Yes Feb-12 Alibaba.com Inv. 1688 HK Alibaba.com Corp. 73.2% 27.21x n.a. 6.23x n.a. 46% 43.1% Yes Mar-14 New World China 917 HK New World Development (17 HK) 68.9% 13.35x 99% 0.73x 59% 32%** 27.4% No*** Current: Current: ? Towngas China 1083 HK Hong Kong China Gas (3 HK) 60.8% 9.2x -58% 0.80x -71% ? ? ?

Source: Bloomberg, Daiwa Note: * Together with China Netcom ** discount of 32% after asset revaluation *** New World China received sufficient votes in terms of shareholding %, but insufficient votes in terms of attendance

Widening the valuation gap The 12-month forward PER valuation gap between HKCG and TCCL reached a 10-year peak in February 2016 and has stayed high since then, at around 60%. We think the large valuation gap supports the case for a TCCL privatisation, as HKCG would be able to offer a relatively high offer-price premium.

But while the PER valuation gap is at a past-10-year high, the PBR valuation gap, at around 70%, is still lower than the peak of 2009, at 84%. If the PBR valuation gap were to increase back to the 2009 level, we would see the likelihood a privatisation offer for TCCL increasing further.

HKCG and TCCL: 12-month-foreward PER valuation gap HKCG and TCCL: 12-month-foreward PBR valuation gap 12M PER (x) 12M PBR (x) 70 3.0 5 7 60 6 2.5 4 50 5 2.0 40 3 4 1.5 30 2 3 1.0 20 2 1 10 0.5 1

0 0.0 0 0

Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Jan-09 Jan-07 Jan-08 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 HKCG (LHS) TCCL (LHS) HKCG/TCCL ratio (RHS) HKCG (LHS) TCCL (LHS) HKCG/TCCL ratio (RHS)

Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Towngas China (1083 HK): 21 April 2016

The major reasons for the differences in the valuation gap are due to: 1) The ongoing low valuation since 1H15 for the China Gas Sector, due to the low price competitiveness of gas compared to competing fuels and slowing demand for industrial gas. But as HKCG has smaller relative exposure to business in Mainland China vs. TCCL, its valuation should be less affected. 2) HKCG has a higher EBITDA margin than TCCL (2015: HKCG’s Hong Kong business 48%; HKCG’s Mainland business: 25%; TCCL: 17%). 3) TCCL’s gas sales volume is more sensitive than HKCG’s to the current industrial production slowdown in China, especially given the company’s greenfield status. Possible delays in the new commissioning of factories in the cities where TCCL operates will greatly affect its profitability. HKCG’s Hong Kong business has a much more stable outlook as demand is derived mainly from residential consumption in Hong Kong. Thus, HKCG recorded 2% YoY gas sales volume growth for 2015, compared with 0% for TCCL.

We expect the valuation gap divergence to continue in the medium term due to the slowing consumption of industrial gas in China and thus likely low profitability of TCCL’s projects in the tier-3 or tier-4 cities.

Given that we don’t think TCCL will see high enough economies of scale until at least 2018, we don’t think it will be able to fully realise the value of its city-gas projects until then. Accordingly, we expect the stock to remain cheap compared to peers ENN (2688 HK, HKD41.85, Buy [1]) and CR Gas (1193 HK, HKD21.80, Buy [1]). At the same time, an asset injection from HKCG to TCCL seems unlikely due to the wide valuation gap between the two.

30-50% price premium possible As TCCL is trading at We think most of TCCL’s greenfield projects will be ramped up and developed into 44% below its past-10- profitable operations after 2018E. And given the long-term nature of this industry, we think year average and at a HKCG may be willing to pay up to a 30-50% price premium to privatise TCCL, given its low 38% discount to its PER valuation, and because the China Gas Sector also looks attractive right now (TCCL is current peer average, trading at a PER discount of 44% to its past-10-year average, while the China Gas Sector HKCG could offer a 30- is trading at a 30% discount to its past-10-year average). Also, compared with its peers, 50% premium to TCCL is trading at an average 38% discount (9.2x 2016 PER vs. ENN’s 12x and CRG’s privatise TCCL (from 15x, on our forecasts). In addition, HKCG may achieve higher operating efficiency after current the price) reorganising its city-gas project portfolio in China, supporting our view that HKCG might be willing to pay a premium for privatisation.

China Gas Sector: 12-month PERs (x) 30 25 20 15 10 5

Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Apr-08 Apr-11 Oct-11 Apr-07 Oct-07 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-14 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-15 Jan-16 ENN Energy Beijing Enterprise Holdings CR Gas China Gas Towngas China Kunlun Source: Bloomberg, Daiwa forecasts for ENN, Beijing Enterprise, CR Gas, China Gas and Towngas China

Towngas China (1083 HK): 21 April 2016

Concentrated shareholding structure We see a high chance of Apart from HKCG’s 61% stake in TCCL, the company is owned mostly by institutional a privatisation proposal investors, which account for 25% of TCCL’s shares. Thus, we believe it is highly likely that being approved by HKCG will win enough votes (more than of 75% of total voting rights) at an EGM should shareholders given the privatisation be proposed. TCCL’s concentrated shareholding structure TCCL: shareholding structure Shareholder structure % % HKCG 60.8% Institutional investors 25.0% - Commonwealth Bank of Australia 8.0% - Invesco 2.0% - Planwise Properties 1.7% - Value Partners 0.9% - Matthews International Capital 0.8% - Others 11.8% Insiders 0.4% Free float 13.8%

Source: Bloomberg Note: As at 20 April 2016

Towngas China (1083 HK): 21 April 2016

Valuation

Given the slow earnings growth that we see for 2016-18, we are downgrading our rating on TCCL to Outperform (2) from Buy (1), and cut our DCF-based 12-month target price to HKD5.0, from HKD7.5. Despite the slow earnings growth, we still like TCCL’s story given what we see as its attractive valuation.

Our DCF-based target We are revising down our 2016-17 EPS forecasts by 8-12%, due mainly to our lower gas price of HKD5.0 implies sales volume growth and connection profit assumptions, on the back of a slowdown in the a 10.3x 2016E PER expansion of TCCL’s industrial park projects and the sluggish property markets in the cities where TCCL operates its projects. The stock is trading currently at 9.2x 2016E PER, on our revised recurring EPS forecast, which is 1.5SD below its past-7-year average 12-month- forward PER of 16.3x. We believe this multiple is appealing, and much lower than those of its pure city-gas distributor peers (8-15x, on our forecasts), which supports our view that a privatisation by its parent HKCG makes sense.

We value TCCL using a DCF methodology to reflect the stable long-term income generated by its gas sales volume and residential connections. We assume a WACC of 9.6% (previously 10%) and a terminal growth rate of 2% (unchanged). Our DCF-based valuation yields a fair value of HKD5.0, implying a 2016E PER of 10.3x.

TCCL: DCF valuation Forecast 12 mths to 31 Dec, All figures in HKDm 2016 2017 2018 2019 2020 2021 2022 Terminal

Valuation Date 21-Apr-16 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21 31-Dec-22 31-Dec-22 Next Balance Date 31-Dec-16 First Year Cash Flow Adjustment 0.70

Free Cash Flow EBITDA 1,722 1,800 1,922 2,023 2,138 2,283 2,116 Less: Other Non Cash ------Less: Cash Tax Payable on EBIT (252) (273) (305) (334) (369) (413) (382) Plus: Decrease in Working Capital (316) 266 318 350 361 360 432 Less: Capital Expenditure (770) (740) (710) (490) (480) (470) (448) Free Cash Flow 384 1,053 1,225 1,549 1,650 1,760 1,718 1,751.9

Free Cash Flow for Valuation Purposes 384 1,053 1,225 1,549 1,650 1,760 1,718 1,751.9

WACC 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6%

NPV of Free Cash Flow 361 902 957 1,104 1,073 1,044 930 12,505.5

Source: Daiwa forecasts

Towngas China (1083 HK): 21 April 2016

TCCL: DCF calculation TCCL: DCF sensitivity analysis Target gearing (debt/capital) (%) 30% Discount NPV of Enterprise Equity Equity Value Per Share Market risk premium (%) 10.00% Rate FCF Value Value (HKD) Risk-free rate (%) 3.50% 7.1% 6,998 28,767 23,207 8.71 Cost of debt (%) 2.60% 7.6% 6,866 26,078 20,517 7.70 Cost of equity (%) 12.86% 8.1% 6,737 23,832 18,271 6.86 WACC (%) 9.59% 8.6% 6,612 21,928 16,367 6.14 9.1% 6,490 20,294 14,733 5.53 Terminal Value 9.6% 6,371 18,877 13,316 5.00 Terminal Growth Rate 2.00% 10.1% 6,256 17,636 12,075 4.53 Terminal WACC 9.59% 10.6% 6,143 16,540 10,979 4.12 Estimated Terminal Free Cash Flow 1,752 11.1% 6,034 15,566 10,005 3.75 NPV of Terminal Value (as at 31 Dec 2022) 23,090 11.6% 5,927 14,694 9,133 3.43 NPV of Terminal Value (as at 21 Apr 2016) 12,506 12.1% 5,823 13,910 8,349 3.13

DCF Valuation NPV of Forecasts (HKDm) 6,371 NPV of Terminal Value (HKDm) 12,506 Add: Market value of stakes in Associates #1 - Associate #2 - Associate #3 - Enterprise Value (HKDm) 18,877 Less: Net Debt (as at 21 Apr 2016) -5,561 Equity Value (HKDm) 13,316 No. Shares (m) 2,665 Per Share Equity Value HK$5.00

Source: Daiwa forecasts Source: Daiwa estimates and forecasts

Towngas China (1083 HK): 21 April 2016

Risks A further decline in the gas sales volume growth Lower-than-expected While we are already conservative when it comes to TCCL’s industrial gas sales volume gas sales volume due to growth for 2016-18, lower-than-expected gas sales volume growth could still materialise if the low price the expected CNY0.32/CNY city-gate tariff cut in 1H16 is delayed further, or if the industrial competitiveness of gas production in the cities where TCCL has its projects were to decline further amid structural could further hurt economic restructuring. And these are the main risks to our call on the stock. TCCL’s overall earnings We have carried out a sensitivity analysis to assess the impact on TCCL’s 2016E earnings and ROE if its gas sales volume growth were to change. We conclude that TCCL’s 2016E earnings would decline by 0.2%, with the 2016E ROE down 0.02pp should there be a 1pp decline in our 2016E subsidiary gas sales volume growth forecast (base case: 11%).

TCCL: sensitivity analysis of impact of 2016E gas sales volume growth NAV 2016E earnings 2016E ROE 2016E gas sales volume (mcm) Change in Base case 4.40 1,279 9.2% 1,908 NAV 2016E earnings 2016E ROE 2016E gas sales volume (mcm) -1% 4.43 1,277 9.2% 1,891 0.7% -0.2% -.02ppt -0.9% -2% 4.37 1,274 9.2% 1,874 -0.7% -0.4% -.04ppt -1.8% -3% 4.30 1,272 9.1% 1,857 -2.2% -0.6% -.05ppt -2.7% Source: Daiwa estimates

Lower-than-expected connection volumes As TCCL’s net profit relies on connection fees, a lower-than-expected connection volume, possibly due to the sluggish property market, could affect TCCL’s net profit significantly. Based on our sensitivity analysis, TCCL’s 2016E earnings would decline by 0.8%, with the 2016E ROE falling by 0.07pp should there be a 2pp cut in our 2016E forecast number of consolidated new connections (base case: 0.43m).

TCCL: sensitivity analysis of impact of 2016E new residential connection NAV 2016E earnings 2016E ROE 2016E residential connected households (’000) Change in Base case 4.40 1,279 9.2% 0.43 NAV 2016E earnings 2016E ROE 2016E residential connected households ('000) -2% 4.48 1,269 9.1% 0.42 1.9% -0.8% -.07ppt -2.0% -4% 4.47 1,260 9.1% 0.41 1.6% -1.5% -.14ppt -4.0% -6% 4.45 1,250 9.0% 0.41 1.2% -2.3% -.20ppt -6.0% Source: Daiwa estimates

Towngas China (1083 HK): 21 April 2016

Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware Kevin LAI (852) 2848 4926 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Junjie TANG (852) 2773 8736 [email protected] Kevin JIN (82) 2 787 9168 [email protected] Macro Economics (China) Small/Mid Cap Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property TAIWAN Cynthia CHAN (852) 2773 8243 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Property (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Leon QI (852) 2532 4381 [email protected] (Regional) Banking (Hong Kong/China); Broker (China); Insurance (China) Christie CHIEN (886) 2 8758 6257 [email protected] Anson CHAN (852) 2532 4350 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Consumer (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (PC Hardware) Gaming and Leisure (Hong Kong/China) Christine WANG (886) 2 8758 6249 [email protected] Dennis IP (852) 2848 4068 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Power; Utilities; Renewables and Environment (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] John CHOI (852) 2773 8730 [email protected] IT/Technology Hardware (Handsets and Components) Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Helen CHIEN (886) 2 8758 6254 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap Head of Automobiles; Transportation and Industrial (Hong Kong/China) Brian LAM (852) 2532 4341 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Transportation – Railway; Construction and Engineering (China) Jibo MA (852) 2848 4489 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group Thomas HO (852) 2773 8716 [email protected] Capital Goods; Utilities

Custom Products Group SINGAPORE Ramakrishna MARUVADA (65) 6499 6543 [email protected] PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Utilities and Energy Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods David LUM (65) 6329 2102 [email protected] Banking; Property and REITs Shane GOH (65) 64996546 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

Towngas China (1083 HK): 21 April 2016

Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc. New York Head Office Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100 Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935 Daiwa Capital Markets Europe Limited, London Head Office 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Neue Mainzer Str. 1, 60311 Frankfurt/Main, Germany (49) 69 717 080 (49) 69 723 340 Daiwa Capital Markets Europe Limited, Paris Representative Office 17, rue de Surène 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808 Daiwa Capital Markets Europe Limited, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441 Daiwa Capital Markets Europe Limited, Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, (7) 495 641 3416 (7) 495 775 6238 Moscow Representative Office Russian Federation Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, (973) 17 534 452 (973) 17 535 113 Manama, Bahrain Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621 Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, OUE Downtown 2, Singapore 068809, (65) 6220 3666 (65) 6223 6198 Republic of Singapore Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, (61) 3 9916 1300 (61) 3 9916 1330 Victoria 3000, Australia DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, (632) 813 7344 (632) 848 0105 Makati City, Republic of the Philippines Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638 Daiwa Securities Capital Markets Korea Co., Ltd. 20 Fl.& 21Fl. One IFC, 10 Gukjegeumyung-Ro, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, Korea Daiwa Securities Co. Ltd., Beijing Representative Office Room 301/302，Kerry Center，1 Guanghua Road，Chaoyang District， (86) 10 6500 6688 (86) 10 6500 3594 Beijing 100020, People’s Republic of China Daiwa (Shanghai) Corporate Strategic Advisory Co. Ltd. 44/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road, Pudong, (86) 21 3858 2000 (86) 21 3858 2111 Shanghai China 200120 , People’s Republic of China Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, (66) 2 252 5650 (66) 2 252 5665 Lumpini, Pathumwan, Bangkok 10330, Thailand Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, (91) 22 6622 1000 (91) 22 6622 1019 Bandra East, Mumbai – 400051, India Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Hoan Kiem Dist. Hanoi, Vietnam

DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

New York Research Center 11th Floor, Financial Square, 32 Old Slip, NY, NY 10005-3504, U.S.A. (1) 212 612 6100 (1) 212 612 8417 London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550

Towngas China (1083 HK): 21 April 2016

Important Disclosures and Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.

Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.

Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); econtext Asia Ltd (1390 HK); GF Securities Co Ltd (1776 HK); Mirae Asset Life Insurance Co Ltd (085620 KS); China Reinsurance Group Corporation (1508 HK). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research.

Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research.

Australia This research is distributed in Australia by Daiwa Capital Markets Australia Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research.

India This research is distributed in India to Institutional Clients only by Daiwa Capital Markets India Private Limited (Daiwa India) which is an intermediary registered with Securities & Exchange Board of India as a Stock Broker, Merchant Bank and Research Analyst. Daiwa India, its Research Analyst and their family members and its associates do not have any financial interest save as disclosed or other undisclosed material conflict of interest in the securities or derivatives of any companies under coverage. Daiwa India and its associates may have received compensation for any products other than Investment Banking (as disclosed) or brokerage services from the subject company in this report during the past 12 months. Unless otherwise stated in BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action, Daiwa India and its associates do not hold more than 1% of any companies covered in this research report.

There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report.

Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research.

Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE links at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively.

Thailand This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”). This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user. Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Towngas China (1083 HK): 21 April 2016

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, 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 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 66.9% Hold** 19.7% Sell*** 13.5% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2016. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association