China / Hong Kong Company Guide Towngas China Co Ltd Version 1 | Bloomberg: 1083 HK Equity | Reuters: 1083.HK Refer to important disclosures at the end of this report DBS Group Research . Equity 21 May 2018 BUY (Initiate coverage) Storing up for growth Last Traded Price ( 18 May 2018):HK$7.90 (HSI : 31,048) First mover advantage in large scale storage facilities Price Target 12-mth: HK$9.00 (14% upside) Dollar margin to remain stable despite winter gas A nalyst shortage Tony WU CFA +852 2971 1708 [email protected] Sales volume to reach CAGR of 14% in FY17-20 Patricia YEUNG +852 28638908 [email protected] Initiate with BUY rating, TP is set at HK$9.00 Price Relative More re-rating to go. Towngas China differs from other gas distributors in its determination to invest in midstream assets. By leveraging on the vast experience and resources of the parent company such as underground storage facility and LNG receiving terminal, it will allow the company to mitigate the dollar margin pressure and we believe the dollar margin will remain stable in FY18. Also, its gas sales volume growth is expected to reach a CAGR of 14% in FY17-20, which will help to drive up the adjusted earnings growth to 14% in FY17-20. This is expected to help the stock re-rate Forecasts and Valuation back to the 15-23x PE range before the oil price collapsed in FY Dec (HK$ m) 2017A 2018F 2019F 2020F 2014 and when volume growth was at double digit. Turnover 8,760 10,120 11,223 12,260 EBITDA 2,619 3,034 3,361 3,663 Where w e differ. The market underestimated the benefit of Pre-tax Profit 1,918 2,172 2,447 2,697 the gas storage facilities and LNG receiving terminal on the Net Profit 1,365 1,524 1,720 1,898 dollar margin. Our earnings estimate is 8% above the Net Pft (Pre Ex) (core profit) 1,284 1,524 1,720 1,898 EPS (HK$) 0.51 0.56 0.62 0.69 consensus. The market remain cautious on the downside in Core EPS (HK$) 0.48 0.56 0.62 0.69 margin and has not priced in the stable dollar margin EPS Gth (%) 38.3 9.5 11.6 10.4 outlook. Core EPS Gth (%) 22.4 16.5 11.6 10.4 Diluted EPS (HK$) 0.25 0.28 0.31 0.34 Potential catalyst. Better than expected dollar margin DPS (HK$) 0.15 0.18 0.20 0.22 supported by access to underground storage facility and a BV Per Share (HK$) 5.90 6.17 6.52 6.99 PE (X) 15.5 14.2 12.7 11.5 less severe winter gas shortage. Potential privatisation by Core PE (X) 16.5 14.2 12.7 11.5 HKCG may drive up the valuation closer to its parent as P/Cash Flow (X) 14.0 14.8 11.8 10.9 Towngas China is trading at >50% discount to HKCG. EV/EBITDA (X) 11.4 10.2 9.3 8.6 Net Div Yield (%) 2.0 2.3 2.5 2.8 Valuation: P/Book Value (X) 1.3 1.3 1.2 1.1 We initiate coverage on Towngas China with a BUY rating. Net Debt/Equity (X) 0.4 0.4 0.4 0.4 ROAE (%) 9.3 9.3 9.8 10.2 TP is set at HK$9.00 based on DCF valuation method. We assumed a beta of 1.0 with WACC of 7.4% and 1% Consensus EPS (HK$) 0.51 0.57 0.64 terminal growth. Other Broker Recs: B:5 S:1 H:3 Key Risks to Our View: ICB Industry: Utilities Low er-than-expected dollar margin. A more severe winter ICB Sector: Gas, Water & Multiutilities Principal Business: Investment, construction and operation of city gas shortage and dollar margin compression from gas pipeline projects government regulation will be negative to earnings growth. Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX At A Glance Issued Capital (m shrs) 2,769 Mkt Cap (HK$m/US$m) 21,873 / 2,787 Major Shareholders (%) Hong Kong and China Gas Co Ltd 67 Common Wealth Bank of Australia 8 Free Float (%) 25 3m Avg. Daily Val. (US$m) 2.5 ed-TH / sa– CS / AH China /Hong Kong Company Guide Towngas China Co Ltd Table of Contents SWOT Analysis 3 Valuation 4 Deeply rooted to the ground 5 Storing up for growth 6 Financial Analysis 9 Key Risks 10 Appendix 11 A lucrative industry with bright prospects 12 Page 2 China/Hong Kong Company Guide Towngas China Co Ltd SWOT Analysis Strengths Weak nesses Solid management team Weaker new project acquisition ability Strong support by parent company, HKCG, which is Hong Lack of SOE background Kong’s first public utility company founded in 1862 Opportunities T hreats Coal-to-gas conversion initiative to drive up gas sales volume Winter gas shortage may squeeze dollar margin in the short term Broadening of gas supply by construction of gas storage and LNG receiving terminal Downturn of industrial activities in China Development of integrated energy projects Government policy on gas distribution business Privatisation by parent company Source: DBS Vickers Page 3 China /Hong Kong Company Guide Towngas China Co Ltd Valuation We initiate coverage on Towngas China with a BUY rating, target price is set at HK$9.00 based on DCF valuation method, PE vs earnings growth which implies 16x FY18PE. We assumed a beta of 1.0 with WACC of 7.4% and 1% terminal growth. PE 20 China Gas The stock is currently trading at 13x twelve month rolling PE, 18 which is at a 15% discount to its major peers. The gas sales ENN 16 volume growth is expected to maintain a CAGR of 14% in CR Gas 14 FY17-20, and together with stable dollar margin, we believe the Towngas stock will re-rate back at least to the low end range of 15x-23x 12 PE before the oil price collapsed in 2014. 10 Kunlun The drop in dollar margin for gas distributors has been one of 8 Tian Lun Gas the major overhangs for investors. We believe a stable dollar 6 BEH margin in FY18 would be positive to the share price. We reckon 4 Towngas China would be able to leverage on HKCG’s gas 2 storage and LNG receiving terminals to alleviate the margin pressure. The Jintan underground gas storage is the first large 0 scale underground storage of its kind built by city gas operators 0% 5% 10% 15% 20% 25% in China, and this puts it in a better position than operators FY18-20 earnings growth such as CR Gas, which lacks such facilities currently. Source: Bloomberg, DBS Vickers Similar to ENN, Towngas China has shifted its focus to develop distributed energy projects and we believe it is on the right track in tapping into a market with strong growth potential. While the related gas consumption remains small at c.300m m³ in FY17, it targets to reach 3.5bn m³ by 2022, which accounts for 42% of the total gas sales volume in FY17. Peers valuation Mk t PE PE Yield Yield P/Bk P/Bk EV /EBIT DA ROE ROE Price Cap F iscal 18F 19F 18F 19F 18F 19F 18F 19F 18F 19F Company Name Code Local$ US$m Yr x x % % x x x x % % China Gas Holdings*# 384 HK 30.05 19,101 Mar 18.5 16.2 1.6 1.8 4.9 4.0 13.0 11.4 29.0 27.1 Enn Energy Holdings*^ 2688 HK 77.6 10,768 Dec 15.5 13.9 2.0 2.2 3.5 3.0 9.0 8.0 20.7 21.5 China Resources Gas Group* 1193 HK 29.15 8,294 Dec 15.8 15.2 2.3 2.6 2.6 2.4 8.0 7.6 17.3 16.5 Towngas China* 1083 HK 7.9 2,798 Dec 14.1 12.6 2.3 2.5 1.3 1.2 10.1 9.3 9.4 9.9 Beijing Enterprises Holdings 392 HK 43.25 6,983 Dec 7.6 6.9 2.5 2.7 0.8 0.7 11.0 10.6 10.3 10.4 Kunlun Energy 135 HK 7.19 7,425 Dec 9.9 8.7 3.5 3.9 1.1 1.0 5.1 4.6 11.5 12.2 China Tian Lun Gas Hdg.* 1600 HK 5.41 685 Dec 8.4 7.1 3.2 4.2 1.4 1.2 7.6 6.5 17.5 18.1 # FY18: FY19; FY19: FY20 ^ Core EPS Source: Thomson Reuters, *DBS Vickers Page 4 China/Hong Kong Company Guide Towngas China Co Ltd Deeply rooted to the ground Early mover in gas distribution. Towngas China is one of the piped gas in China, including the provision of piped gas, major gas distributors in China and has accumulated rich construction of gas pipelines, operation of city gas experiences through its long operation history in China since networks/gas refilling stations and the sales of household gas 1994. It is mainly engaged in the sales and distribution of appliances. Business overview Source: Company, DBS Vickers Its parent company, The Hong Kong and China Gas Company Company structure (HKCG, 3 HK), is the first public utility in Hong Kong founded in 1862. Panvas Gas was Towngas China's predecessor before The Hong Kong and China Gas it was acquired in 2007.