China / Hong Kong Company Guide China Resources Gas Version 1 | Bloomberg: 1193 HK EQUITY | Reuters: 1193.HK Refer to important disclosures at the end of this report DBS Group Research . Equity 11 May 2018 FULLY VALUED (Initiate coverage) Losing Steam Last Traded Price ( 10 May 2018):HK$28.25 (HSI : 30,809) Dollar margin remain under pressure from lack of Price Target 12-mth: HK$25.00 (-12% downside) midstream facilities and government regulation A nalyst Conservative development strategy hinders growth Tony WU CFA +852 2971 1708 potential [email protected] Patricia YEUNG +852 2863 8908 Diminishing SOE advantage [email protected] Initiate with FULLY VALUED, TP is set at HK$25 Price Relative Not the time to be optimistic on margin yet. In contrary to HK$ Relative Index 33.1 market’s expectation on a rebound in dollar margin, we believe 206 31.1 the dollar margin for CR Gas could remain suppressed and decline 29.1 186 27.1 166 by Rmb0.03/m3 in the next two years. The market has 25.1 146 23.1 underestimated the severity of winter gas supply shortage, and 126 21.1 106 CR Gas will suffer in dollar margin due to the lack of midstream 19.1 17.1 86 facilities. It also has high exposure to regions with higher pressure 15.1 66 May-14 May-15 May-16 May-17 May-18 on dollar margin coming from government’s regulation on distribution margin. Moreover, conservative development strategy China Resources Gas (LHS) Relative HSI (RHS) towards integrated energy and rural coal to gas projects could Forecasts and Valuation FY Dec (HK$ m) 2017A 2018F 2019F 2020F hinder its growth potential. Turnover 39,838 46,481 51,630 56,505 Where w e differ. We are conservative on the outlook on the EBITDA 8,509 9,336 10,116 11,119 Pre-tax Profit 6,613 7,389 7,932 8,605 dollar margin of CR Gas. The market is too optimistic on the Net Profit 3,654 4,020 4,261 4,607 recovery of dollar margin. Thus, our earnings forecast is 7% lower Net Pft (Pre Ex) (core profit) 3,654 4,020 4,261 4,607 than the market. EPS (HK$) 1.68 1.85 1.92 2.07 Core EPS (HK$) 1.68 1.85 1.92 2.07 Potential catalyst. Continued gas shortage during winter and the EPS Gth (%) 11.0 9.9 3.8 8.1 full implementation of the distribution return requirement by local Core EPS Gth (%) 11.0 9.9 3.8 8.1 Diluted EPS (HK$) 1.68 1.85 1.92 2.07 governments, may trigger pressure on dollar margin and negative DPS (HK$) 0.56 0.68 0.77 0.83 sentiment on the stock. BV Per Share (HK$) 10.11 11.26 12.18 13.42 PE (X) 16.8 15.3 14.7 13.6 Valuation: Core PE (X) 16.8 15.3 14.7 13.6 We initiate with FULLY VALUED rating and target price is set at P/Cash Flow (X) 7.9 9.9 8.4 7.9 HK$25, based on DCF valuation. We have assumed a beta of 1 P/Free CF (X) 18.2 nm nm 64.4 EV/EBITDA (X) 8.2 7.8 7.4 6.7 with WACC of 8.5% and 1% terminal growth. Net Div Yield (%) 2.0 2.4 2.7 2.9 Key Risks to Our View: P/Book Value (X) 2.8 2.5 2.3 2.1 Upside risk on dollar margin. A less severe winter gas shortage or Net Debt/Equity (X) 0.0 0.1 0.0 0.0 ROAE (%) 18.4 17.3 16.5 16.2 lower than expected dollar margin pressure on project return investigation from government will be positive to earnings growth Consensus EPS (HK$) 1.88 2.07 2.43 Other Broker Recs: B:15 S:2 H:8 At A Glance Issued Capital (m shrs) 2,224 ICB Industry: Utilities Mkt. Cap (HK$m/US$m) 63,161 / 8,046 ICB Sector: Gas, Water & Multiutilities Major Shareholders Principal Business: Investment, construction and operation of city gas projects CR Company Limited (%) 63.9 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Capital Group Compan (%) 7.9 Free Float (%) 28.2 3m Avg. Daily Val. (US$m) 9.6 ed-TH / sa– CS / AH China /Hong Kong Company Guide China Resources Gas Table of Contents SWOT Analysis 3 Valuation 4 Solid and steady gas distributor 6 Careful of the hiccups ahead 8 Financial Analysis 11 Key Risks 12 Appendix 13 A lucrative industry with bright prospects 14 Page 2 China/Hong Kong Company Guide China Resources Gas SWOT Analysis Strengths Weak nesses Backed by one of the largest conglomerates in China Slower earnings growth on lack of new business initiatives Steady gas volume growth with higher proportion of residential and commercial gas volume Higher sensitivity to decline in dollar margin Solid balance sheet Lack of midstream facilities such as storage and LNG receiving terminal Opportunities T hreats Cut in city-gate price from lowering intra-provincial pipeline Gas supply shortage during winter season tariff Local government lowering dollar margin while Acceleration in the replacement of coal with gas implementing ROA requirement Source: DBS Vickers Page 3 China /Hong Kong Company Guide China Resources Gas Valuation Initiate with FULLY VALUED. Given CR Gas’s leading position in CR Gas is currently trading at the five-year mean and it has the gas distribution industry, we reckon the company will be been trading at a 24% premium against other listed peers in one of the major beneficiaries from accelerating gas the past three years due to its strong SOE background. consumption in China. However, it is more prone to potential However, we believe the valuation will be suppressed by the downward pressure on dollar margin, which will negatively pressure over dollar margin and lack of new growth drivers. impact earnings growth. We estimate CR Gas to achieve a After the recent share price hike of >15%, we believe the FY17-20 earnings CAGR of 8%, which is less exciting than current share price is fully valued. major peers. Our estimation is also lower than the market projection by 7%. We initiate coverage with a FULLY VALUED PE chart – Main gas distributors rating with TP set at HK$25. X The stock dropped c.25% from the peak in January this year 35 over concerns on the decline of dollar margin from elevated 30 LNG price last winter. Despite that the stock rebounded >15% 25 afterwards, we believe the market were too optimistic on the 20 recovery in dollar margin. We expect the dollar margin continue to drop c.Rmb0.03/m3 by 2019 from the implementation of 15 ROA requirement on local level. CR Gas has the highest number 10 of projects in provincial capitals/direct-controlled municipalities 5 and high exposure to high risks regions, which are prone to a 0 cut in dollar margin. Also, the company has the high earnings Jul-15 Jul-16 Jul-17 Jan-15 Jan-16 Jan-17 Jan-18 Oct-15 Oct-16 Oct-17 Apr-15 Apr-16 Apr-17 sensitivity in a dollar margin cut. Therefore, we believe a miss on Apr-18 dollar margin estimate will negatively impact earnings growth CR Gas China Gas and share price. ENN Towngas China BEH Source: Thomson Reuters, DBS Vickers PE band chart PB band chart Share Price (HK$) Share Price (HK$) 40 45 20x 3.5x 35 40 18x 3.2x 35 30 16x 2.8x 2.5x 14x 30 25 2.1x 12x 25 20 20 15 15 10 10 Jan-15 Jan-15 Sep-15 Apr-18 Dec-16 Mar-16 Aug-17 Aug-18 May-16 May-17 Source: Thomson Reuters, DBS Vickers Source: Thomson Reuters, DBS Vickers Page 4 China/Hong Kong Company Guide China Resources Gas Peers PE vs EPS growth PE 20 China Gas 18 ENN 16 CR Gas 14 Towngas 12 10 Kunlun 8 6 Tian Lun BEH Gas 4 2 0 0% 5% 10% 15% 20% 25% FY18-20 earnings growth Source: Thomson Reuters, DBS Vickers Peers valuation Mk t PE PE Yield Yield P/Bk P/Bk EV /EBIT DA ROE ROE Price Cap F iscal 18F 19F 18F 19F 18F 19F 18F 19F 18F 19F Company Name Code Local$ US$m Yr x x % % x x x x % % China Gas Holdings*# 384 HK 29.2 18,560 Mar 17.9 15.7 1.6 1.9 4.7 3.9 12.7 11.1 29.0 27.1 Enn Energy Holdings* 2688 HK 75.25 10,442 Dec 17.4 14.5 2.1 2.3 3.4 2.9 8.8 7.8 20.7 21.5 China Resources Gas Group 1193 HK 28.25 8,038 Dec 15.0 13.6 2.3 2.6 2.5 2.2 7.6 6.9 17.7 17.5 Towngas China 1083 HK 7.36 2,607 Dec 14.3 12.9 2.2 2.5 1.2 1.1 9.8 8.9 8.8 9.0 Beijing Enterprises Holdings 392 HK 40.1 6,474 Dec 7.0 6.4 2.7 2.9 0.7 0.6 11.0 10.6 10.3 10.4 Kunlun Energy 135 HK 6.89 7,115 Dec 9.5 8.4 3.7 4.1 1.1 1.0 5.1 4.6 11.5 12.2 China Tian Lun Gas Hdg.