China Gas Utilities Sector A new income stream for gas distributors from sale of steam and electricity Geographical exposure and supportive government policy are critical factors ENN

ASIAN INSIGHTS

DBS HK's discussion of the issuer (Vpower Group, 1608 HK) in this report will not be continuously followed. Accordingly, this report is being provided as a stand-alone analysis and recipients of this report should not expect additional reports relating to this issuer, unless so decided by DBS HK

ed- JS / sa- CS/DL

27 July 2018 DBS Group Research . Equity

Integrated energy market: Vast potential for gas distributors

Integrated energy market driven by higher energy

efficiency, more cost savings, and lower emissions

A new income stream for gas distributors from

sale of steam and electricity

Geographical exposure and supportive

government policy are critical factors

ENN (2688 HK) and China Gas (384 HK) in the best

position to be winners

New income stream from sale of steam and electricity.

Mirroring the success in the Western world, China is adopting

the integrated energy systems due to its distributive nature,

energy efficiency, cost savings, and low emissions. Natural gas is

the preferred fuel, and gas distributors will be the major

beneficiaries. We estimate the integrated energy market can

bring in revenue of Rmb133-160bn to gas distributors from the

sale of steam and electricity, which will be equivalent to 30-

40% of revenue from sales of gas by 2020, as well as lift dollar

margins of gas distributors.

ENN is the major beneficiary. We reckon gas distributors with

market presence in regions with favourable policies and larger

gap between electricity price and gas fuel price are well

positioned to have a larger market share in the integrated

energy market. Players with the most industrial parks within the

project concession will enjoy higher growth. Also, supportive

local government policies and a larger gap between electricity

price and gas fuel cost will attract more installations within the

integrated energy system. Among the listed gas distributors,

ENN (2688 HK) and China Gas (384 HK) are best positioned to

ride on the big wave in the integrated energy market.

HSI: 28,663

ANALYST Patricia YEUNG +852 2863 8908; [email protected] Tony WU CFA +852 2971 1708; [email protected]

Stock picks

Source: Thomson Reuters, *DBS Bank Hong Kong Limited (“DBS HK”) #FY18:FY19F’ ^Core EPS Based on closing prices as at 24 Jul 18

Company Price Mkt Target Upside/ Recom 18F

Cap Price(downside) PE

HK$ US$m HK$ % x

Enn Energy

Holdings* ^

(2688 HK)

83.85 11,596 105.00 25% BUY 17.6

China Gas

Holdings*#

(384 HK)

33.45 21,180 40.00 20% BUY 19.8

China Resources

Gas Gp.*

(1193 HK)

35.70 10,118 32.50 -9% HOLD 18.9

Towngas

China*

(1083 HK)

7.91 2,833 9.00 14% BUY 14.2

China Tian Lun

Gas Hdg.*

(1600 HK)

10.00 1,261 10.50 5% BUY 13.2

Vpower Group

Intl.

(1608 HK)

3.77 1,231 n.a. n.a. NR 26.2

Asian Insights SparX

China Gas Utilities Sector Refer to important disclosures at the end of this report

mailto:[email protected]


China Gas Utilities Sector

ASIAN INSIGHTS

Page 2

The DBS Asian Insights SparX report is a deep dive look into thematic angles impacting the longer term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one off treatise on the topic, and invite feedback from our readers, and in particular welcome follow on questions worthy of closer examination.

Table of Contents

Investment summary 3

What is an integrated energy system? Why is it needed? 4

Successful cases in overseas markets 5

Huge market potential in China 7

Attractiveness of integrated energy projects 9

How much revenue are we talking about? 10

Case studies in China 12

Critical factors of integrated energy market in China 14

Stock picks 17

Stock profile 20

Enn Energy Holdings 21 China Gas Holdings 29 China Resources Gas 37 Towngas China 44 China Tian Lun Gas 52 Vpower Group 60

Note: Prices used as of 24 July 2018



ASIAN INSIGHTS

Page 3

Investment summary

Energy cost sav ings, enhanced energy efficiency , and

tightening environmental requirement s underpin the huge

potential in the integrated energy industry in China, as it

transitions towards increasing the proportion of clean energy

consumption. Integrated energy system combines various clean

energy systems into one to provide energy to customers. It is

an on-site distributive system highly customized to suit

different customer needs. We expect natural gas to be the

major fuel used in an integrated energy system led by the

stability in energy supply and supportive government policies in

distributive gas power. Such a trend has been echoed by the

success of integrated energy systems overseas, including the

US, Germany, Denmark, the UK, etc. The downstream gas

utilities players in China will be the main beneficiaries as they

will enjoy higher volumes from rising gas consumption and

additional revenue from other energy sales.

Huge market potential. We project the total revenue from

integrated energy systems could reach Rmb133-160bn for gas

utility players by 2020 through the provision of around 195m

tons of steam and 130bn kilowatt hour (kWh) of electricity .

The amount of revenue from selling electricity and steam is

estimated to be equivalent to 30-40% of total gas sales by gas

utilities players in 2020.

In our top down approach based on our market size estimates,

we project the generation of steam and electricity by

Combined Cooling Heating and Power/Combined Heat and

Power (CCHP/CHP) systems will boost gas demand by 32.5bn

cubic metres (m3) during 2017-2020. This is based on the

government’s target to install 50 Gigawatt (GW) of distributive

gas power by 2020. We conservatively assume 36GW of

distributive gas power will be installed by 2020.

We also used a bottom up approach to cross check the market

size by analysing the largest user groups, namely industrial

parks, data centres, commercial buildings, and hospitals. We

estimate gas demand of c.36bn m3 will be generated from

these users during 2017-2020. Industrial park is the largest

customer group requiring 33.5bn m3 of gas, assuming 15% of

small-scale coal boilers are converted into gas boilers by 2020.

In addition, we also assume a small percentage of just 15% of

newly constructed data centres and 5% of newly constructed

hospitals / commercial buildings will use gas in their integrated

energy systems. We reckon this percentage is very

conservative, given that government is increasingly aggressive

in pushing for a “blue sky” in China.

A t tractive project returns for gas utilities players. Our analysis

on the returns for integrated energy projects shows that these

have similar or higher internal rates of returns (IRRs) compared

to city gas projects. If high efficiency can fully materialize, the

equity IRR on integrated energy projects is at least 12% and

capable of reaching above 15-20%, while city gas projects are

usually at c.12%. Also, other than selling electricity , CCHP

projects can enjoy extra revenue from selling steam for

heating/cooling serv ices. The dollar margin for integrated

energy projects is estimated at c.Rmb2.16/m3, which is

substantially higher than typical city gas projects at

c.Rmb0.6/m3.

A dvantages of using natural gas as fuel. We believe natural gas

has its special place and plays an essential role in the energy

mix. F irstly , compared to renewable energy which has large

fluctuations in energy output in different timeframes, natural

gas is a reliable fuel source as it can provide stable energy

levels throughout the day as long as there is fuel supply.

Secondly, distributive gas power is encouraged by the

government and it is an important tool to boost gas

consumption in China. While the growth in distributive solar

power has been robust in recent years, the government has

restricted the installation to 10GW per year as it seeks to

control the exploding growth in solar power installation. China

already installed >10GW of solar power during the first six

months of this year. Thirdly, we see low risk of downward

rev ision of on-grid tariffs for distributive gas power as it is

pegged to gas prices. Solar power on the other hand is subject

to high uncertainty from on-grid tariffs and subsidies.

Who is the main beneficiary in the gas utilities sector? The two

critical factors for gas utility players to excel in the market

depend on geographic exposure and government policy . Due

to concession rights for gas projects, having the right

geographic exposure will guarantee that local gas distributors

will enjoy higher gas volume sales from the development of

integrated energy projects. Since industrial parks has the

largest share of demand for integrated energy projects, gas

utility players with higher number of industrial parks will have

an advantage. Also, the attractiveness of integrated energy in a

region also depends on the local government policies such as

tariff system, activeness in promotion of direct trading of

power with nearby customers, relevant subsidy schemes, and

supporting regulations for gas power installation. We reckon

ENN Energy (2688 HK) is the main beneficiary due to its

advantage of having a higher proportion of projects in the

right regions, as well as possessing strong technical know-how

in the market. We believe the development of the integrated

energy market will help ENN Energy boost its earnings growth,

and this segment is expected to account for about 15% of its

earnings by 2020 from less than 1% currently . China Gas (384

HK) is also in a good position to garner more market share

with the higher number of industrial parks within its project

concession.



ASIAN INSIGHTS

Page 4

What is an integrated energy system? Why

is it needed?

Total solution for energy

In a conventional energy system, the various kinds of energy

that users require are supplied by different serv ice providers

and there is no synergy among the separate systems. As shown

in the picture below, solar power is used for water heating

while a coal-fired heating system is used for the provision of

heat. Meanwhile, electricity is provided by the State Grid’s

centralised power network.

This contrasts with an integrated energy system, which is a

smart system providing various kinds of energy integrated into

one system. The system is an on-site distributive system i.e.

decentralised at the premises and is highly customised to suit

the different needs of different users. The example shown in

the picture below uses natural gas as the major fuel with solar

energy as the complementary energy. In fact, the type of

energy to be integrated is wide, such as natural gas, industrial

waste heat, solar energy, geothermal energy and wind power.

It also provides broad energy solutions, including gas,

electricity , cooling, heating and steam.

Higher efficiency with a smaller energy bill

One of the main advantages of an integrated energy system is

higher efficiency. The traditional method of generation and

transmission of electricity wastes a lot of heat and is only 35-

50% efficient, according to data from Digest of UK energy

statistics 2017. However, an on-site integrated energy system

can achieve efficiency as high as 80%. This is because the

excess heat energy during the production of electricity , which

is usually wasted in a conventional system, is also captured for

the production of energy that can be used in cooling or

heating systems.

Comparison of conventional energy system and

integrated energy system

Source: DBS HK

Improvement in energy efficiency also means a reduction in the

energy bill of at least 20% for customers. Depending on the

design of the system and government policies, excess electricity

can also be sold back to the national grid to further increase

the return on investment in some cases.

Another major advantage is emissions reduction. As renewable

energy or clean energy is usually used as a major fuel for the

system, the use of coal or consumption of electricity from the

grid will be less. In addition, due to the higher energy

efficiency, less fuel is being consumed to generate the same

amount of energy. Thus, it is more environmentally friendly

than a conventional energy system.

Conventional energy system vs integrated energy system

Source: DBS HK

Integrated

sy stem

T radit ional

sy stem

Efficiency 80% 35-50%

Energy bill 20% savings -

Emission lower higher

Energy security higher lower

Operation mode distributive centralised

Capital investment small large

I n tegrated energy system Co nventional energy system



ASIAN INSIGHTS

Page 5

In addition, an integrated energy system can increase the

reliability of the energy supply network for users. The

traditional energy supply mode of a large centralised power

plant is subject to high risk in energy security . Any

malfunction of the centralised system will affect a large area

of users. But with a decentralised integrated energy system,

though this can still malfunction, is equipped with a small-

scale energy source and higher degree of energy

independency, hence resulting in controlled repercussions

and faster recovery.

Who are the target customers?

Generally speaking, integrated energy system can be applied

in both residential, industrial and commercial markets as the

system is highly customised. However, we reckon those

markets with relatively higher demand for energy will have

stronger tendency to adopt an integrated energy system.

These include industrial parks, hotels, hospitals, commercial

buildings, data centers, etc.

Successful cases in overseas markets

The development of integrated energy systems in overseas

markets started in the form of large-scale combined heating

and power (CHP) plants. According to Absolute Reports, the

total CHP capacity increased from 437GW in 2006 to

755.2GW in 2016. APAC (mainly China, India and Japan)

and EMEA (Europe, the Middle East and Africa) accounted

for 46% and 39% of cumulative installed capacity in 2015

respectively . Global installation of CHP capacity is projected

to reach 972GW by 2025. Transparency Market Research

estimates that the global market for CHP installations is

anticipated to rise at a compound annual growth rate

(CAGR) of 4.4% between 2014 and 2024 to US$812.8bn.

Although large-scale CHP plants currently hold the majority

market share of >85%, such a percentage is expected to

decline with the rising use of small-scale / micro-scale CHP

plants, as well as combined cooling, heating and power

(CCHP) systems, in commercial and residential sectors due

to the heavy investment in the large-scale system. We have

seen many successful cases of smaller-scale CHP / CCHP

systems not just in developed countries, but also developing

countries, although the driv ing factors are different.

Cumulative installed capacity of CHP market (2016)

Source: GlobalData Power Database

Western world: a sustainable energy solution

The major motivation for the initial adoption of CHP in the

1970s in developed countries, we believe, was energy

security . Following the oil crisis in 1973, many governments

realised the need to reduce fuel consumption through

higher energy efficiency. Hence, supportive government

policies were launched to accelerate the application of utility

scale CHP systems. Natural gas was the major fuel for CHP

installed capacity. The blackout incidents in North America

triggered the promotion of distributive CHP / CCHP systems.

In 2000, there were 980 sets of distributed energy systems

in commercial / public buildings with total capacity of

4.9GW, and 1,016 sets in industrial areas with total capacity

of 45.5GW in the US. The US government has set a target

that distributed energy systems must be installed in 50% of

new office / commercial buildings, and 15% of the old

systems to be upgraded as distributed system. As a result,

distributed energy will account for 29% of total

installations.

APAC , 45.9%

EMEA, 38.8%

Americas, 15.4%



ASIAN INSIGHTS

Page 6

US CHP installed capacity by fuel mix (2016)

Source: Energy Information Administration

In the EU, many important regulations were also launched

to promote CHP systems, such as Cogeneration Directive,

Emissions Trading Directive, and the New Electricity and Gas

Directives. These have also resulted in growth in installed

capacity of CHP systems.

Nowadays, energy security remains one of the major

reasons that governments are pushing for the development

of CHP systems but we also see an additional driv ing force,

and that is env ironmental considerations. With the strong

commitment to reduce carbon emissions, the use of

renewable energy has been widely adopted, particularly in

the EU. In the course of decarbonisation, more users are

looking for a sustainable solutions to improve energy

reliability , boost energy efficiency and lower energy costs.

Thus, an integrated energy system or distributed CCHP

system is an obvious solution.

In 2016, around 12% of European electricity production

and 15% of heat production came from CHP / CCHP

systems. The CODE2 project (Cogeneration Observatory and

Dissemination Europe), which aims to assist EU members in

pushing forward their CHP / CCHP plans, estimated that

CHP systems could generate 20% of the EU’s electricity

requirements and 25% of heat in 2030. According to data

from Eurostat, natural gas has the highest share in the fuel

mix of CHP / CCHP systems at 45% in the EU. Nevertheless,

with advancements in technology and increasing popularity

of renewable energy, there is a wider variety of energy

choices being used in integrated energy systems. In

addition, we are seeing a growing number of small capacity

CHP / CCHP systems in the EU as the transition in energy

markets towards more decentralised generation and

electricity self-consumption takes place.

EU CHP installed capacity by fuel mix (2016)

Source: Eurostat

Denmark : from centralised to distributed energy

According to data from European Cogenerat ion Review,

Denmark had the most extensive CHP market in EU in 2014

as about half of Danish electricity was co-generated with

heat in 2014. This was on the back of the government’s

determination to be less dependent on coal and oil supply

and it has moved from centralised power stations to

distributed local CHP plants (mainly fuelled by biomass) and

distributed wind power systems. In fact, it was one of the

first to implement a green energy transition strategy across

all sectors and is aiming for 100% renewables by 2050.

UK: latest energy solution in the oldest hospital

St Bartholomew’s Hospital in the UK is a typical example of

a trend towards utilising a more decentralised CCHP system.

St Bartholomew’s Hospital was founded in 1123 and is

managed by Barts Health NHS Trust, the largest National

Health Serv ice Trust in England. The Trust aims to be

financially , environmentally and socially sustainable and to

achieve the carbon reductions required by the Climate

Change Act. After installing the CCHP system, which is

fuelled by natural gas with an on-site power generator, the

ageing energy and heating supply system of the hospital

was modernised with a more improved and resilient power

generation system. This saved the Trust EUR675,000 or

25% in energy costs, EUR54,000 per annum in carbon tax

and removed 2,500 tons of carbon dioxide or CO2 (17% of

the site’s overall emissions).

Dev eloping countries: a baseload power supply from

biomass and solar power

The driv ing forces of integrated energy in developing

countries are slightly different from that in developed

countries. This is because power shortage and improvement

in accessibility to electricity have higher priority in

Natural gas, 69.5%

Coal, 13.1%

Waste, 10.2%

Biomass, 3.2%

Wood, 2.1%

Oil, 1.5% Others, 0.4%

Solid fossil fuels,

16.8%Oil,

6.5%

Natural gas, 44.8%

Renewable energy, 21.0%

Others, 10.8%



ASIAN INSIGHTS

Page 7

developing countries. The distributive nature of integrated

energy system is a perfect solution to increase electrification,

particularly in those areas which are off the central grid. In

addition, lower initial capital cost than a traditional

centralised system is a big advantage. The type of fuel used

in the system will depend on the availability of energy

resources. Nevertheless, the use of biomass and solar power

is more common as a baseload power supply than in the

western countries. For example, the cogeneration plants in

Mauritius (a country in East Africa), which burns bagasse

into power, is such a success that it has prompted the

United Nations Environment to spread this method to other

sugar cane producing countries in Africa, including Kenya,

Ethiopia, Sudan, Tanzania, etc. Not only can this help

increase access to electricity in rural and remote areas, it

also increases income for farmers.

Huge market potential in China

China: fighting air pollution

Similar to the Western world, the development of integrated

systems in China started in the form of CHP plants. In fact,

the adoption of CHP systems has been quite popular in

China due to its energy efficiency and cost sav ings. The

major difference from the Western world lies in the fuel

used. While natural gas is the major fuel for CHP / CCHP

systems in the EU, the US and Japan, CHP systems in China

are mainly run in coal-fired power facilities. By 2014, around

30% of coal-fired power facilities had CHP systems.

However, the serious air pollution from carbon emissions,

particularly in the northern part of China, prompted the

government to increase the proportion of cleaner fuel, not

just for power generation but also for distributive CCHP

systems.

In addition, during the course of restructuring the electricity

market, not only has the electricity generation market been

opened up to more competition but also the electricity

retailing market. This has accelerated the development of

distributed energy serv ices and more value added serv ices at

the retail end. Value added serv ices include energy efficiency

management, enhancement in energy security , electricity bill

sav ings etc; hence, the emergence of the integrated energy

market.

According to the “Implementation Opinions on the

Integration and Optimisation of Demonstrative Project

Construction” (关于推进多能互补集成优化示范工程建设的

实施意见) by National Development and Reform

Commission (NDRC) and National Energy Administration

(NEA), the primary composition of the integrated energy

network consists of gas CCHP systems and distributive

renewable energy. By 2020, the proportion of integrated

energy systems will reach 30% in existing industrial parks,

and the share of integrated energy systems in newly -

established industrial parks will reach 50%. This

demonstrates government’s intention to create a more

efficient energy network.

13th Five Year Plan targets

Source: NEA

In the 13th F ive Year Plan (FYP) for natural gas development,

gas consumption used for electricity generation is an

important growth driver. The guideline clearly states its

intention to increase the proportion of gas used in electricity

generation. Due to the higher efficiency and flexibility , the

proportion of distributive gas power plants is expected to

increase. The installation capacity for gas power plants is

targeted to reach 110GW by the end of 2020, from 57GW

in 2015, imply ing a CAGR of 14%. By the end of 2015, the

installed capacity for distributive gas power only reached

c.10GW. However, the government targeted the installed

capacity for distributive gas power plants to reach 50GW by

2020.

Natural gas as the preferred fuel

Based on the experience of Western countries, although the

percentage of renewable energy, such as solar and biogas,

used in integrated energy systems is increasing, natural gas

remains the major fuel. We reckon natural gas has several

advantages over other forms of clean energy as a major fuel

in the integrated energy system. And given the distributive

nature of integrated energy systems, natural gas integrated

energy systems can also enjoy supportive policies for

distributive gas power.

F irstly , natural gas is a reliable base load energy source

which can provide steady power supply to end-users

throughout the day. This is because supply of gas fuel is

secured and reliable. However, other forms of renewable

energy has restriction in this regard. For instance, without

storage facilities, solar power can only be used for a limited

2015 2020 CA GR

Gas power installed

capacity 57GW 110GW 14.1%

Cumulative proven reserves

(m m3) 13,000,000 16,000,000 4.2%

Production (m m3 / year) 135,000 207,000 8.9%

Proportion of energy

consumption (%) 5.9% 10.0%

Total population using gas

(m) 330 470 7.3%

Proportion of population

above town level using gas

42.8% 57.0%

Pipeline length ('000 km) 64 104 10.2%

Pipeline transmission

capacity (m m3) 280,000 400,000 7.4%

Underground storage

capcaity (m m3) 5,500 14,800 21.9%



ASIAN INSIGHTS

Page 8

number of hours during the day time. Wind power has

restrictions on the development landscape. Use of biogas is

constrained by the availability of biomaterials.

Secondly, installation of distributive solar energy is restricted

to only 10GW per year and is estimated to already hit above

10GW in 1H2018. Thus, there is limited capacity of

distributive solar power available for the rest of this year.

However, higher distributive gas capacity is key in increasing

gas consumption. The NDRC issued the “Opinions on

accelerating the use of natural gas” in the middle of 2017,

in which the government is encouraging the construction of

(i) gas power plants in city areas, (ii) integrated energy

projects with other renewable power sources, and (iii)

industrial parks with gas power plants. Furthermore, the

document has also stated an intention to establish a more

comprehensive gas power pricing mechanism and provide

financial support.

Opinions on accelerating the use of natural gas

Source: NEA

Thirdly, we see higher downside risk on the return of solar

energy projects because government is rev ising down the

subsidy for distributive solar power. After the central

government lowered the subsidy for those projects which

sell excess electricity to the grid from Rmb0.42 to Rmb0.37

per kWh in Jan 2018, this was cut further to Rmb0.32 per

kWh in June 2018. On the other hand, we expect steady

spread between on-grid price and gas fuel price because the

pricing mechanism of gas power projects is pegged to the

gas fuel price. In addition, the power industry is gradually

moving to direct negotiation between distributive power

producers and nearby users. In 2H2017, the NDRC issued

the Notification on pilot projects for market-oriented

reforms for distributed power generation “关于开展分布式

发电市场化交易试点的通知”. We believe the allowance for

distributed energy projects to sell extra electricity generated

to nearby users will further improve the attractiveness of

distributive gas projects and reduce the financial burden on

local governments.

Related policy on distributive gas power

Source: NEA, NDRC

Distributive gas-power on-grid tariff

Source: Provincial Price Bureau

Focus - C&I and residential replacement of coal with gas

- Distributive gas power

- Peak shaving gas power

- Natural gas vehicles and ships

Target - Proportion of energy consumption to reach 10% by

2020 and 15% by 2025

- Underground storage to reach 14.8bn m3 by 2020

and 35bn by 2030

Gas power - Accelerate the development of distributive gas

power in industrial parks, logistics centers, commercial

buildings, traffic hubs, hospitals, schools, etc

- Develop gas CHP systems in Pan Beijing-Tianjin-Hebei,

Yangtze River Delta, Pearl River Delta, and north

eastern China

Improve gas

power tariff

mechanism

- Increase financial subsidies to compensate for the

flaws in the current gas power tariff system

- Accelerate the progress of market-oriented reforms

for gas power

Policy

Release

T ime Key point s

Guiding opinion on

development of

natural gas distributed

energy

"关于发展天然气分布式能源指导意见"

Nov-11 1) Encourage the development of CHP

systems in regions with high energy

loads

2) Construct 1000 natural gas

distributive energy systems with total

installed capacity of 50GW

Natural gas

distributive energy

demonstration project

implementation detail

"天然气分布式能源示范项目实施细则“

Oct-14 1) Natural gas distributive energy

systems are mainly CHP systems with

>70% energy efficiency

2) Reduce the application procedures for

new projects

3) Prov ide discounts to help to manage

gas supply costs

4) Prov ide financing and tax subsidies

Notice to regulate gas

power on-grid price

"关于规范天然气发电上网电价管理有关问题的通知"

Dec-14 1) Encourage direct price negotiation

between users and distributive gas

energy providers

2) Establish pricing system to correlate

electricity price and gas price

Guiding opinion on

accelerating the

development of

internet + smart grid

energy

"关于推进“互联网+”智慧能源发展的指导意见"

Feb-16 1) Encourage the construction of CCHP

systems with other distributive

renewable energy providers

2) Establish smart grid systems and

leverage on technological advancements

to improve energy efficiency

3) Encourage market-oriented grid

systems

13th FYP on natural

gas development

"天然气发展十三五规划"

Jan-17 1) Encourage the development of

distributive gas energy and high

efficiency projects

2) Installation capacity for gas power is

targeted to reach 110GW by 2020

Gas DG on-grid

v olume price (Rmb

/ kwh)

Gas DG on-grid

capacit y price (Rmb /

kw per y ear)

Zhejiang 0.567 470

Shanghai 0.7655 na

Guangdong 0.715 na

J iangsu 0.784 na

Beijing 0.65 na

Tianjin 0.73 na



ASIAN INSIGHTS

Page 9

Attractiveness of integrated energy projects

Throughout our analysis on the investment return on typical

integrated energy projects, such as CCHP projects in China,

we found that they have similar IRRs compared to city gas

projects, if not higher. In addition, the dollar margin on

CCHP projects is higher than city gas projects on the sales of

both electricity and steam, if higher efficiency of the system

can fully materialize. Thus, CCHP projects are attractive to

gas distributors as it provides additional income with decent

investment returns.

CCHP project base case IRR assumption

Source: DBS HK

Utilisation hour sensitivity

Source: DBS HK

Electricity and steam ASP sensitivity

Source: DBS HK

The equity IRR of a CCHP project can reach above 12%,

which is similar or better than city gas projects. Due to the

distributive nature of CCHP, the utilisation can easily reach

above 6,000 hours as energy generated can be absorbed by

nearby customers, compared to <3,000 hours for normal

gas power plants. Also, other than selling electricity , CCHP

projects can enjoy extra revenue from selling steam for

heating/cooling serv ices. On top of the 3.5-4 kWh of

electricity generated for each cubic metre of natural gas,

CCHP can utilise the excess heat to generate 2.2 to 4 kWh

equivalent of steam for heating/cooling serv ices.

Customers can obtain 10-20% energy cost sav ings with a

CCHP system compared to a traditional energy system. The

tariff on electricity sold to customers is usually at a 5-10%

discount to the local industrial/commercial electricity tariff,

and the average selling price (ASP) for steam is at a 20%

discount at c.Rmb250/ton due to the lower gas fuel cost

from gas distributors. This incentiv ises customers to adopt

the system.

Construction cost (Rmb / w) 10

Steam price (Rmb / ton) 250

Electricity price (Rmb / kWh) 0.7

Fuel costs (Rmb / kWh) 0.61

Utilisation hour 6,100

Electricity generated (m kWh / yr) 31

Steam generated (ton /yr) 45,934

Equity IRR 12.14%

0%

2%

4%

6%

8%

10%

12%

14%

16%

5000

5200

5400

5600

5800

6000

6200

6400

6600

6800

7000

Hours

Equity IRR

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0.6

0.6

2

0.6

4

0.6

6

0.6

8

0.7

0.7

2

0.7

4

0.7

6

0.7

8

0.8

Rmb / kWh

Equity IRR

0%

5%

10%

15%

20%

25%

150

170

190

210

230

250

270

290

310

330

350

Rmb / ton

Equity IRR



ASIAN INSIGHTS

Page 10

CCHP project IRR calculation

Source: NDRC, DBS HK

In addition to the gas volume growth, china gas distributors

would be able to earn a higher dollar margin for CCHP.

Assuming the steam ASP and electricity tariff at Rmb250/ton

and Rmb0.7/kwh respectively , the dollar margin for CCHP

projects could reach Rmb2.16 / m3, compared to the city

gas project’s c.Rmb0.6 / m3.

How much revenue are we talking about?

The integrated energy market has extended the business

scope of gas distributors to the provision of steam and

electricity . We have used both top-down and bottom-up

approaches to estimate the revenue gas distributors can

earn from the new business line, and we projected this to

be c.Rmb133-160bn by 2020 through provision of around

195m tons of steam and 130bn kWh of electricity . This new

business line is equivalent to 30-40% of recurring gas sales

revenue of gas distributors by 2020.

The top-down approach. We project that the generation of

steam and electricity within CHP/CCHP systems can boost

gas demand by at least 32.5bn m3 during 2017-2020. This

implies an annual gas consumption growth of 3%. Our

calculations are based on additional installation of

distributed gas power plants of just 25GW and reach 36GW

by 2020. Such assumption is conservative compared with

the government’s “Guiding opinions of the development for

natural gas distributed energy” (关于发展天然气分布式能源

的指导意见), where the installed capacity for distributed gas

power plants is targeted to reach 50GW by 2020. The

installed capacity of natural gas power plants reached

66GW by 2015, of which distributed gas power plants

accounted for only c.11GW.

Natural gas power - installed capacity

Source: DBS HK

Based on the 13th FYP issued at the provincial level, J iangsu,

Guangdong, Shanxi, Shandong, and Shanghai have the

most ambitious plans to install gas power, which in

aggregate account for >60% of the installations during

2015-2020. Chinese gas distributors with most projects in

these regions should benefit.

Gas power new installation target 2015-2020

Source: NDRC, DBS HK

A bottom-up analysis based on major user group. According

to the China Gas Association, there were 288 distributive

gas power projects as of the end of 2015, of which 37.2%,

29.2%, 11.1% and 5.6% were industrial parks, commercial

buildings, hospitals and data centres respectively . We have

estimated the potential market size of these major user

groups, and project c.36bn m3 of gas demand would be

CCHP

(Rmb /m3)

Revenue - Steam 1.51

Revenue - Electricity 2.80

Fuel cost (2.15)

Dollar margin 2.16

Equity IRR >12%

Gas dist ribut ion

Revenue 2.68

Dollar margin 0.60

Equity IRR 12%0

10

20

30

40

50

60

70

80

90

2011 2012 2013 2014 2015 2016 2017

GW

MW



ASIAN INSIGHTS

Page 11

generated from them by 2020. This figure is similar to that

derived from a top-down approach.

Installed capacity by customer type – distributive gas

Source: China Gas Association, DBS HK

Average installed capacity by customer type

Source: China Gas Association, DBS HK

In particular, industrial park is the largest gas consumer in

integrated energy system. There were approximately 500k

of industrial coal-boilers installed in China in 2015, and

more than 80% are small boilers with a capacity of below

10 tons/hr. The government is enforcing small boilers to

undergo a clean emissions conversion, especially in core

regions of the Pan Beijing-Tianjin-Hebei area. Assuming

15% of the small-scale boilers are converted to gas boilers

with average capacity of 3 tons/hr by 2020, we estimate this

can boost gas demand by c.33.5bn m3 by 2020 with 200m

tons of steam and 1,338m kwh of electricity generated.

In addition, we also assume a small percentage of just 15%

of data centers and 5% of hospitals / commercial buildings

that will convert to use gas integrated energy systems. We

reckon the conversion percentage is very conservative, given

that government is increasingly aggressive in pushing for a

“blue sky” in China. There will be upside in the amount of

gas consumed or additional revenue if more conversions to

integrated energy systems are realised.

FY17-20 gas demand

Source: Wind, MIIT, National Health Commission, DBS HK

Industrial37%

Commerical29%

Data Centre6%

School5%

Transportation Hub3%

Hospital11%

Hotel4%

Others5%

Total 288 projects

Industrial, 87.6%

Commerical, 4.5%

Data Centre, 3.5%

Others, 4.5%

Total 11GW installed capacity

0.9

1.1

1.5

5.9

13.1

17.6

24.2

91.1

0 20 40 60 80 100

Hotel

Office

Hospital

Commerical

School

Transportation Hub

Data Centre

Industrial

MW

# new

sites per

y ear

Conv ersion

rat io

A nnual

energy

demand (m

kwh)

Gas

demand 17-

20 (m m3)

Data center

500k

cabinets 15% 6,000 900

Commercial 166.7m m2 5% 25,005 1,250

Hospitals 1,082 5% 8,764 438



ASIAN INSIGHTS

Page 12

Case studies in China

Yuhang Economic and Technological Development Zone

The Yuhang Economic and Technological Development

Zone (YETDZ) is a large industrial park with over 200

companies in the equipment manufacturing, textile and

pharmaceutical industries. The industrial park originally used

coal-fired boilers, but this was converted into gas fuelled

CHP plants due to environmental regulations. Multiple

companies such as ENN, Towngas, Datang Power, and

Huaneng Power tried to bid for the project. Eventually ENN,

Towngas (local gas distributor) and Hanzhou Gas (local

government) co-invested in the project with 51%, 24% and

25% stakes respectively .

Yuhang Economic and Technological Development

Zone

Gas boiler and site under construction for gas power

Source: DBS HK

The customers are able to obtain 10-20% energy cost

sav ings by utilising the integrated energy network. The

YETDZ is currently constructing the first power/steam

station, which has six gas boiler (40tons/hr each), gas

turbine (7.9MW) and waste heat boiler (16.5tons/hr). The

station is expected to generate 42m kWh of electricity and

900k tons of steam per annum. In terms of gas supply cost,

Towngas China will be able to supply at the local city gate

price of Rmb2.09/m3 plus Rmb0.07 /m3 transmission fee.

The YECDZ negotiates electricity tariff to nearby users, and

is at c.5% discount to normal Commercial & Industrial (C&I)

electricity price of Rmb0.66-0.70 / kWh. The steam price is

c.Rmb250/ton. The equity IRR is expected to reach >12%.

This is a good example showing that a local gas distributor is

able to enjoy growth in gas consumption even though the

project is operated by other parties.

Project info

Source: Company, DBS HK

Dongguan Haofeng integrated energy project

The Haofeng project at Dongguan is located in the western

part of Dongguan. The industrial park has a planned total

area of 1,500 Mu. The main customers within the industrial

park are mainly in the textile and electroplating industry.

The industrial park is still in the expansion phase with >100

customers. The customers are expected to enjoy cost sav ings

of 10-15% in their electricity bills.

The project will be constructed in 2 phases. The first phase

consists of a 6.53MW gas turbine, a 13.4tons/hr waste heat

boiler, and two gas boilers (10tons/hr each). In addition, a

solar plant with 1.2MW will be installed. The second phase

will consist of a 6.53 MW gas turbine, a 13.4 tons/hr waste

heat boiler and two gas boilers each with a capacity of

15tons/hr. A total capex of Rmb150m is required for the

two phases.

The project can generate 300k tons of steam and 75m kWh

of electricity per annum. The steam is expected to be sold at

Rmb260/ton while the electricity will be sold to the grid

company at Rmb0.715/kWh since direct negotiation with

customers is not allowed. The gas supply cost will be at local

city-gate price plus a transmission fee as it is under ENN’s

project concession. Nevertheless, the equity IRR could reach

10-12%.

Yuhang project (# 3 stat ion)

Location Hangzhou, Zhejiang

Owner ENN (51%) , Towngas (24%),

Hangzhou Gas (25%)

Capex (Rmb m) 140

Gas power ASP (Rmb / kwh) 5% discount to end user price

Steam ASP (Rmb / ton) 250

Gas supply costs (Rmb / m3) 2.16

Equity IRR 12%



ASIAN INSIGHTS

Page 13

Project data


Haofeng project - Gas boiler


Haofeng project - Gas power engine


Dongguan Haofeng project (phase 1 & 2)

Location Dongguan, Guangdong

Owner ENN(100%)

Capex (Rmb m) 150

Gas power ASP (Rmb / kwh) 0.715

Steam ASP (Rmb / ton) 260

Gas supply costs (Rmb / m3) >2.08

Equity IRR 10-12%



ASIAN INSIGHTS

Page 14

Critical factors of integrated energy market in China

The table on the following page highlights Porter’s F ive

Forces analysis for the integrated energy market in China.

As the electricity retailing market opens up, the number of

players in the integrated energy market will inevitably

increase with more intense competition. However, we

reckon that those gas distributors with the right

geographical exposure will be able to benefit more from the

expanding integrated energy market.

Geographical exposure and government policy are

important winning factors

We reckon that having the operation concession for gas

supply in the “right region” is an important winning factor

in the integrated energy market. This is because gas supply

in the integrated energy system will be eventually supplied

by the local gas distributor, and this does not matter who

the integrated energy system operator is. The YETDZ project

that we mention in our case studies in China is a good

example where the local gas supplier is able to take a share

in the integrated energy project even though the project is

operated by a third party. The local gas distributor, thus, can

enjoy higher gas sales volume.

We analyse the attractiveness of integrated energy in a

region in terms of the tariff-setting system, direct trading of

power with nearby customers, subsidies scheme, and

supportive policies for gas power installation.

The local governments are rolling out the relevant policies

and submitting projects for pilot programs on direct trading

of distributive generation (DG) projects to nearby customers.

The most active provinces are Guangdong, Zhejiang,

Shandong, J iangsu, and Zhejiang. We reckon projects in

these provinces will be able to maximize the energy

efficiency with higher return. In addition, the NDRC released

a notice on “Proactive promotion of marketisation of

electricity market” (关于积极推进电力市场化交易进一步

完善交易机制的通知) in July 2018, with the aim to

accelerate cross-regional power trading and marketisation

of electricity price. Central government is encouraging direct

electricity trading between users and all types of power

generators, including distributive power producers. Thus, we

expect more supportive policies will be launched from

provincial governments, increasing business opportunities

for integrated energy serv ice providers.

Meanwhile, regions with schemes such as timely adjustment

of tariff price with the fluctuation in gas price, and

installation/tax subsidies are favourable for the development

of CCHP systems. Zhejiang, Shandong, Shanghai,

Guangdong, and J iangsu are the provinces with the most

comprehensive subsidy schemes.

Regions with higher installation target implies stronger

policy support and more demand. J iangsu, Guangdong,

Shanxi, Shandong, and Shanghai have the most ambitious

plans to install gas power, and would account for >60% of

the installation during 2015-2020. Therefore, we believe gas

distributors with the most projects in these key regions

would benefit the most.

The electricity price and the gas supply costs are important

variables affecting the return on CCHP projects. The larger

the gap between the electricity price and gas supply costs,

the higher the project return which gives end users strong

incentive to install an integrated energy system. Therefore,

we have factored this to determine the regions which are

relatively more attractive.



ASIAN INSIGHTS

Page 15

Perspective from Porter’s Five Forces for gas utilities players

Source: DBS HK

Bargaining power of customer - moderateLarge number of target customers- Industrial park, hospital, data center, school, commercial

building

Customers are price sensitive- Energy and cost savings of 20% offer incentives and

additional room for price negotiation

Strict government regulation force customers to use clean energy

- Implementation of coal-free zones to prevent users from coal consumption- Penalties may arise from inability to shut down coal

power- Carbon policy increase competitiveness of gas

generation

Threat of new entrants -low / moderateModerate entry barrier:

- Limitation on gas supply due to concession right

- No limitation if renewable energy or other fuel is used

- Solid technical-know-how and sound experience of design team

are required to achieve high efficiency

Require solid financial strength:

- Large amount of capex is required to have meaningful

project development.

Bargaining power of supplier - highGas distributors' edge on gas supply:- Local gas distributor is the only source of gas fuel due to

concession right

Limited choice in equipment sourcing:- Core and leading technologies for gas turbine are

possessed by oversea manufacturers while domestic manufactured equipment has less efficiency

- Supply of solar panal or equipment for reneable energy is abundant

Threat of substitutes - lowSolar power is unstable:- Largely depend on exposure to

radiation - Storage capacity is required

- Restriction on installation by government

- Has a similar LCOE at the moment, but it is declining at a

fast pace

Wind power has its limit for distributive use:- Limitation on construction

landscape- Wind speed is the major factor

for energy output, subject to big fluctuation

- Lower LCOE

Competitive rivalry -moderateGrowing number of competitors:

- Distributed energy encouraged by government

- Other service providers include renewable energy operator or IPP

Quality difference depends on

system design: - Similar service offered by

different operators with major difference in system design and

efficiency



ASIAN INSIGHTS

Page 16

Market potential of different provinces

Source: NDRC, NEA, Provincial Price Bureau, DBS HK

A bility to enhance project return

Although project return will vary from province to province

due to difference in government policies, we reckon

operators’ vast experiences and solid technical-know-how

are also important in project evaluation and maximizing

project return. These include the ability to make accurate

forecast on energy demand at different times and locations,

evaluate users’ energy usage characteristics, compare the

value of various technologies in terms of economics or

energy reduction, provide reliable decision-making basis for

energy systems planning, designing and operation,

effectively integrating energy facilities and network, etc.

These factors will determine how effective the integration

energy system is, how much cost sav ings can be achieved

and the “profitability” of the system. Among the gas

utilities players, ENN and China Gas has the most number of

integrated energy projects on hand and they have

accumulated rich experiences in the industry.

F av ourable

subsidies

Expect t rial direct

negot iat ion w ith nearby

customers for DG

High installat ion

target

High elect ric it y

price v s fuel price Ov erall

Hunan 4

J iangsu 3

Henan 3

Guangdong 3

Shandong 3

Shanghai 3

Sichuan 3

Zhejiang 2

Shaanxi 2

J iangxi 1

Hainan 1

Hebei 1

J ilin 1

Gansu 1

Heilongjiang 1

Inner Mongolia 1

Hubei 1

Qinghai 1

Guangxi 1

Liaoning 1

Shanxi 1

Guizhou

Tianjin

Xinjiang

Yunnan

Anhui

Fujian



ASIAN INSIGHTS

Page 17

Stock picks

Under our theme of a fast growing integrated energy

market in China, the gas distributors will be the main

beneficiaries as they can provide stable gas supply, lower

fuel costs, and have solid financials. We believe the key

route to gain market share will depend on the government

policy and regional distribution of projects of integrated

energy operators. Based on our investigation on local

government policies and spread between electricity price

and fuel price, ENN (63%) and CR Gas (51%) has the

highest proportion of projects located in our favoured

regions.

Number of projects in our favoured regions


In addition, since one of the main demand source for

integrated energy projects come from industrial parks, gas

distributors with higher number of industrial parks under

the project concession is more likely to have higher growth

rate. ENN and China Gas has the highest number of

industrial parks in this regards. Also, the industrial

production hub in China is gradually shifting from core cities

into lower tier cities, and companies such as China Gas with

more exposure in lower tier city will benefit.

Overall, we believe ENN Energy and China Gas will be the

major beneficiary among the gas distributors in China as

they have high exposure to our favoured regions and

industrial parks.

Estimated number of Industrial park


ENN Energy (2688 HK) is our top pick in the sector. It is the

major beneficiary of the growing popularity of integrated

energy network in China. ENN gained first mover advantage

by shifting its development focus from downstream gas

distribution to the integrated energy market. The acquisition

of ENN Ubiquitous Energy Network, one of the leading

integrated serv ices providers in China with top notch

technology, together with highest exposure to our favoured

region for integrated energy development, will help the

company to grab additional market share. ENN targets to

increase the revenue contribution of integrated energy from

Rmb294m in FY18 to Rmb10bn in FY20. Also, the operation

of Zhoushan LNG receiv ing terminal in 3Q18 would enhance

gas supply and support dollar margin during the upcoming

winter. We maintain our BUY rating with TP lifted to

HK$105 on higher assumption of profit contribution from

integrated energy business.

China Gas Holdings (384 HK) is also one of our sector top

picks. The company is willing to take a more active role in

developing integrated energy projects when the market

becomes more attractive. Though it is not the company’s

main focus, we are positive on its strong execution ability

and favourable project distribution. The company is the first

mover in penetrating the rural coal-to-gas conversion

market. It signed a contract to convert 3.1m rural

households by the end of FY18, and the number reached

4.3m by mid June18. We expect new connections in rural

regions to reach 2.1m and 2.9m in FY19 and FY20

respectively . We expect dollar margin to drop to Rmb0.6/m3

and Rmb0.59/m3 in FY19 and FY20 due to the delay in pass

through of residential city -gate price hikes, increasing

proportion of lower dollar margin (Rmb0.45/m3) rural users,

and discounts offered to attract additional coal-to-gas

customers. Nevertheless, gas sales volume growth of 35%

and 30% in FY19 and FY20 can more than offset the drop

in dollar margins. We have a BUY rating with TP lifted to

0

20

40

60

80

100

120

140

CR Gas ENN Energy China Gas TowngasChina

No. of Project

0

50

100

150

200

250

300

350

ENN Energy China Gas CR Gas TowngasChina

No. of Project



ASIAN INSIGHTS

Page 18

HK$40 on higher growth assumption in coal-to-gas

conversion.

China T ian Lun Gas (1600 HK) does not have the intention

to develop integrated energy projects. Rather, it is focusing

its resources to expand market share in rural coal-to-gas

market in Henan. It has setup a Rmb10bn fund with the

Henan government for rural coal-to-gas projects. By

leveraging its strong relationship with the Henan

government and largely unpenetrated market size of c.15m

households in the area, we estimate total new connections

will increase from 226k in FY17 to 509k in FY18 and 811k

in FY19. With the high proportion of city gas projects in Tier

3/4 cities, its dollar margin is expected to remain stable.

With strong city gas volume growth of c.33% in FY19, we

expect earnings growth to reach 61% in FY18. Its current

valuation of 9x FY19F PE is undemanding. We maintain our

BUY rating with TP at HK$10.50.

China Resources Gas (1193 HK) is the largest SOE gas

distributor in China with a relatively high exposure to our

favoured regions for integrated energy projects. However, it

will continue to focus on city gas project development. We

think its development strategy is rather conservative

compared to others, which hinders its ability to tab into new

growth opportunities. In v iew of its high exposure to high

dollar margin regions, the dollar margin is expected to

remain under pressure and we expect the dollar margin to

drop from Rmb0.58/m3 in FY17 to Rmb0.56/m3 by FY19.

Riding on the coal-to-gas conversion initiative in China, the

volume growth may increase 20-22% during 1H18, which is

above our expectation. We rev ise up our volume growth

estimate by 3% in FY18 and FY19. We upgrade to HOLD

rating with TP lifted to HK$32.50.

Towngas China (1083 HK) had set up an integrated energy

investment platform in 2016 and is seeking opportunities in

the market. The company targets to boost related gas

consumption to 3.5bn m³ by 2022, which is 42% of the

company's total gas sales volume in FY17. The Hong Kong

and China Gas Company (HKCG) is aiming to increase new

energy business to 15-20% of earnings by 2019/2020,

demonstrating its determination to aggressively develop in

the clean energy market. Towngas China has priority access

to HKCG’s J intan underground storage, which can help

allev iate margin pressure during the winter period. We

believe dollar margin will remain stable in FY18 on gas sales

volume growth of 16%. We currently have a BUY rating

with TP at HK$9.

V Power (1608 HK) is also one of the beneficiaries of the

rising integrated energy market in China. Approximately

30% of its system integration (SI) revenue was generated in

China during 2017. With rising demand for integrated

energy projects and distributive gas power generation

systems, we expect SI revenue to achieve strong growth in

the next few years. VPower is constructing the first

Investment, Building and Operating (IBO) project in China

and is looking to tap into the growing market. Furthermore,

VPower intends to capture opportunities arising from

China’s Belt and Road Initiative (BRI) in developing countries.

PE vs EPS growth


0

5

10

15

20

25

0% 10% 20% 30% 40%

PE

FY18-20 earnings growth

ENN

CR Gas

China Gas

Towngas

BEH

KunlunChina TianLun Gas



ASIAN INSIGHTS

Page 19

Peers comparison


# FY18: FY19; FY19: FY20

^ Core EPS

Mkt PE PE Yield Yield P/Bk P/Bk 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 33.45 21,180 Mar 19.8 15.6 1.4 1.8 4.8 3.9 13.7 11.3 26.6 27.9

Enn Energy Holdings*^ 2688 HK 83.85 11,596 Dec 17.6 15.3 2.5 2.8 4.1 3.6 9.9 8.4 21.3 23.2

China Resources Gas Group* 1193 HK 35.7 10,118 Dec 18.9 17.4 2.0 2.3 3.2 2.9 9.3 8.5 17.7 17.6

Towngas China* 1083 HK 7.91 2,833 Dec 14.2 12.7 2.3 2.5 1.3 1.2 10.2 9.4 9.3 9.8

China Tian Lun Gas Hdg.* 1600 HK 10 1,261 Dec 13.2 9.5 2.0 3.2 2.6 2.2 9.9 7.3 21.5 25.4

Vpower Group Intl. 1608 HK 3.77 1,231 Dec 26.2 17.1 1.0 1.5 3.5 3.0 13.2 9.1 14.8 18.9

EV /EBITDA

Note: Prices used as of 24 July 2018

STOCK PROFILES

sa- CS /AH

BUY

Last Traded Price ( 24 Jul 2018):HK$83.85(HSI : 28,781)

Price Target 12-mth:HK$105 (25.2% upside) (Prev HK$95.00) Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

What’s New Major beneficiary of the integrated energy market

in China ENN has the most number of projects in high

growth potential regions and industrial parks Turning more optimistic on its long term growth

outlook and revise up earnings growth estimate Maintain BUY rating with TP revised up to HK$105

Price Relative

Forecasts and Valuation FY Dec (RMBm) 2017A 2018F 2019F 2020F Turnover 48,269 61,564 76,144 92,675 EBITDA 7,703 9,517 11,192 13,038 Pre-tax Profit 5,190 7,151 8,847 10,911 Net Profit 2,802 3,846 4,758 5,894 Net Pft (Pre Ex) (core profit) 3,697 4,461 5,139 5,894 Net Profit Gth (Pre-ex) (%) 15.1 20.7 15.2 14.7 EPS (RMB) 2.59 3.55 4.40 5.45 EPS (HK$) 2.99 4.11 5.08 6.29 Core EPS (HK$) 3.95 4.76 5.49 6.29 Core EPS (RMB) 3.42 4.12 4.75 5.45 EPS Gth (%) 30.3 37.3 23.7 23.9 Core EPS Gth (%) 15.1 20.7 15.2 14.7 Diluted EPS (HK$) 2.79 4.10 5.08 6.29 DPS (HK$) 1.25 2.08 2.34 2.90 BV Per Share (HK$) 18.09 20.40 23.44 27.21 PE (X) 28.0 20.4 16.5 13.3 CorePE (X) 21.2 17.6 15.3 13.3 P/Cash Flow (X) 12.9 16.4 12.4 10.4 P/Free CF (X) 50.2 nm 228.4 31.0 EV/EBITDA (X) 11.9 9.9 8.4 7.1 Net Div Yield (%) 1.5 2.5 2.8 3.5 P/Book Value (X) 4.6 4.1 3.6 3.1 Net Debt/Equity (X) 0.5 0.5 0.3 0.2 ROAE(%) 17.6 21.3 23.2 24.9 Earnings Rev (%): Nil 2 5 Consensus EPS (RMB) 3.82 4.55 5.26 Other Broker Recs: B:20 S:2 H:3

Source of all data on this page: Company, DBS Bank (Hong Kong) Limited (“DBS HK”), Thomson Reuters, HKEX

Powering ahead with integrated energy

Undervalued gem. We like ENN’s rapid development in the

integrated energy business as an additional earnings growth

driver, as well as access to the LNG receiving terminal to

broaden gas supply and support dollar margin. We revised up

our long-term earnings growth estimate to reflect its strong

ability to secure integrated energy projects. We believe the

current valuation of 15x FY19F PE looks attractive amid strong

earnings CAGR of 17% from FY17-FY20. As one of the leading

non state-owned enterprise (SOE) gas distributor, we reckon the

stock is poised to re-rate further.

Where we differ. We are optimistic on the outlook of integrated

energy projects in China, which is expected to boost earnings

growth and stimulate sales volume. Our assumption for

earnings from integrated energy and gas sales volume growth is

higher than market projections. Our earnings estimate is 7%

above the market.

Potential catalysts. Higher-than-expected earnings contribution

from integrated energy projects would also be a boost. Strong

implementation of coal-to-gas conversion could drive up sales

volume.

Valuation: We maintain our BUY rating with TP lifted to HK$105, based on DCF valuation. We revised up our earnings estimate to take into consideration of its strong ability to secure more integrated energy projects in the next 10 years. For our DCF assumptions, we have assumed a beta of 1.2 with WACC of 7.5% (equity risk premium of 7%; risk free rate of 3%; after tax cost of debt of 3.1%), and 1% terminal growth. Key Risks to Our View:

Poor execution of government policies may negatively affect

demand for gas.

At A Glance

Issued Capital (m shrs) 1,085

Mkt Cap (HK$m/US$m) 90,994 / 11,596

Major Shareholders (%)

ENN Group International Investment Ltd. 30.3

Capital Research Global Investors 13.0

First State Investments (HK) Ltd. 6.7

Free Float (%) 50.0

3m Avg. Daily Val. (US$m) 31.0

ICB Industry: Utilities / Gas, Water & Multiutilities

DBS Group Research . Equity

27 Jul 2018

China / Hong Kong Company Guide

ENN Energy Holdings Ltd Version 2 | Bloomberg: 2688 HK Equity | Reuters: 2688.HK

Refer to important disclosures at the end of this report

Page 22

Company Guide

ENN Energy Holdings Ltd

CRITICAL FACTORS TO WATCH

Critical Factors

Successful growth in integrated energy business. ENN is

looking to transform from a natural gas distributor into an

integrated energy supplier. It is targeting to increase profit

contribution from this segment to over 50% in five years.

Although this target may be ambitious, we agree that there is

ample growth potential in the integrated energy market.

Compared to peers, ENN has the most number of projects in

high growth potential regions and industrial parks, therefore it

is in a solid position to capture the integrated energy market.

ENN will be investing mainly in gas-fired distributed power

projects which are usually under 25-30 years contracts to

ensure continuity. The equity IRR requirement for each project

is >12%, which we believe is reasonable given its similarity to

other renewable energy projects in China.

Positive government policies. The government intends to focus

on coal-to-gas conversions and increasing the competitiveness

of retail gas prices, which would be positive for ENN’s gas

demand growth. Following the conversion/closure of coal-fired

boilers with steam capacity of below 10 t/h in cities above

prefecture-level, we are expecting the restrictions to be

extended to more regions and more boilers (such as those

between 10 t/h to 35 t/h) to be converted.

The gradual roll-out of policies to restrict returns on intra-

provincial pipeline transmissions may help reduce retail prices

to end users. In fact, some provinces such as Shandong and

Zhejiang have lowered their intra-provincial tariffs by 7%-34%,

and more provinces are expected to follow.

LNG terminal to lower gas costs. The Zhoushan LNG terminal

(Phase 1) held under its parent company in Zhejiang is expected

to commence operations in 3Q18, which will enable ENN to

procure cheap LNG supplies during winter. Assuming oil price

of US$65 per barrel, LNG cost is expected to be at a 5%

discount to the city-gate price in Zhejiang. The company

expects 700m m3 of LNG to be supplied through the terminal.

Assuming an average LNG spot price of c.Rmb7000/m3 during

Nov-Dec implies c.56% cost savings during the peak period.

Total gas sales volume (m m3)

New Residential connections (m households)

Blended dollar margin (Rmb/m3)


Page 23

Company Guide


Share price vs HSI

Source: Thomson Reuters, DBS HK

0

50

100

150

200

250

300

350

400

450

Jan-1

0

Jul-10

Jan-1

1

Jul-11

Jan-1

2

Jul-12

Jan-1

3

Jul-13

Jan-1

4

Jul-14

Jan-1

5

Jul-15

Jan-1

6

Jul-16

Jan-1

7

Jul-17

Jan-1

8

Jul-18

ENN Energy rel to HSI (Rebased Jan 10 = 100)Acceleration of coal-to-gas conversion and removal of ROA overhang

Page 24

Company Guide


Balance Sheet:

Healthy financials. Capital expenditure is expected to reach

Rmb6bn in FY18F. Amid strong cash inflow, we expect net

gearing to continue to decline from 50% in FY17 to 20% in

FY20, and ENN may boost dividend payout.

Share Price Drivers:

Integrated energy projects. The investments in integrated

energy projects may help boost gas sales volume and earnings

growth. The company targets to increase the earnings

contribution from this segment to 50% in five years from less

than 1% in FY17.

More coal-to-gas conversions. Regulations to convert coal-fired

boilers with capacity of 10 – 35 t/h and the implementation of

additional coal-free zones will help generate demand for gas.

Key Risks:

Poor government policy execution. The Chinese government

has rolled out multiple supportive policies for the industry,

such as regulating transmission tariffs and accelerating coal-

to-gas progress. Gas demand could be negatively affected by

slow execution of these policies.

Company Background

Established in 1993, ENN is one of the first privately owned

gas distributors in China. The company is mainly involved in

the distribution of natural gas through city gas operations,

wholesale distribution and CNG/LNG refuelling stations. It is

also involved in integrated energy supply (cooling, heating and

steam and electricity), gas appliances, and materials.

Leverage & Asset Turnover (x)

Capital Expenditure

ROE

Forward PE Band

PB Band


Page 25

Company Guide


Key Assumptions

FY Dec 2016A 2017A 2018F 2019F 2020F


14,385.9 19,616.0 24,952.9 30,275.5 35,466.2

New Residential connections (m households)

1.8 2.1 2.3 2.4 2.6


0.73 0.63 0.62 0.61 0.6


Segmental Breakdown (RMB m)

FY Dec 2016A 2017A 2018F 2019F 2020F

Revenues (RMB m) Piped gas 17,900 23,948 30,021 36,120 41,844 Gas connection fees 5,611 5,954 6,336 6,571 6,963 Vehicle gas refuelling stations

3,169 3,102 2,954 2,994 3,063

Wholesale of gas 6,153 11,878 16,035 20,044 24,053 Sales of integrated energy 153 294 1,636 4,467 9,614 Sales of gas appliances 238 320 422 541 649

Total 34,103 48,269 61,564 76,144 92,675

GPM (RMB m) Piped gas 3,240 4,038 5,133 6,174 7,119 Gas connection fees 3,591 3,735 3,928 4,009 4,178 Vehicle gas refuelling stations

274 177 163 159 160

Wholesale of gas 97 217 289 361 433 Sales of integrated energy 17 15 131 447 1,250 Sales of gas appliances 100 122 161 205 247

Total 7,219 8,182 9,644 11,149 13,140

GPM Margins (%) Piped gas 18.1 16.9 17.1 17.1 17.0 Gas connection fees 64.0 62.7 62.0 61.0 60.0 Vehicle gas refuelling stations

8.6 5.7 5.5 5.3 5.2

Wholesale of gas 1.6 1.8 1.8 1.8 1.8 Sales of integrated energy 11.1 5.1 8.0 10.0 13.0 Sales of gas appliances 42.0 38.1 38.0 38.0 38.0

Total 21.2 17.0 15.7 14.6 14.2


Page 26

Company Guide


Income Statement (RMB m) FY Dec 2016A 2017A 2018F 2019F 2020F

Revenue 34,103 48,269 61,564 76,144 92,675

Cost of Goods Sold (26,753) (39,930) (51,739) (64,763) (79,257)

Gross Profit 7,350 8,339 9,825 11,381 13,419

Other Opng (Exp)/Inc (1,046) (1,441) (1,638) (2,141) (3,118)

Operating Profit 6,304 6,898 8,188 9,241 10,300

Other Non Opg (Exp)/Inc (1,010) (895) (616) (381) 0

Associates & JV Inc 571 634 809 1,000 1,217

Net Interest (Exp)/Inc (609) (552) (614) (632) (606)

Dividend Income 0 0 0 0 0

Exceptional Gain/(Loss) (1,061) (895) (616) (381) 0

Pre-tax Profit 4,195 5,190 7,151 8,847 10,911

Tax (1,307) (1,517) (2,074) (2,566) (3,164)

Minority Interest (737) (871) (1,231) (1,523) (1,854)

Preference Dividend 0 0 0 0 0

Net Profit 2,151 2,802 3,846 4,758 5,894

Net Profit before Except. 3,212 3,697 4,461 5,139 5,894

EBITDA 6,929 7,703 9,517 11,192 13,038

Growth

Revenue Gth (%) 6.4 41.5 27.5 23.7 21.7

EBITDA Gth (%) 10.0 11.2 23.5 17.6 16.5

Opg Profit Gth (%) 19.8 9.4 18.7 12.9 11.5

Net Profit Gth (%) 5.6 30.3 37.2 23.7 23.9

Margins & Ratio

Gross Margins (%) 21.6 17.3 16.0 14.9 14.5

Opg Profit Margin (%) 18.5 14.3 13.3 12.1 11.1

Net Profit Margin (%) 6.3 5.8 6.2 6.2 6.4

ROAE (%) 15.1 17.6 21.3 23.2 24.9

ROA (%) 4.4 5.1 6.2 6.8 7.4

ROCE (%) 12.1 12.3 13.3 13.8 14.2

Div Payout Ratio (%) 41.7 41.7 50.8 46.1 46.1

Net Interest Cover (x) 10.4 12.5 13.3 14.6 17.0


Page 27

Company Guide


Balance Sheet (RMB m)

FY Dec 2016A 2017A 2018F 2019F 2020F

Net Fixed Assets 22,297 25,490 30,455 35,219 38,789

Invts in Associates & JVs 5,054 5,434 5,493 5,565 5,654

Other LT Assets 10,190 10,665 11,464 12,355 13,384

Cash & ST Invts 7,179 7,976 7,224 8,296 10,162

Inventory 515 744 803 993 1,209

Debtors 4,423 6,068 6,690 8,275 10,071

Other Current Assets 1,723 2,838 3,620 4,477 5,449

Total Assets 51,381 59,215 65,748 75,180 84,717

ST Debt

4,644 8,368 8,368 8,368 7,868

Creditors 10,472 13,351 15,434 19,319 23,643

Other Current Liab 3,225 3,886 4,956 6,130 7,461

LT Debt 12,147 9,699 9,699 9,699 8,699

Other LT Liabilities 3,039 3,694 3,694 3,694 3,694

Shareholder’s Equity 14,966 16,952 19,100 21,950 25,479

Minority Interests 2,888 3,265 4,496 6,019 7,873

Total Cap. & Liab. 51,381 59,215 65,748 75,180 84,717

Non-Cash Wkg. Capital (7,036) (7,587) (9,278) (11,705) (14,375)

Net Cash/(Debt) (9,612) (10,091) (10,843) (9,771) (6,405)

Debtors Turn (avg days) 40.0 39.7 37.8 35.9 36.1

Creditors Turn (avg days) 141.0 111.9 103.8 100.0 100.9

Inventory Turn (avg days) 6.5 5.9 5.6 5.2 5.2

Asset Turnover (x) 0.7 0.9 1.0 1.1 1.2

Current Ratio (x) 0.8 0.7 0.6 0.7 0.7

Quick Ratio (x) 0.6 0.5 0.5 0.5 0.5

Net Debt/Equity (X) 0.5 0.5 0.5 0.3 0.2

Net Debt/Equity ex MI (X) 0.6 0.6 0.6 0.4 0.3

Capex to Debt (%) 18.2 25.1 33.2 33.2 30.2

Z-Score (X) NA NA NA NA NA


Cash Flow Statement (RMB m)

FY Dec 2016A 2017A 2018F 2019F 2020F

Pre-Tax Profit 4,195 5,190 7,151 8,847 10,911

Dep. & Amort. 1,064 1,118 1,136 1,332 1,520

Tax Paid (1,452) (1,471) (2,074) (2,566) (3,164)

Assoc. & JV Inc/(loss) (571) (634) (809) (1,000) (1,217)

(Pft)/ Loss on disposal of FAs 0 0 0 0 0

Chg in Wkg.Cap. 751 767 1,402 2,111 2,312

Other Operating CF 1,379 1,123 (2,013) (2,380) (2,825)

Net Operating CF 5,366 6,093 4,794 6,344 7,536

Capital Exp.(net) (3,049) (4,527) (6,000) (6,000) (5,000)

Other Invts.(net) (1,304) (2) 0 0 0

Invts in Assoc. & JV (324) (354) 0 0 0

Div from Assoc & JV 802 588 750 928 1,129

Other Investing CF 35 (237) (900) (987) (1,119)

Net Investing CF (3,840) (4,532) (6,150) (6,060) (4,990)

Div Paid (705) (775) (1,700) (1,909) (2,364)

Chg in Gross Debt 493 2,147 0 0 (1,500)

Capital Issues 3 38 0 0 0

Other Financing CF (1,527) (2,118) 2,302 2,697 3,184

Net Financing CF (1,736) (708) 601 788 (680)

Currency Adjustments 18 (41) 0 0 0

Chg in Cash (192) 812 (755) 1,072 1,866

Opg CFPS (RMB) 4.26 4.92 3.13 3.91 4.83

Free CFPS (RMB) 2.14 1.45 (1.12) 0.32 2.34


Page 28

Company Guide


Target Price & Ratings History

Source: DBS HK

Analyst: Tony WU CFA

Patricia YEUNG

1

23

45

47.0

52.0

57.0

62.0

67.0

72.0

77.0

82.0

87.0

92.0

97.0

Jul-17

Aug-1

7

Sep-1

7

Oct

-17

Nov-

17

Dec

-17

Jan-1

8

Feb-1

8

Mar-

18

Apr-

18

Apr-

18

May-

18

Jun-1

8

Jul-18

HK$S.No. Date Closing 12-mth Rat ing

Price Target

Price

1: 29-Sep-17 HK$53.45 HK$66.00 Buy

2: 16-Mar-18 HK$62.20 HK$66.00 Buy

3: 23-Mar-18 HK$64.15 HK$76.00 Buy

4: 21-Jun-18 HK$75.45 HK$95.00 Buy

5: 26-Jun-18 HK$82.65 HK$95.00 Buy

sa- CS /AH

BUY


Price Target 12-mth:HK$40.00 (19.6% upside) (Prev HK$37.00) Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

What’s New Core regions for pollution prevention extended to

Fenwei Plain and Yangtze River Delta More financial support for rural coal-to-gas

conversion Signed 1.1m households in less than two months,

revising up earnings to reflect better outlook for

rural coal-to-gas conversion Maintain BUY rating with TP lifted to HK$40.

Price Relative

Forecasts and Valuation FY Mar (HK$m) 2018A 2019F 2020F 2021F Turnover 52,832 68,365 83,564 95,796 EBITDA 10,759 14,270 17,420 19,466 Pre-tax Profit 8,600 11,856 15,069 16,948 Net Profit 6,095 8,374 10,683 11,993 Net Pft (Pre Ex) (core profit) 6,362 8,674 10,683 11,993 Net Profit Gth (Pre-ex) (%) 42.2 36.3 23.2 12.3 EPS (HK$) 1.23 1.69 2.15 2.41 Core EPS (HK$) 1.28 1.75 2.15 2.41 EPS Gth (%) 45.2 37.4 27.6 12.3 Core EPS Gth (%) 40.5 36.3 23.2 12.3 Diluted EPS (HK$) 1.20 1.65 2.10 2.36 DPS (HK$) 0.34 0.47 0.60 0.67 BV Per Share (HK$) 5.73 6.94 8.49 10.23 PE (X) 27.3 19.8 15.6 13.9 CorePE (X) 26.1 19.2 15.6 13.9 P/Cash Flow (X) 29.3 17.3 14.2 12.3 P/Free CF (X) nm 275.4 61.2 25.3 EV/EBITDA (X) 18.1 13.7 11.3 9.9 Net Div Yield (%) 1.0 1.4 1.8 2.0 P/Book Value (X) 5.8 4.8 3.9 3.3 Net Debt/Equity (X) 0.7 0.6 0.5 0.3 ROAE(%) 24.9 26.6 27.9 25.8 Earnings Rev (%): 0 0 0 Consensus EPS (HK$) 1.55 1.85 2.20 Other Broker Recs: B:12 S:4 H:8


Leading the village invasion

Growth leader in gas distribution. China Gas Holdings (CGH) is

the first mover and major beneficiary of the strong growth of

rural coal-to-gas conversions. We are confident in the

company’s execution ability to grab the largest market share

and drive up connection revenue, recurring gas sales, as well as

revenue from value-added services. According to the “Three

year action plans fighting for blue sky” released in July 18,

Yangtze River Delta and Fen Wei Plain were added as the core

regions for rural coal-to-gas conversion in addition to 2+26

cities, and financial supports were also extended. Thus we are

revising up our estimate to reflect higher growth in coal-to-gas

conversion. CGH is expected to achieve higher than peers

earnings CAGR of 23% in FY18-21. Trading at 20x FY19 PE and

PEG of 0.9x, the stock looks attractive in our view.

Where we differ. We are more bullish than the market on CGH

as we are optimistic on the prospects of rural coal-to-gas

conversion, which is the key driver in gas sales volume and

connection fees. Our earnings estimate is 10% above the

market.

Potential catalyst. Strong execution in rural coal-to-gas

conversion project development to drive up connection revenue

and sales volume growth. Valuation: We maintain our BUY rating with TP lifted to HK$40.0 based on DCF valuation. We have assumed beta of 1.1, 7.2% WACC (equity risk premium of 7%, risk free rate of 3%, and 3.6% after tax cost of debt) and 2.5% terminal growth. Key Risks to Our View:

Slowdown in rural coal-to-gas projects from increasing

competition or lack of government support.

At A Glance


Mkt Cap (HK$m/US$m) 166,197 / 21,180


Beijing Enterprises Holdings Ltd 24.9

China Gas Group Ltd. 15.2

SK E&S Company Ltd 14.2

Capital World Investors 8.0

Liu (Ming Hui) 5.7

Free Float (%) 32.0


ICB Industry: Oil & Gas / Oil Equipment, Services & Distribution

61

81

101

121

141

161

181

201

221

8.5

13.5

18.5

23.5

28.5

33.5

38.5

Jul-14 Jul-15 Jul-16 Jul-17 Jul-18

Relative IndexHK$

China Gas Holdings (LHS) Relative HSI (RHS)


27 Jul 2018


China Gas Holdings Version 2 | Bloomberg: 384 HK Equity | Reuters: 0384.HK


Page 30

Company Guide

China Gas Holdings


Critical Factors

First mover into rural coal-to-gas. We believe the company’s

main earnings driver is rural coal-to-gas conversion.

The market has not fully appreciated its growth potential in

these areas. The government continues to roll out supportive

policies for coal-to-gas conversion such as the “Clean Winter

Heating Plan for Northern China” (“北方地区冬季清洁取暖规

划”). We believe the potential market size exceeds 60m

households. CGH gained early mover advantage for being the

first aggressive player to tap into the market.

The number of township coal-to-gas replacements only

reached 34,432 by the end of FY17. By the end of March

2018, CGH has completed 1.1m rural coal-to-gas conversion

projects, with a project backlog of 2.1m households. The

project backlog grew to 3.16m by mid-June 2018. We believe

that new connections from township conversion projects will

reach 2.1m in FY19, which may boost new residential

connections. Our forecast for new connections of residential

users amount to 5m, 5.9m, and 6.4m in FY19, FY20, and FY21

respectively.

Lower transmission tariffs, higher demand. We believe that

intra-provincial tariffs could be cut further amid the

government’s intensifying regulations for the midstream. The

potential merger of pipeline companies could further reduce

transmission tariffs by the midstream. This could lower end

selling price without affecting distribution dollar margin and

may boost gas demand growth and share price.

Average connection fee - residential (HK$)

New connections - residential (m households)

Gas sales volume (m m3)

Dollar margin (Rmb/m3)


2938

3336 3401 3401 3401

0

491

981

1,472

1,963

2,454

2,944

3,435

2017A 2018A 2019F 2020F 2021F

2.6

3.9

5.0

5.9

6.4

0.00

1.31

2.63

3.94

5.25

6.56

2017A 2018A 2019F 2020F 2021F

12,224.3

18,659.3

24,846.4

31,674.9

38,081.0

0

7,769

15,537

23,306

31,074

38,843

2017A 2018A 2019F 2020F 2021F

1

11 1 1

0.00

0.14

0.27

0.41

0.55

0.68

2017A 2018A 2019F 2020F 2021F

Page 31

Company Guide

China Gas Holdings

Share price vs HSI


0

100

200

300

400

500

600

700

800

900

Jan-1

0

Jul-10

Jan-1

1

Jul-11

Jan-1

2

Jul-12

Jan-1

3

Jul-13

Jan-1

4

Jul-14

Jan-1

5

Jul-15

Jan-1

6

Jul-16

Jan-1

7

Jul-17

Jan-1

8

Jul-18

China Gas rel to HSI (Rebased Jan 10 = 100)

Acceleration of rural coal-to-gas conversion

Page 32

Company Guide

China Gas Holdings

Balance Sheet:

Strong balance sheet. Strong earnings growth in the next few

years is expected to support the higher capital expenditure

(capex) needed for gas storage and rural coal-to-gas conversion

projects. The company plans to spend capex of HK$9bn in

FY19, which consists of HK$3.5bn for city gas projects,

HK$3.5bn for rural coal-to-gas projects, HK$1bn for LPG &

integrated energy projects and HK$1bn for storage facilities.


Coal-to-gas conversion. The coal-to-gas conversion progress in

China will determine the ramp up of gas consumption. Market

share gain in rural coal-to-gas conversions may help to drive up

share price.

Lower gas selling price. The midstream reform may drive down

transmission tariffs and result in a lowering of end selling price

and boost gas consumption.

Key Risks:

Sluggish economic growth in China. Natural gas sales volume

is sensitive to China’s underlying economic growth. A

slowdown in economic growth would have a negative impact

on demand for gas.

Lack of government policy enforcement. Poor execution

despite supportive government policies may negatively affect

sentiment and performance for the gas sector. For instance, a

prolonged subsidy payment delay for rural customers could

discourage new customers from entering the market.

Company Background

CGH is mainly involved in the construction and operation of

city gas pipelines as well as the sale of natural gas and

liquefied petroleum gas (LPG) in China. The company also

invests in gas terminals, storage, transportation, logistics

systems and vehicle refilling stations. CGH was listed in 2001

on the Hong Kong Stock Exchange.


Capital Expenditure

ROE

Forward PE Band

PB Band


0.5

0.6

0.6

0.7

0.7

0.8

0.8

0.9

0.9

1.0

1.0

0.00

0.20

0.40

0.60

0.80

1.00

2017A 2018A 2019F 2020F 2021F

Gross Debt to Equity (LHS) Asset Turnover (RHS)

0.0

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0

6,000.0

7,000.0

8,000.0

9,000.0

10,000.0

2017A 2018A 2019F 2020F 2021F

Capital Expenditure (-)

HK$m

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2017A 2018A 2019F 2020F 2021F

Avg: 14x

+1sd: 17.3x

+2sd: 20.5x

-1sd: 10.7x

-2sd: 7.5x6.7

8.7

10.7

12.7

14.7

16.7

18.7

20.7

22.7

24.7


(x)

Avg: 3.61x

+1sd: 4.36x

+2sd: 5.11x

-1sd: 2.85x

-2sd: 2.1x1.8

2.3

2.8

3.3

3.8

4.3

4.8

5.3

5.8

6.3

6.8


(x)

Page 33

Company Guide

China Gas Holdings

Key Assumptions

FY Mar 2017A 2018A 2019F 2020F 2021F

Average connection fee - residential (HK$)

2,937.6 3,336.2 3,401.2 3,401.2 3,401.2

New connections - residential (m households)

2.6 3.9 5.0 5.9 6.4

Gas sales volume (m m3) 12,224.3 18,659.3 24,846.4 31,674.9 38,081.0 Dollar margin (Rmb/m3) 0.68 0.62 0.6 0.59 0.58 Source: Company, DBS HK

Segmental Breakdown (HK$ m)

FY Mar 2017A 2018A 2019F 2020F 2021F

Revenues (HK$ m) Piped gas 13,779 22,613 31,390 40,256 48,714 Connection fee 5,748 11,303 13,781 16,421 17,848 LPG 11,655 15,970 17,831 18,623 19,368 Value added services 812 2,947 5,363 8,265 9,866

Total 31,993 52,832 68,365 83,564 95,796

GPM (HK$ m) Piped gas 2,463 3,075 4,140 5,280 6,366 Connection fee 4,225 6,179 7,572 8,821 9,246 LPG 1,313 1,521 1,699 1,774 1,845 Value added services 376 1,002 1,690 2,497 2,977

Total 8,377 11,778 15,100 18,372 20,434

GPM Margins (%) Piped gas 17.9 13.6 13.2 13.1 13.1 Connection fee 73.5 54.7 54.9 53.7 51.8 LPG 11.3 9.5 9.5 9.5 9.5 Value added services N/A N/A N/A N/A N/A

Total 26.2 22.3 22.1 22.0 21.3


Page 34

Company Guide

China Gas Holdings

Income Statement (HK$ m) FY Mar 2017A 2018A 2019F 2020F 2021F

Revenue 31,993 52,832 68,365 83,564 95,796


Gross Profit 8,377 11,671 15,100 18,372 20,434



Other Non Opg (Exp)/Inc 488 262 827 930 970

Associates & JV Inc 904 1,255 1,395 1,621 1,859



Exceptional Gain/(Loss) (327) (267) (300) 0 0

Pre-tax Profit 5,902 8,600 11,856 15,069 16,948

Tax (1,208) (1,931) (2,662) (3,383) (3,805)

Minority Interest (547) (574) (820) (1,003) (1,150)


Net Profit 4,148 6,095 8,374 10,683 11,993


EBITDA 7,825 10,759 14,270 17,420 19,466

Growth

Revenue Gth (%) 8.5 65.1 29.4 22.2 14.6

EBITDA Gth (%) 13.6 37.5 32.6 22.1 11.7

Opg Profit Gth (%) 19.9 47.4 32.9 23.8 11.4

Net Profit Gth (%) 82.5 47.0 37.4 27.6 12.3

Margins & Ratio

Gross Margins (%) 26.2 22.1 22.1 22.0 21.3



ROAE (%) 21.6 24.9 26.6 27.9 25.8

ROA (%) 7.3 8.6 9.8 11.3 11.5

ROCE (%) 9.4 10.9 12.2 14.0 14.4

Div Payout Ratio (%) N/A N/A N/A N/A N/A



Page 35

Company Guide

China Gas Holdings

Balance Sheet (HK$ m)

FY Mar 2017A 2018A 2019F 2020F 2021F

Net Fixed Assets 25,879 34,088 41,895 49,428 54,697


Other LT Assets 9,402 10,744 11,574 12,386 13,017

Cash & ST Invts 4,752 8,294 5,362 3,419 3,637

Inventory 1,679 3,069 3,072 3,755 4,305

Debtors 6,067 9,019 9,761 11,931 13,677


Total Assets 60,222 82,058 89,140 99,534 108,866

ST Debt

10,873 11,079 11,079 8,579 7,079

Creditors 9,650 14,045 15,331 18,764 21,691

Other Current Liab 2,056 1,977 3,418 4,178 4,790

LT Debt 12,745 21,293 18,793 18,793 16,293

Other LT Liabilities 951 933 933 933 933



Total Cap. & Liab. 60,222 82,058 89,140 99,535 108,866

Non-Cash Wkg. Capital (1,095) 561 (789) (989) (1,315)

Net Cash/(Debt) (18,866) (24,078) (24,510) (23,954) (19,736)




Asset Turnover (x) 0.6 0.7 0.8 0.9 0.9

Current Ratio (x) 0.7 0.9 0.8 0.8 0.9

Quick Ratio (x) 0.5 0.6 0.5 0.5 0.5

Net Debt/Equity (X) 0.8 0.7 0.6 0.5 0.3


Capex to Debt (%) 12.5 19.8 30.1 32.9 29.9



Cash Flow Statement (HK$ m)

FY Mar 2017A 2018A 2019F 2020F 2021F

Pre-Tax Profit 5,902 8,600 11,856 15,069 16,948

Dep. & Amort. 960 1,179 1,321 1,592 1,853

Tax Paid (1,102) (1,931) (2,662) (3,383) (3,805)

Assoc. & JV Inc/(loss) 0 0 0 0 0


Chg in Wkg.Cap. (1,473) 53 542 580 631

Other Operating CF (170) (2,221) (1,453) (2,143) (2,067)

Net Operating CF 4,116 5,680 9,603 11,715 13,560

Capital Exp.(net) (2,959) (6,409) (9,000) (9,000) (7,000)

Other Invts.(net) (442) (74) 0 0 0

Invts in Assoc. & JV (351) (2,771) 0 0 0

Div from Assoc & JV 50 0 0 0 0

Other Investing CF (411) (750) (960) (939) (756)

Net Investing CF (4,112) (10,004) (9,960) (9,939) (7,756)

Div Paid (954) (1,703) (2,339) (2,984) (3,350)

Chg in Gross Debt 1,430 8,754 (2,500) (2,500) (4,000)

Capital Issues (539) 0 0 0 0

Other Financing CF (458) 799 2,261 1,763 1,761

Net Financing CF (520) 7,850 (2,578) (3,722) (5,589)

Currency Adjustments (256) 0 0 0 0

Chg in Cash (772) 3,526 (2,934) (1,946) 215

Opg CFPS (HK$) 1.14 1.13 1.82 2.24 2.60

Free CFPS (HK$) 0.24 (0.15) 0.12 0.55 1.32


Page 36

Company Guide

China Gas Holdings


Source: DBS HK


Patricia YEUNG

1

2

3 45

6

17.0

22.0

27.0

32.0

37.0

Jul-17

Aug-1

7

Sep-1

7

Oct

-17

Nov-

17

Dec

-17

Jan-1

8

Feb-1

8

Mar-

18

Apr-

18

Apr-

18

May-

18

Jun-1

8

Jul-18


Price Target

Price

1: 29-Sep-17 HK$22.90 HK$27.10 Buy

2: 25-Oct-17 HK$23.75 HK$27.10 Buy

3: 15-Nov-17 HK$23.50 HK$28.20 Buy

4: 28-Nov-17 HK$23.05 HK$28.20 Buy

5: 25-Jun-18 HK$32.60 HK$37.00 Buy

6: 20-Jul-18 HK$33.95 HK$37.00 Buy

sa- CS /AH

HOLD (Upgrade from FULLY VALUED)

Last Traded Price ( 24 Jul 2018):HK$35.70 (HSI : 28,781)

Price Target 12-mth:HK$32.50 (9.0% downside) (Prev

HK$25.00) Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

What’s New 1H18 volume growth is expected to be strong at

20-22% We lift dollar margin assumption on acceleration

in gas storage and potential midstream pipeline

reform We upgrade our rating to HOLD, TP is revised up

to HK$32.50

Price Relative

Forecasts and Valuation FY Dec (HK$m) 2017A 2018F 2019F 2020F Turnover 39,838 47,430 54,674 60,026 EBITDA 8,509 9,499 10,665 11,962 Pre-tax Profit 6,613 7,552 8,481 9,459 Net Profit 3,654 4,112 4,573 5,130 Net Pft (Pre Ex) (core profit) 3,654 4,112 4,573 5,130 Net Profit Gth (Pre-ex) (%) 11.1 12.5 11.2 12.2 EPS (HK$) 1.68 1.89 2.06 2.31 Core EPS (HK$) 1.68 1.89 2.06 2.31 EPS Gth (%) 11.0 12.4 8.9 12.2 Core EPS Gth (%) 11.0 12.4 8.9 12.2 Diluted EPS (HK$) 1.68 1.89 2.06 2.31 DPS (HK$) 0.56 0.70 0.82 0.92 BV Per Share (HK$) 10.11 11.29 12.29 13.67 PE (X) 21.3 18.9 17.4 15.5 CorePE (X) 21.3 18.9 17.4 15.5 P/Cash Flow (X) 10.0 11.8 9.5 9.4 P/Free CF (X) 23.0 nm 89.3 55.6 EV/EBITDA (X) 10.1 9.3 8.5 7.5 Net Div Yield (%) 1.6 2.0 2.3 2.6 P/Book Value (X) 3.5 3.2 2.9 2.6 Net Debt/Equity (X) 0.0 0.1 0.0 CASH ROAE(%) 18.4 17.7 17.6 17.8 Earnings Rev (%): 7 11 Consensus EPS (HK$) 1.92 2.14 Other Broker Recs: B:16 S:3 H:7


Good volume seen in 1H18

Performing well in 1H18. The replacement of coal with gas in

China has exceeded the market expectation during 5M18. CR

Gas’ volume growth from C&I customers is also expected to be

strong at 25-30% during 1H18. Thus, we are revising up our

volume growth estimate from 17% to 20% in FY18. Despite

gas shortage in the near term, we slightly lift our dollar margin

assumption as we see the acceleration in gas storage and

potential reform in midstream will help to resolve gas shortage

over the medium term. Thus, we expect earnings growth to

accelerate to 14% in FY18 and we upgrade to HOLD with TP

lifted to HK$32.50. However, the dollar margin for CR Gas may

remain suppressed in the next few years as it has high exposure

to regions with pressure on dollar margin coming from

government’s regulation on distribution margin.

Where we differ. We are more conservative on the outlook on

the dollar margin of CR Gas. The market is too optimistic on the

recovery of dollar margin. Thus, our earnings forecast is 4%

lower than the market.

Potential catalyst. Continued gas shortage during winter and

the full implementation of the distribution return requirement

by local governments may trigger pressure on dollar margin and

negative sentiment on the stock. Valuation: We upgrade our rating to HOLD and target price is lifted to HK$32.50, based on DCF valuation. We have assumed a beta of 1 with WACC of 8.5% and 1% terminal growth. Key Risks to Our View:

Upside risk on dollar margin. A less severe winter gas shortage

or lower than expected dollar margin pressure on project

return investigation from government will be positive to

earnings growth

At A Glance


Mkt Cap (HK$m/US$m) 79,397 / 10,118


China Resources National Co Ltd 64.0

Capital World Investors 7.9

Capital Research Global Investors 6.0

Free Float (%) 22.2




27 Jul 2018


China Resources Gas Version 2 | Bloomberg: 1193 HK EQUITY | Reuters: 1193.HK


Page 38

Company Guide

China Resources Gas


Critical Factors

Dollar margin under pressure. CR Gas may face pressure on

dollar margin and market expectation on dollar margin is too

optimistic. The supply for natural gas is expected to remain

tight in the next two years and downstream distributors may

continue to face pressure during winter peak season.

According to our channel checks, downstream distributors

have different opinions on gas storage and some of them lacks

motivation to construct storage facilities until detailed return

policy is issued. Unlike ENN and Towngas, which will have LNG

receiving terminals access and underground gas storage in

2018, CR Gas currently lacks midstream facilities. Therefore, CR

Gas is less equipped to mitigate dollar margin pressure during

winter peak season if severe gas shortage occurs again.

We also identified regions with higher pressure on dollar

margin in the next few years and CR Gas’ exposure in these

regions is also high. The provincial governments will finalise the

gas distribution return regulatory documents before end of

June and return analysis on local level will be conducted

throughout the year. CR Gas has the most number of projects

located in provincial capitals, which usually are more mature

and have higher return. And regions with higher dollar margin

level will face more pressure on dollar margin as volume

expands.

Conservative development strategy. The company will be

focusing in city gas project development. Our perception is that

its development strategy is rather conservative, which hinders

its ability to tab into new opportunities and miss out the

earnings growth potential. China Gas has started to

aggressively expand into rural coal-to-gas conversion projects

early and achieved strong growth in earnings. ENN and

Towngas China on the other hand, has aggressive target in the

development of integrated energy projects. We believe

investors would favor companies that can leverage on its

existing business to seek new growth drivers.

Volume growth remained strong. The acceleration of coal-to-

gas conversion, speed up of the construction of natural gas

infrastructure and cut in the short distance pipeline

transmission fee will boost the sales volume growth for gas

distributors. Since CR Gas’ projects are located in eastern

region with strong economic growth, its volume growth will

outperform industry average. Its volume growth is expected to

reach 20-22% during 1H18 amid strong coal-to-gas conversion

in China.


New Residential connections (m) - consolidated


New connection - residential ASP


Page 39

Company Guide

China Resources Gas

Share price vs HIS


0

50

100

150

200

250

300

350

Jan-1

0

Jul-10

Jan-1

1

Jul-11

Jan-1

2

Jul-12

Jan-1

3

Jul-13

Jan-1

4

Jul-14

Jan-1

5

Jul-15

Jan-1

6

Jul-16

Jan-1

7

Jul-17

Jan-1

8

Jul-18

China Resources Gas Group rel to HSI

Strong growth in gas consumption

Collapse of oil prices leads to lower price competitiveness for natural gas

pick up of gas volume growth from coal-to-gas conversion

Page 40

Company Guide

China Resources Gas

Balance Sheet:

Close to net cash by end of FY20. The company has a solid

balance sheet from steady cash inflows each year. We factor in

capital expenditure of HK$8bn in our model for FY18, of which

75% will be used for organic expansion and maintenance

while the rest is used for M&A. We expect CR Gas to be close

to net cash position by FY20.


Winter gas shortage. The supply for natural gas will remain

tight during peak season in winter due to insufficient gas

storage and pipeline network in the country in the near term.

Gas distributors with lack of storage facilities and access to

LNG receiving terminals will be prone to dollar margin squeeze.

Government implementation of ROA requirement. The

document for return restriction for gas distributors will be

issued by all provinces before end of June, and investigation on

project returns will be conducted throughout the year. CR Gas

has the most number of projects located in provincial capitals,

which usually are more mature and have higher return. And

regions with higher dollar margin level will face more pressure

on dollar margin as volume improves.

Key Risks:

Upside risk on dollar margin. A less severe winter gas shortage

or lower than expected dollar margin cut on project return

investigation from government will be positive to earnings

growth

Company Background

CR Gas is the largest downstream gas distributor in China in

terms of gas sales volume. Its principal businesses are in piped

gas distribution, natural gas filling station operations and sale

of gas appliances. By the end of FY17, its gas sales volume

had grown 21% y-o-y to 19.7bn m³.


Capital Expenditure

ROE

Forward PE Band

PB Band


Page 41

Company Guide

China Resources Gas

Key Assumptions

FY Dec 2016A 2017A 2018F 2019F 2020F


16,272.0 19,667.0 23,590.4 28,060.0 31,448.7

New Residential connections (m) - consolidated

1.8 2.1 2.3 2.6 2.8


0.71 0.58 0.57 0.56 0.55

New connection - residential ASP

2,970.0 2,940.0 2,940.0 2,940.0 2,940.0



FY Dec 2016A 2017A 2018F 2019F 2020F

Revenues (HK$ m) Sale & distribution of gas fuel & related products

23,872 29,082 35,838 42,337 46,952

Gas connection 7,439 8,927 9,664 10,335 11,016 Others 1,606 1,829 1,927 2,001 2,058

Total 32,916 39,838 47,430 54,674 60,026

GPM (HK$ m) Sale & distribution of gas fuel & related products

6,493 6,427 7,576 8,854 9,746

Gas connection 4,448 5,169 5,605 5,994 6,389 Others 243 320 337 350 360

Total 11,184 11,916 13,518 15,198 16,495

GPM Margins (%) Sale & distribution of gas fuel & related products

27.2 22.1 21.1 20.9 20.8

Gas connection 59.8 57.9 58.0 58.0 58.0 Others 15.1 17.5 17.5 17.5 17.5

Total 34.0 29.9 28.5 27.8 27.5


Page 42

Company Guide

China Resources Gas

Income Statement (HK$ m) FY Dec 2016A 2017A 2018F 2019F 2020F

Revenue 32,916 39,838 47,430 54,674 60,026


Gross Profit 11,184 11,916 13,518 15,198 16,495




Associates & JV Inc 772 787 854 984 1,080



Exceptional Gain/(Loss) 0 0 0 0 0

Pre-tax Profit 6,189 6,613 7,552 8,481 9,459

Tax (1,751) (1,703) (1,944) (2,183) (2,435)

Minority Interest (1,148) (1,257) (1,496) (1,725) (1,894)


Net Profit 3,289 3,654 4,112 4,573 5,130


EBITDA 7,788 8,509 9,499 10,665 11,962

Growth

Revenue Gth (%) 0.3 21.0 19.1 15.3 9.8

EBITDA Gth (%) 17.9 9.2 11.6 12.3 12.2

Opg Profit Gth (%) 26.1 5.8 11.5 11.7 10.5

Net Profit Gth (%) 15.9 11.1 12.5 11.2 12.2

Margins & Ratio

Gross Margins (%) 34.0 29.9 28.5 27.8 27.5



ROAE (%) 18.9 18.4 17.7 17.6 17.8

ROA (%) 5.5 5.7 5.7 5.8 6.0

ROCE (%) 10.0 10.5 10.7 11.2 11.7

Div Payout Ratio (%) 30.4 33.5 37.0 40.0 40.0



Page 43

Company Guide

China Resources Gas


FY Dec 2016A 2017A 2018F 2019F 2020F

Net Fixed Assets 24,059 28,608 34,910 40,338 44,943


Other LT Assets 4,754 4,337 4,647 4,942 5,143

Cash & ST Invts 9,525 10,356 7,910 8,295 7,317

Inventory 413 595 600 692 760

Debtors 8,021 9,463 10,408 11,997 13,171


Total Assets 59,675 68,764 74,440 82,786 88,312

ST Debt

3,139 5,328 4,828 3,828 2,828

Creditors 21,737 26,050 29,019 33,780 37,250

Other Current Liab 540 634 754 870 955

LT Debt 9,028 6,039 5,039 5,039 3,039

Other LT Liabilities 1,526 1,544 1,544 1,544 1,544



Total Cap. & Liab. 59,675 68,764 74,440 82,786 88,312


Net Cash/(Debt) (2,642) (1,011) (1,956) (571) 1,450




Asset Turnover (x) 0.6 0.6 0.7 0.7 0.7

Current Ratio (x) 0.8 0.7 0.6 0.6 0.6

Quick Ratio (x) 0.7 0.6 0.5 0.5 0.5

Net Debt/Equity (X) 0.1 0.0 0.1 0.0 CASH

Net Debt/Equity ex MI (X) 0.1 0.0 0.1 0.0 CASH

Capex to Debt (%) 27.2 38.8 81.1 84.6 119.3




FY Dec 2016A 2017A 2018F 2019F 2020F

Pre-Tax Profit 6,189 6,613 7,552 8,481 9,459

Dep. & Amort. 1,285 1,643 1,779 2,149 2,469

Tax Paid (1,654) (1,700) (1,944) (2,183) (2,435)

Assoc. & JV Inc/(loss) (772) (787) (854) (984) (1,080)


Chg in Wkg.Cap. 1,941 1,764 2,019 3,081 2,228

Other Operating CF 373 260 (1,946) (2,154) (2,211)

Net Operating CF 7,362 7,793 6,605 8,389 8,429

Capital Exp.(net) (3,314) (4,411) (8,000) (7,500) (7,000)

Other Invts.(net) (9) (5) 0 0 0

Invts in Assoc. & JV (1) (529) 0 0 0

Div from Assoc & JV 582 685 743 857 940

Other Investing CF (4,206) 4,050 (390) (372) (275)

Net Investing CF (6,948) (209) (7,647) (7,016) (6,335)

Div Paid (827) (980) (1,521) (1,829) (2,052)

Chg in Gross Debt (2,671) (923) (1,500) (1,000) (3,000)


Other Financing CF (1,733) (1,254) 1,617 1,840 1,979

Net Financing CF (5,232) (3,157) (1,404) (989) (3,073)


Chg in Cash (5,253) 4,852 (2,446) 385 (979)

Opg CFPS (HK$) 2.49 2.77 2.11 2.39 2.79

Free CFPS (HK$) 1.86 1.55 (0.64) 0.40 0.64


sa- CS /AH

BUY


Price Target 12-mth:HK$9.00 (13.8% upside) Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

Price Relative

Forecasts and Valuation FY Dec (HK$m) 2017A 2018F 2019F 2020F Turnover 8,760 10,120 11,223 12,260 EBITDA 2,619 3,034 3,361 3,663 Pre-tax Profit 1,918 2,172 2,447 2,697 Net Profit 1,365 1,524 1,720 1,898 Net Pft (Pre Ex) (core profit) 1,284 1,524 1,720 1,898 Net Profit Gth (Pre-ex) (%) 24.1 18.7 12.8 10.4 EPS (HK$) 0.51 0.56 0.62 0.69 Core EPS (HK$) 0.48 0.56 0.62 0.69 EPS Gth (%) 38.3 9.5 11.6 10.4 Core EPS Gth (%) 22.4 16.5 11.6 10.4 Diluted EPS (HK$) 0.25 0.28 0.31 0.34 DPS (HK$) 0.15 0.18 0.20 0.22 BV Per Share (HK$) 5.90 6.17 6.52 6.99 PE (X) 15.6 14.2 12.7 11.5 CorePE (X) 16.6 14.2 12.7 11.5 P/Cash Flow (X) 14.0 14.8 11.8 10.9 P/Free CF (X) nm nm nm 39087.

2 EV/EBITDA (X) 11.4 10.2 9.4 8.6 Net Div Yield (%) 2.0 2.3 2.5 2.8 P/Book Value (X) 1.3 1.3 1.2 1.1 Net Debt/Equity (X) 0.4 0.4 0.4 0.4 ROAE(%) 9.3 9.3 9.8 10.2 Earnings Rev (%): Nil Nil Nil Consensus EPS (HK$) 0.51 0.57 0.64 Other Broker Recs: B:6 S:1 H:3


Storing up for growth

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 back to the 15-23x PE

range before the oil price collapsed in 2014 and when volume

growth was at double digit.

Where we differ. The market underestimated the benefit of the

gas storage facilities and LNG receiving terminal on the dollar

margin. Our earnings estimate is 8% above the consensus. The

market remain cautious on margin and has not priced in the

stable dollar margin outlook.

Potential catalyst. Better than expected dollar margin supported

by access to underground storage facility and a less severe

winter gas shortage. Potential privatisation by HKCG may drive

up the valuation closer to its parent as Towngas China is trading

at 50% discount to HKCG. Valuation: We have a BUY rating with TP HK$9.00 based on DCF valuation method. We assumed a beta of 1.0 with WACC of 7.4% and 1% terminal growth. Key Risks to Our View:

Lower-than-expected dollar margin. A more severe winter gas

shortage and dollar margin compression from government

regulation will be negative to earnings growth.

At A Glance


Mkt Cap (HK$m/US$m) 22,227 / 2,833


Hong Kong and China Gas Co Ltd 67.4

First State Investments (HK) Ltd. 6.9

Free Float (%) 25.7



43

63

83

103

123

143

163

183

203

3.0

4.0

5.0

6.0

7.0

8.0

9.0


Relative IndexHK$

Towngas China Co Ltd (LHS) Relative HSI (RHS)


27 Jul 2018


Towngas China Co Ltd Version 1 | Bloomberg: 1083 HK Equity | Reuters: 1083.HK


Page 45

Company Guide

Towngas China Co Ltd


Critical Factors

Gas supply facilities to support dollar margin. We expect its

dollar margin to remain relatively stable as it can utilise HKCG’s

gas storage and LNG receiving terminal as early as FY18. We

forecast the dollar margin to be flat at Rmb0.63/m3 in FY18.

HKCG is constructing a storage facility in Jiangsu with a

capacity of 440m m³. Construction of phase 1 of the storage

facility, with a capacity of 140m m³, was completed in January

2018. In addition, HKCG invested in a LNG receiving terminal

in Cangzhou city of Hebei in early 2018. The terminal has a

designed receiving capacity of 2.6m tons per year, and half of

it is expected to be operational by 2021. This would imply a

total of c.1.8bn m³ of additional gas supply for winter usage in

the Hebei-Tianjin-Beijing area. We believe the improvement of

storage infrastructure and access to LNG terminal will help

Towngas to ease winter gas shortage and dollar margin

pressure in the medium term.

Increasing demand for natural gas. Amid the government’s

push and initiatives to increase natural gas usage, we believe

Towngas China will be one of the major beneficiaries.

According to the 13th FYP for natural gas, the government

targets to increase the proportion of natural gas consumption

from 6.4% in 2016 to 10% in 2020. We expect the total gas

consumption to exceed 340bn m³ in 2020, implying a CAGR of

14%. Towngas China’s sales volume outperformed the

industry average at 18% during FY17 and our channel check

shows that the company continued to achieve decent volume

growth of c.17% y-o-y during 1QFY18 while the natural gas

consumption growth reached c.12% in China. We expect the

company to achieve 18% gas sales growth in FY18.

Privatisation by parent company. We believe it is possible for

HKCG to privatise Towngas China. HKCG has been a strong

backup for Towngas China with integrated natural gas

business in HK/China, and the parent company still has 34 city

gas projects in China. Also, Towngas China has been trading at

a significant discount of >50% to HKCG.

Blended dollar margin (Rmb / m3)

Gas sales volume (m m3)

Consolidated new connection #


0.69

0.63 0.63 0.62 0.61

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

2016A 2017A 2018F 2019F 2020F

7,120.0

8,417.0

9,747.7

11,099.5

12,440.4

0

2,538

5,076

7,614

10,151

12,689

2016A 2017A 2018F 2019F 2020F

400,000.0 400,000.0 412,000.0 424,360.0 432,847.2

0

88,301

176,602

264,902

353,203

441,504

2016A 2017A 2018F 2019F 2020F

Page 46

Company Guide


Share price vs HSI


60

110

160

210

260

310

360

Jan-1

0

Jul-10

Jan-1

1

Jul-11

Jan-1

2

Jul-12

Jan-1

3

Jul-13

Jan-1

4

Jul-14

Jan-1

5

Jul-15

Jan-1

6

Jul-16

Jan-1

7

Jul-17

Jan-1

8

Jul-18

Towngas rel to HSI (Rebased Jan 10 = 100)


Acceleratedsales volume growth from coal-to-gas conversion

Oil price collapse lowered price competitiveness for natural gas

Page 47

Company Guide


Balance Sheet:

Solid balance sheet. The net gearing level will gradually

decline as FCF increases on higher gas sales volume. This will

support the increase in dividend payout in the future. The

capital expenditure is expected to reach HK$2bn in FY18, of

which c.HK$1.5bn will be utilised for maintenance while the

rest will be used to acquire new projects. We expect the net

gearing ratio to drop from 45% in FY17 to 40% in FY20.


Narrowing of dollar margin decline. The operation of Jintan

underground storage and the construction of LNG receiving

terminal will allow Towngas China to have additional low

cost gas supply during peak season in the winter, supporting

the dollar margin pressure going forward.

Sales volume increase from coal-to-gas conversion. Towngas

China will be one of the beneficiaries of China’s increasing

demand for natural gas. The strong momentum in coal-to-

gas conversion and strong growth potential from integrated

energy business will help to drive up the gas sales volume.

Key Risks:

Lower-than-expected gas sales volume. A downturn in

economic activities, sharp drop in oil price, and sluggish

coal-to-gas conversion could negatively affect demand for

natural gas.

Company Background

Towngas China is one of the major gas distributors in

China. It is mainly engaged in the sales and distribution of

piped gas in China, including the provision of piped gas,

construction of pipelines, operation of city gas networks

and gas refilling stations as well as the sales of household

gas appliances. By the end of FY17, it had a total of 105 gas

projects while its total gas sales volume had reached 8.4bn

m³.


Capital Expenditure

ROE

Forward PE Band

PB Band


0.2

0.2

0.2

0.3

0.3

0.3

0.3

0.3

0.4

0.4

0.4

0.00

0.10

0.20

0.30

0.40

0.50

0.60

2016A 2017A 2018F 2019F 2020F


1,700.0

1,750.0

1,800.0

1,850.0

1,900.0

1,950.0

2,000.0

2,050.0

2016A 2017A 2018F 2019F 2020F


HK$m

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2016A 2017A 2018F 2019F 2020F

Avg: 12.3x

+1sd: 15.8x

+2sd: 19.3x

-1sd: 8.8x

-2sd: 5.3x4.7

6.7

8.7

10.7

12.7

14.7

16.7

18.7

20.7


(x)

Avg: 1x

+1sd: 1.23x

+2sd: 1.45x

-1sd: 0.78x

-2sd: 0.56x0.5

0.7

0.9

1.1

1.3

1.5

1.7

Dec-14 Dec-15 Dec-16 Dec-17

(x)

Page 48

Company Guide


Key Assumptions

FY Dec 2016A 2017A 2018F 2019F 2020F

Blended dollar margin (Rmb / m3)

0.69 0.63 0.63 0.62 0.61

Gas sales volume (m m3) 7,120.0 8,417.0 9,747.7 11,099.5 12,440.4 Consolidated new connection #

400,000.0 400,000.0 412,000.0 424,360.0 432,847.2



FY Dec 2016A 2017A 2018F 2019F 2020F

Revenues (HK$ m) Gas sales 5,518 6,996 8,243 9,290 10,288 Connection fee 1,663 1,764 1,877 1,933 1,972

Total 7,181 8,760 10,120 11,223 12,260

EBIT margin (HK$ m) Gas sales 301 482 704 854 1,007 Connection fee 722 807 858 884 902

Total 1,023 1,289 1,563 1,739 1,909

EBIT margin Margins (%) Gas sales 5.5 6.9 8.5 9.2 9.8 Connection fee 43.4 45.7 45.7 45.7 45.7

Total 14.2 14.7 15.4 15.5 15.6


Page 49

Company Guide


Income Statement (HK$ m) FY Dec 2016A 2017A 2018F 2019F 2020F

Revenue 7,181 8,760 10,120 11,223 12,260

Cost of Goods Sold 0 0 0 0 0

Gross Profit 7,181 8,760 10,120 11,223 12,260




Associates & JV Inc 618 633 698 774 834



Exceptional Gain/(Loss) (60) 82 0 0 0

Pre-tax Profit 1,455 1,918 2,172 2,447 2,697

Tax (362) (405) (478) (538) (593)

Minority Interest (119) (147) (170) (188) (206)


Net Profit 974 1,365 1,524 1,720 1,898


EBITDA 2,246 2,619 3,034 3,361 3,663

Growth

Revenue Gth (%) (7.0) 22.0 15.5 10.9 9.2

EBITDA Gth (%) 2.8 16.6 15.8 10.8 9.0

Opg Profit Gth (%) (17.0) 11.4 29.4 11.2 9.8

Net Profit Gth (%) 20.7 40.2 11.6 12.8 10.4

Margins & Ratio

Gross Margins (%) 100.0 100.0 100.0 100.0 100.0



ROAE (%) 7.2 9.3 9.3 9.8 10.2

ROA (%) 3.4 4.5 4.5 4.9 5.1

ROCE (%) 3.5 3.9 4.5 4.8 5.0

Div Payout Ratio (%) N/A N/A N/A N/A N/A



Page 50

Company Guide



FY Dec 2016A 2017A 2018F 2019F 2020F

Net Fixed Assets 12,692 15,060 16,515 17,918 19,270


Other LT Assets 6,738 7,210 7,290 7,351 7,408

Cash & ST Invts 1,439 1,605 1,093 944 924

Inventory 493 637 652 724 790

Debtors 1,190 1,393 1,492 1,655 1,808

Other Current Assets 420 528 609 676 738

Total Assets 28,027 32,775 34,414 36,493 38,664

ST Debt

2,653 3,708 3,708 3,708 3,708

Creditors 4,333 5,173 5,444 6,034 6,586

Other Current Liab 785 1,041 1,203 1,334 1,457

LT Debt 5,184 5,072 5,072 5,072 5,072




Total Cap. & Liab. 28,027 32,775 34,414 36,493 38,664


Net Cash/(Debt) (6,398) (7,174) (7,686) (7,836) (7,856)


Creditors Turn (avg days) (3,229.0) (3,332.8) (3,438.3) (3,400.1) (3,454.1)

Inventory Turn (avg days) (399.7) (396.0) (417.4) (407.6) (414.4)

Asset Turnover (x) 0.3 0.3 0.3 0.3 0.3

Current Ratio (x) 0.5 0.4 0.4 0.4 0.4

Quick Ratio (x) 0.3 0.3 0.2 0.2 0.2

Net Debt/Equity (X) 0.4 0.4 0.4 0.4 0.4


Capex to Debt (%) 24.2 20.8 22.8 22.8 22.8




FY Dec 2016A 2017A 2018F 2019F 2020F

Pre-Tax Profit 1,455 1,918 2,172 2,447 2,697

Dep. & Amort. 480 521 564 616 667

Tax Paid (294) (319) (478) (538) (593)

Assoc. & JV Inc/(loss) (618) (633) (698) (774) (834)


Chg in Wkg.Cap. 656 229 156 356 332

Other Operating CF (13) (200) (252) (255) (268)

Net Operating CF 1,667 1,515 1,464 1,852 2,001

Capital Exp.(net) (1,900) (1,824) (2,000) (2,000) (2,000)

Other Invts.(net) (139) (65) 0 0 0

Invts in Assoc. & JV (156) (345) 0 0 0

Div from Assoc & JV 419 247 279 310 333

Other Investing CF 179 106 (99) (80) (75)

Net Investing CF (1,596) (1,880) (1,820) (1,770) (1,742)

Div Paid (63) (49) (488) (550) (607)

Chg in Gross Debt (608) 562 0 0 0


Other Financing CF (89) 7 331 319 329

Net Financing CF (759) 520 (156) (231) (278)


Chg in Cash (787) 254 (512) (150) (20)

Opg CFPS (HK$) 0.38 0.48 0.48 0.54 0.60

Free CFPS (HK$) (0.09) (0.12) (0.20) (0.05) 0.00


Page 51

Company Guide



Source: DBS HK


Patricia YEUNG

1 2

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Jul-17

Aug-1

7

Sep-1

7

Oct

-17

Nov-

17

Dec

-17

Jan-1

8

Feb-1

8

Mar-

18

Apr-

18

Apr-

18

May-

18

Jun-1

8

Jul-18


Price Target

Price

1: 21-May-18 HK$7.90 HK$9.00 Buy

2: 6-Jul-18 HK$7.51 HK$9.00 Buy

sa- CS /AH

BUY


Price Target 12-mth:HK$10.50 (5.0% upside) Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

Price Relative

Forecasts and Valuation FY Dec (RMBm) 2016A 2017A 2018F 2019F Turnover 2,693 3,109 4,648 6,315 EBITDA 796 843 1,313 1,828 Pre-tax Profit 445 576 928 1,293 Net Profit 313 404 650 906 Net Pft (Pre Ex) (core profit) 313 404 650 906 Net Profit Gth (Pre-ex) (%) 10.3 29.0 60.7 39.4 EPS (RMB) 0.33 0.40 0.66 0.92 EPS (HK$) 0.38 0.47 0.76 1.06 Core EPS (HK$) 0.38 0.47 0.76 1.06 Core EPS (RMB) 0.33 0.40 0.66 0.92 EPS Gth (%) (4.4) 23.0 62.6 39.4 Core EPS Gth (%) (4.4) 23.0 62.6 39.4 Diluted EPS (HK$) N/A N/A 0.76 1.06 DPS (HK$) 0.09 0.12 0.20 0.32 BV Per Share (HK$) 2.94 3.21 3.80 4.54 PE (X) 26.4 21.4 13.2 9.5 CorePE (X) 26.4 21.4 13.2 9.5 P/Cash Flow (X) 19.0 14.6 16.1 11.1 P/Free CF (X) 14635.

2 nm nm 115.0

EV/EBITDA (X) 13.9 14.1 9.9 7.3 Net Div Yield (%) 0.9 1.2 2.0 3.2 P/Book Value (X) 3.4 3.1 2.6 2.2 Net Debt/Equity (X) 0.9 0.9 1.1 1.0 ROAE(%) 13.1 15.5 21.5 25.4 Earnings Rev (%): Nil Nil Consensus EPS (RMB) 0.60 0.87 Other Broker Recs: B:11 S:0 H:0


Time to gas up

Promising growth story. China Tian Lun Gas (TL Gas) has

developed a strong M&A track record, and we believe it will

continue to prudently expand. It shifted its development focus

to rural coal-to-gas conversion by setting up Rmb10bn fund

with Henan provincial government. We expect the new

connection to increase from 226k in FY17, to 0.51m and 0.8m

in FY18 and FY19. This will drive its earnings growth to reach

CAGR of 50% over FY17-19. Also, the company has lower risk

to major industry overhangs on declining dollar margin and

tight gas supply. It has a strong presence in 3rd / 4th tier cities

in Central and Western parts of China, which are rich in gas

supply and have lower base in dollar margin.

Where we differ. We are optimistic on the outlook of rural coal-

to-gas conversion. Early penetration into the segment will boost

short-term earnings growth and enhance long- term gas volume

growth.

Potential catalyst. The successful penetration into rural coal-to-

gas conversion during 2018 will serve as a re-rating catalyst for

the company as it can significantly boost its earnings growth. Valuation: We have a BUY rating with a TP of HK$10.50, based on DCF valuation method. We have assumed a beta of 1.15 with WACC of 7.6% and terminal growth of 1%. Key Risks to Our View:

Sluggish new project acquisition. Our call depends on the

company’s ability to obtain new projects from the government

and acquire projects from other players. Slow acquisition

progress or value-destructive M&A will be negative for the

share price.

At A Glance

Issued Capital (m shrs) 990

Mkt Cap (HK$m/US$m) 9,896 / 1,261


Gold Shine Development Ltd. 47.6

IFC Asset Management Company 9.2

Koo (Yuen Kim) 6.6

Zhang (Yingcen) 6.4

Free Float (%) 30.2



35

55

75

95

115

135

155

175

195

215

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5


Relative IndexHK$

China Tian Lun Gas Holdings (LHS) Relative HSI (RHS)


27 Jul 2018


China Tian Lun Gas Holdings Version 1 | Bloomberg: 1600 HK Equity | Reuters: 1600.HK


Page 53

Company Guide

China Tian Lun Gas Holdings


Critical Factors

M&A to accelerate. TL Gas has been growing its gas project

portfolio through M&A in the past years and developed a solid

track record. The gas sales volume grew from 57m m3 in 2010

to 1,927m m3 in 2017. TL Gas made only one acquisition for

the project in Sichuan Jintang in May 2017. Despite the fact

that M&A activities slowed down during 2017, we see a pick-

up in momentum this year, which can help to drive up the

share price. It is currently in the process of negotiating with

governments and companies for potential deals in the pipeline.

In fact, it successfully secured a new project concession in Ye

County of Henan province in January 2018 and acquired new

projects in Shaanxi in February 2018.

Strategic expansion into rural coal-to-gas conversion. The

Chinese government is currently pushing for clean heating,

especially for rural regions to curb the use of scattered coal. TL

Gas will focus in obtaining rural coal-to-gas conversion projects

in Henan province. It has setup a Rmb10bn fund with Henan

provincial government for the development of rural coal-to-gas

conversion projects. The rural regions in Henan province are

largely untouched with >16m of rural households in the area.

We conservatively assume 300k and 600k of new connections

from rural coal-to-gas conversion in FY18 and FY19,

respectively.

Stable dollar margin. Since the dollar margin for the gas

distributors are expected to trend down, the outperformance

of TL Gas’s dollar margin will be positive to the company. The

outlook for TL Gas’s overall dollar margin is stable due to its

geographic mix and high discount to peers. We expect the

overall dollar margin to remain steady at around Rmb0.4/m3

from FY17 to FY19.

Increase in gas sales volume growth. The acceleration in gas

sales volume growth can help to boost the profitability of TL

Gas. Besides M&A, we estimate the organic volume growth for

city gas projects (excluding wholesale) to increase at a CAGR of

31% from FY17-FY19. The volume growth is expected to be

driven by the increase in residential penetration rate, shift of

industrial production base in lower level cities and

government’s push in coal-to-gas conversion.


New Residential connections (k) - consolidated


Average residential connection fee (Rmb/ household)


1235

1698

1927

2281

2710

0

391

782

1,173

1,564

1,955

2,346

2,737

2015A 2016A 2017A 2018F 2019F

202.3 206.4 226.2

509.3

811.4

0

166

331

497

662

828

2015A 2016A 2017A 2018F 2019F

0.50.4

0.4 0.4 0.4

0.00

0.09

0.19

0.28

0.37

0.47

2015A 2016A 2017A 2018F 2019F

2,546 2,551 2,550 2,499 2,474

0

515

1,031

1,546

2,061

2,577

2015A 2016A 2017A 2018F 2019F

Page 54

Company Guide


Share price vs HSI


0

50

100

150

200

250

300

350

400

450

500

Nov-

10

Mar-

11

Jul-11

Nov-

11

Mar-

12

Jul-12

Nov-

12

Mar-

13

Jul-13

Nov-

13

Mar-

14

Jul-14

Nov-

14

Mar-

15

Jul-15

Nov-

15

Mar-

16

Jul-16

Nov-

16

Mar-

17

Jul-17

Nov-

17

Mar-

18

Jul-18

China Tian Lun Gas Hdg. rel to HSI


Oil price collapse lowered price competitiveness for natural gas

Announcement of rural coal-to-gas conversion in Henan

Page 55

Company Guide


Balance Sheet:

Higher debt from M&A needs. The net gearing level reached

93% in FY17, which is higher than its peers. We factor in

capital expenditure of HK$1.2bn in our model for FY18, of

which 60% will be used for organic expansion and M&A, while

the rest will be used for rural coal-to-gas conversion projects


Rural coal-to-gas conversion. The successful negotiation with

Henan government to secure rural coal-to-gas conversion

projects will confirm our view that it has a strong earnings

growth outlook.

Qualify for southbound trading. The company may qualify for

Southbound trading in August 2018, which can trigger fund

inflow and speed up the re-rating process.

Key Risks:

Sluggish new project acquisition. Our call depends on the

company’s ability to obtain new projects from the government

and acquire projects from other players. Slow acquisition

progress or value-destructive M&A will be negative for the

share price.

Company Background

TL Gas was founded in 2002 by Mr. Zhang Yingcen. The

company is involved in the development and operation of city

gas projects, vehicle gas refilling stations, and long-haul

pipelines. By the end of FY16, the company holds 53 city gas

projects, 50 gas stations, two LNG plants and six long distance

pipelines.


Capital Expenditure

ROE

Forward PE Band

PB Band


0.3

0.4

0.4

0.5

0.5

0.6

0.6

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2015A 2016A 2017A 2018F 2019F


0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

1,600.0

2015A 2016A 2017A 2018F 2019F


RMBm

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2015A 2016A 2017A 2018F 2019F

Avg: 13.9x

+1sd: 19x

+2sd: 24.1x

-1sd: 8.8x

-2sd: 3.7x3.2

8.2

13.2

18.2

23.2


(x)

Avg: 2.2x

+1sd: 2.92x

+2sd: 3.64x

-1sd: 1.48x

-2sd: 0.75x0.6

1.1

1.6

2.1

2.6

3.1

3.6

4.1

4.6

5.1

Dec-14 Dec-15 Dec-16 Dec-17

(x)

Page 56

Company Guide


Key Assumptions

FY Dec 2015A 2016A 2017A 2018F 2019F


1,235.4 1,698.0 1,927.4 2,281.4 2,709.5

New Residential connections (k) - consolidated

202.3 206.4 226.2 509.3 811.4


0.46 0.42 0.39 0.39 0.39

Average residential connection fee (Rmb/ household)

2,546.0 2,551.0 2,550.0 2,499.0 2,474.0


Segmental Breakdown (RMB m)

FY Dec 2015A 2016A 2017A 2018F 2019F

Revenues (RMB m) Transportation and sales of gas (city gas sales)

1,651 2,063 2,428 3,037 3,768

Gas pipeline connections 571 589 620 1,532 2,448 Others 30 41 61 79 99

Total 2,252 2,693 3,109 4,648 6,315

GPM (RMB m) Transportation and sales of gas (city gas sales)

236 304 361 460 577

Gas pipeline connections 358 372 380 747 1,117 Others 15 17 27 35 43

Total 609 692 768 1,242 1,738

GPM Margins (%) Transportation and sales of gas (city gas sales)

14.3 14.7 14.9 15.2 15.3

Gas pipeline connections 62.7 63.1 61.3 48.8 45.6 Others 49.2 40.9 43.7 43.7 43.7

Total 27.0 25.7 24.7 26.7 27.5


Page 57

Company Guide


Income Statement (RMB m) FY Dec 2015A 2016A 2017A 2018F 2019F

Revenue 2,252 2,693 3,109 4,648 6,315


Gross Profit 609 692 768 1,242 1,738

Other Opng (Exp)/Inc (133) (141) (164) (225) (287)

Operating Profit 476 552 604 1,017 1,450


Associates & JV Inc 0 21 23 54 78



Exceptional Gain/(Loss) 0 0 0 0 0

Pre-tax Profit 429 445 576 928 1,293

Tax (111) (110) (147) (241) (336)

Minority Interest (34) (21) (25) (37) (51)


Net Profit 284 313 404 650 906

Net Profit before Except. 284 313 404 650 906

EBITDA 663 796 843 1,313 1,828

Growth

Revenue Gth (%) 67.6 19.6 15.4 49.5 35.9

EBITDA Gth (%) 49.6 20.1 5.9 55.8 39.3

Opg Profit Gth (%) 31.8 15.9 9.6 68.3 42.6

Net Profit Gth (%) 29.1 10.3 29.0 60.7 39.4

Margins & Ratio

Gross Margins (%) 27.0 25.7 24.7 26.7 27.5



ROAE (%) 16.3 13.1 15.5 21.5 25.4

ROA (%) 5.5 4.4 5.0 6.8 8.0

ROCE (%) 7.7 6.5 6.3 9.0 11.0

Div Payout Ratio (%) 0.0 22.4 24.9 27.0 30.0



Page 58

Company Guide


Balance Sheet (RMB m)

FY Dec 2015A 2016A 2017A 2018F 2019F

Net Fixed Assets 1,944 2,124 2,354 3,439 3,971

Invts in Associates & JVs 0 0 1 401 649

Other LT Assets 3,119 3,696 4,403 4,511 4,635

Cash & ST Invts 931 1,093 978 1,038 1,036

Inventory 61 42 47 66 90

Debtors 593 603 667 1,135 1,662

Other Current Assets 31 76 23 34 46

Total Assets 6,678 7,633 8,472 10,625 12,089

ST Debt

850 848 969 1,169 1,169

Creditors 506 530 528 770 1,034

Other Current Liab 202 254 402 600 816

LT Debt 1,887 2,740 2,898 3,898 4,198



Minority Interests 434 321 339 377 427

Total Cap. & Liab. 6,678 7,633 8,472 10,625 12,089

Non-Cash Wkg. Capital (24) (64) (193) (135) (52)

Net Cash/(Debt) (1,805) (2,496) (2,889) (4,029) (4,331)




Asset Turnover (x) 0.4 0.4 0.4 0.5 0.6

Current Ratio (x) 1.0 1.1 0.9 0.9 0.9

Quick Ratio (x) 1.0 1.0 0.9 0.9 0.9

Net Debt/Equity (X) 0.6 0.9 0.9 1.1 1.0


Capex to Debt (%) 51.7 12.1 19.3 23.7 13.0



Cash Flow Statement (RMB m)

FY Dec 2015A 2016A 2017A 2018F 2019F

Pre-Tax Profit 429 445 576 928 1,293

Dep. & Amort. 142 173 182 193 244

Tax Paid (108) (110) (147) (241) (336)

Assoc. & JV Inc/(loss) 0 (21) (23) (54) (78)


Chg in Wkg.Cap. (109) 9 (71) (246) (285)

Other Operating CF (119) (61) 78 (48) (63)

Net Operating CF 234 434 595 531 775

Capital Exp.(net) (1,414) (434) (745) (1,200) (700)

Other Invts.(net) 1 1 (207) 0 0

Invts in Assoc. & JV 0 (200) 0 (400) (248)

Div from Assoc & JV 5 0 0 54 78

Other Investing CF (96) (18) (55) (185) (201)

Net Investing CF (1,503) (651) (1,007) (1,732) (1,071)

Div Paid 0 (73) (101) (175) (272)

Chg in Gross Debt 770 715 279 1,200 300

Capital Issues 916 (103) 0 0 0

Other Financing CF (90) (213) 166 236 266

Net Financing CF 1,597 326 344 1,261 294

Currency Adjustments 18 36 (9) 0 0

Chg in Cash 346 146 (77) 60 (2)

Opg CFPS (RMB) 0.41 0.45 0.67 0.79 1.07

Free CFPS (RMB) (1.42) 0.00 (0.15) (0.68) 0.08


Page 59

Company Guide



Source: DBS HK


Patricia YEUNG

1 2 3

4

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

Jul-17

Aug-1

7

Sep-1

7

Oct

-17

Nov-

17

Dec

-17

Jan-1

8

Feb-1

8

Mar-

18

Apr-

18

Apr-

18

May-

18

Jun-1

8

Jul-18


Price Target

Price

1: 13-Feb-18 HK$5.35 HK$7.90 Buy

2: 27-Mar-18 HK$5.56 HK$7.60 Buy

3: 29-Mar-18 HK$5.49 HK$7.60 Buy

4: 28-Jun-18 HK$6.93 HK$10.50 Buy

Page 60

DBS HK's discussion of the issuer in this report will not be continuously followed. Accordingly, this report is being provided as a stand-alone analysis and recipients of this report should not expect additional reports relating to this issuer, unless so decided by DBS HK.

sa- CS / AH

NOT RATED

Last Traded Price (24 Jul 2018):HK$3.77 (HSI : 28,663)

Potential Catalyst: Earnings accretion from OCBC-WHB

Where we differ: Earnings are more bullish than consensus with

differential likely from low sustained credit costs Analyst Tony WU CFA+852 2971 1708, [email protected] Patricia YEUNG+852 28638908, [email protected]

Price Relative


Niche play in DPG

A leader in a niche market for distributive power system

SI revenue to grow >10% in FY18 while IBO business

targets to add 1.2GW in the next three years

Fair valuation at 25x FY18PE with strong earnings CAGR of

26% in FY17-20 Leader of its kind. As one of the world’s leading large gen-set SI

provider and one of Southeast Asia’s largest gas-fired engine-based

DG station owner and operator, Vpower secured a solid position in

the niche market of distributive power generation (DPG) industry. It

has a strong relationship with leading engine manufacturers such as

MTU and Komatsu, which enables it to purchase top notch engines in

a timely manner. It also signed cooperation agreement with MTU for

SI and IBO business. In addition, it has good relationship with SOEs

such as CRRC and CNTIC and signed agreements for project

development in countries covered by BRI.

Steady growth in SI and IBO to ramp up. Vpower has an order book

of HK$500m to 600m for the SI business. With more adoption of

distributed energy system globally, we estimate SI revenue to

maintain >10% growth in FY18 and beyond with stable gross

margin. Also, by leveraging on its vast experiences in SI business, we

believe the company has an edge to improve the efficiency and win

project tenders for IBO business. It has 581.4MW of IBO projects in

operation by the end of FY17. It seeks to deepen the penetration of

existing markets and tap into new regions such as China, U.K and

Brazil. It has a target to increase the capacity by 1.2GW during 2018-

2020. By 1Q18, the company signed contracts and MOU for 459MW

of projects, and have another 8 potential projects with 550MW under

advanced negotiation or tender submission stage.

Fair valuation. The share price of the company has fallen >30% since

its peak due to disappointment in FY17 earnings. With earnings

CAGR of 26% in FY17-20, the stock is currently trading at 25x

FY18PE, which looks fair, given its closest peer, Aggreko, is trading at

14x FY18PE with low single digit earnings growth. However, we

reckon Vpower could be re-rated if it could regain market confidence

in delivering a stronger earnings growth of >30% in FY19 and FY20.

At A Glance


Mkt Cap (HK$m/US$m) 9,658 / 1,231


Konwell Developments Ltd. 70.5

CITIC Ltd 8.0

Free Float (%) 21.5


ICB Industry: Industrials / Industrial Engineering

020406080100120140160180200

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Nov-16 Jul-17 Mar-18

Vpower Group Intl. (LHS)

Relative HSI (RHS)

HK$ Relative Index

F Y Dec (HK$m) 2014A 2015A 2016A 2017A

Turnover 930 1,213 1,531 1,746EBITDA 141 256 400 578Pre-tax Profit 141 164 253 357Net Profit 121 141 222 332Net Pft (Pre Ex.) 121 141 222 332EPS (HK$) n.a. n.a. 0.11 0.13EPS Gth (%) n.a. n.a. n.a. 20.4Diluted EPS (HK$) n.a. n.a. 0.11 0.13DPS (HK$) 0.03 0.02BV Per Share (HK$) n.a. n.a. 0.88 0.96PE (X) n.a. n.a. 34.9 29.0P/Cash F low (X) n.a. n.a. 92.6 16.0P/Free CF (X) n.a. n.a. n.m. n.m.EV/EBITDA (X) n.a. n.a. 17.8 17.0Net Div Yield (%) - - 0.7 0.5 P/Book Value (X) n.a. n.a. 4.3 3.9Net Debt/Equity (X) 1.8 1.0 Cash 0.1ROAE (%) 70.9 36.7 15.8 14.1


VPower

Bloomberg: 1608 HK | Reuters: 1608.HK Refer to important disclosures at the end of this report


VPower

Page 61

Income Statement (HK$ m) Balance Sheet (HK$ m)

Cash Flow Statement (HK$ m) Rates & Ratio

Interim Income Statement (HK$ m) Segmental Breakdown (HK$ m) / Key Assumptions


F Y Dec 2014A 2015A 2016A 2017A

Revenue 930 1,213 1,531 1,746Cost of Goods Sold (681) (869) (1,033) (1,169)Gross Prof it 248 344 498 577Other Opg (Exp)/Inc (134) (159) (213) (167)Operat ing Prof it 114 185 285 409Other Non Opg (Exp)/Inc 38 8 32Associates & JV IncNet Interest (Exp)/Inc (11) (29) (64) (52)Exceptional Gain/(Loss) - - - - Pre- tax Prof it 141 164 253 357Tax (20) (23) (31) (26)Minority Interest 1Preference Div idend - - - - Net Prof it 121 141 222 332Net Profit before Except. 121 141 222 332EBITDA 141 256 400 578Revenue Gth (%) 61.5 30.4 26.2 14.0EBITDA Gth (%) 278.4 81.5 56.3 44 Opg Profit Gth (%) 291.9 61.9 54.3 43.7Effective Tax Rate (%) 14.4 14.1 12.3 7.3

F Y Dec 2014A 2015A 2016A 2017A

Net F ixed Assets 606 911 1,931 2,189Invts in Assocs & JVsOther LT Assets 145 79 36 614Cash & ST Invts 216 418 1,683 1,199Inventory 298 563 546 712Debtors 266 715 708 781Other Current Assets 65 70 121 431Total A sset s 1,596 2,756 5,025 5,927

ST Debt 520 556 717 532CreditorsOther Current Liab 605 1,039 992 1,758LT Debt 117 410 322 857Other LT Liabilities 125 212 732 319Shareholder's Equity 230 539 2,262 2,461Minority Interests (1)Total Cap. & L iab. 1,596 2,756 5,025 5,927

Non-Cash Wkg. Cap 24 309 383 167 Net Cash/(Debt) (421) (548) 644 (190)

F Y Dec 2014A 2015A 2016A 2017A

Pre-Tax Profit 141 164 253 357 Dep. & Amort. 27 71 115 168 Tax Paid (17) (29) (21) (46) Assoc. & JV Inc/(loss) - - - -(Pft)/ Loss on disposal of FAs 0 - 0 0 Non-Cash Wkg. Cap. (106) (212) (284) 224 Other Operating CF 18 3 20 (103) Net Operat ing CF 63 (2) 84 601Capital Exp. (net) (294) (148) (337) (628) Other Invts. (net) (105) (12) (161) 126 Invts. in Assoc. & JV - - - - Div from Assoc. & JV - - - - Other Investing CF (104) (5) (55) (662) Net Inv est ing CF (504) (165) (553) (1,164)Div Paid (3) (126) (50) (103) Chg in Gross Debt 346 344 71 352 Capital Issues - 313 1,561 3 Other F inancing CF 174 (160) (8) (48) Net F inancing CF 517 371 1,574 204Chg in Cash 77 203 1,105 (359)

F Y Dec 2014A 2015A 2016A 2017A

Gross Margin (%) 26.7 28.4 32.5 33.0Opg Profit Margin (%) 12.3 15.2 18.6 23.4Net Profit Margin (%) 13.0 11.6 14.5 19.0ROAE (%) 70.9 36.7 15.8 14.1ROA (%) 10.6 6.5 5.7 6.1ROCE (%) 13.8 11.7 8.7 9.3Div Payout Ratio (%) 2.1 89.2 22.5 31.1Interest Cover (x) 10.3 6.5 4.4 7.9Asset Turnover (x) 0.8 0.6 0.4 0.3Debtors Turn (days) 87.6 147.6 169.6 155.6Creditors Turn (days) n.a. n.a. n.a. n.a.Inventory Turn (days) 139.3 180.9 195.9 196.4Current Ratio (x) 0.8 1.1 1.8 1.4Quick Ratio (x) 0.5 0.8 1.5 1.1Net Debt/Equity (X) 1.8 1.0 Cash 0.1Capex to Debt (%) 46.2 15.3 32.5 45.2N. Cash/(Debt)PS (HK$) n.a. n.a. 0.25 (0.07)Opg CFPS (HK$) n.a. n.a. 0.04 0.24Free CFPS (HK$) n.a. n.a. (0.15) (0.05)

F Y Dec 1H16 2H16 1H17 2H17

Revenue 694 837 936 810

Cost of Goods Sold (486) (547) (607) (562)

Gross Prof it 208 290 329 248

Other Oper. (Exp)/Inc (117) (96) (202) 35

Operat ing Prof it 91 194 127 283

Other Non Opg (Exp)/Inc - - 60 (60)

Associates & JV Inc

Net Interest (Exp)/Inc - - (29) (23)

Exceptional Gain/(Loss) - - - -

Pre- tax Prof it 68 185 158 199

Tax (14) (17) (8) (18)

Minority Interest - 1

Net Prof it 54 168 - 182

Net profit bef Except. 54 168 - 182

Growth

Revenue Gth (%) - - 34.8 (3.2)

Opg Profit Gth (%) - - 38.9 45.9

Net Profit Gth (%) - - - 8.4

Margins & Rat io

Gross Margins (%) 30.0 34.6 35.1 30.6

Opg Profit Margins (%) 13.2 23.1 13.6 34.9

Net Profit Margins (%) 7.8 20.0 - 22.4

F Y Dec 2014A 2015A 2016A 2017A

Rev enuesSystem Integration 785 966 1,063 1,183Investment, Building and Operating 144 247 468 563



Page 62

DBS HK recommendations are based an Absolute Total Return* Rating system, defined as follows:

S TRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

B UY (>15% total return over the next 12 months for small caps, >10% for large caps)

HO LD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

S ELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 27 Jul 2018 13:29:38 (HKT) Dissemination Date: 27 Jul 2018 14:36:57 (HKT) Sources for a ll charts and tables are DBS HK unless otherwise specified. GENERAL DISCLOSURE/DISCLAIMER Th is report is prepared by DBS Bank (Hong Kong) Limited (“DBS HK”). This report is solely intended for the clients of DBS Bank Ltd., DBS HK, DBS

Vickers (Hong Kong) Limited (“DBSV HK”), and DBS Vickers Securities (Singapore) Pte Ltd. (“DBSVS”), its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBS HK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., DBS HK, DBSV HK, DBSVS, its respective connected and associated corporations, affi liates and their respective directors, officers,

employees and agents (collectively, the “DBS Group”) have not conducted due diligence on any of the companies, verified any information or sources or taken into account any other factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we

do not make any representation or warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions

expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is

for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain

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be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ra tings or risk assessments.

The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may not contain a ll material information concerning the company (or companies) referred to in this report and the DBS Group is un der no obligation to

update the information in this report. This publication has not been reviewed or authorized by any regulatory authority in S ingapore, Hong Kong or e lsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer. The valuations, opinions, estimates, forecasts , ratings or risk assessments described in this report were based upon a number of estimates and

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UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) such valuations, opinions, estimates, forecasts , ratings or risk assessments or their underlying assumptions will be achieved, and

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Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies)

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has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making.



ASIAN INSIGHTS

Page 63

ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that th e views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) a lso certifies that no part of his /her

compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s) primarily responsible for the content of this research report, in part or in whole, certifies that he or his associate

1 does not serve as an officer of

the is suer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the management of the is suer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or

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procedures in place to e liminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment

banking function of the DBS Group and procedures are in place to ensure that confidential information held by e ither the research or investment banking function is handled appropriately. There is no direct l ink of DBS Group's compensation to any specific investment ba nking function of the

DBS Group.

CO MPANY-SPECIFIC / REGULATORY DISCLOSURES

1. DBS Bank Ltd, DBS HK, DBSVS or their subsidiaries and/or other affi l iates have proprietary positions in Enn Energy Holdings Limited

(2688 HK), China Gas Holdings Limited (384 HK), Beijing Enterprises Holdings Li mited (392 HK) and Kunlun Energy Company Limited (135 HK) recommended in this report as of 25 Jul 2018.

2. Neither DBS Bank Ltd nor DBS HK market makes in equity securities of the issuer(s) or company(ies) mentioned in this Research Report.

3. Co mpensation for investment banking services:

DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affil iates of DBSVUSA have received compensation, within the pas t 12

months for investment banking services from Beijing Enterprises Holdings Limited (392 HK) as of 30 Jun 2018.

DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities

as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security

discussed in this document should contact DBSVUSA exclusively.

4. D isclosure of previous investment recommendation produced: DBS Bank Ltd, DBSVS, DBS HK, their subsidiaries and/or other affil iates of DBSVUSA may have published other investment

recommendations in respect of the same securities / instruments recommended in this research report during th e preceding 12 months . Please contact the primary analyst l isted in the first page of this report to view previous investment recommendation s

published by DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affi liates of DBSVUSA in the preceding 12 months.

1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (i i) the trustee of a trust of

which the analyst, his spouse, minor child (natural or adopted) or minor s tep-child, is a beneficiary or discretionary object; or (i ii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst.

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lis ting applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new lis ting applicant.



Page 64

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