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Morningstar | Higher Gas Demand in China Underpin Hong Kong and China Gas' Solid 1H Result

Higher gas demand in China underpinned Hong Kong and China Gas, or HKCG’s, solid first-half result. The result does not alter our view on the company and the mature Hong Kong operation will continue to generate strong cash flow to be redeployed for growth in China and its new energy business. The new energy business maintained its positive momentum with improving profitability and we expect this to continue in the medium term.

Our fair value is unchanged and we believe the upside for its China operation is factored into current share price. The strong volume growth for its China business is supported over the medium term by the country’s policy to replace coal with natural gas. As expected, the mature Hong Kong operation saw a 1.6% increase in gas consumption against the same period last year while connection was slightly higher at 0.9% against last year. We expect similar growth rates going forward given the limited residential developments and minimal industrial demand. While growth is slow in Hong Kong, severe cold weather earlier this year resulted in higher gas demand in China. Gas sold increased 18% against the first half of last year. However, margin was lower as shortage of gas resulted in higher wholesale, or city-gate prices.

Management’s conversation with oil majors noted that the undersupply of gas will persist in the near term but margins in the second half this fiscal year will not be lower than that of last year, assuming relatively warmer weather does not result in elevated wholesale price. Long term strategy to improve infrastructure in the construction of receiving terminals, the completion of the pipeline from Eastern Siberia, and the development of Shanxi coal bed methane will alleviate the undersupply of gas in China. Security of supply remains a high priority for the country and the national grid for gas pipelines will also allow gas to be transported across different regions. The addition of gas storage facilities should also help as gas stored are released into the market during winter.

From a margin perspective, management noted the strong volume will deliver strong revenue growth and in turn, high margins and profitability to gas operators to encourage infrastructure investments. However, margins are expected to decline over the long term as the gas market heads toward a mature state, in line with infrastructure assets globally. Management do not expect the 7% cap on return on asset for utilities in China will impact profit with assets currently generating return below the new threshold. The 7% cap is unlikely to be applied across the board and adjusts are needed depending on the infrastructure needs within each province.

Connection fee per new customer in China was steady at around the HKD 1,200 to HKD 1,300 level and we continue to assume flat connection fees going forward. There were earlier concerns connection fees were going to be cut in some provinces for residential customers but the regulator recognises investments are needed to encourage a take-up of gas at the household level. As noted earlier, the connection fee cost is factored into the dwelling prices by the developers.