EUR 850.00 For Business Accounts Only

Morningstar | BEH’s Full-Year 2018 Result In-Line; Shares Undervalued on Healthy Long-Term Outlook

We maintain our fair value estimate of HKD 58 per share for narrow-moat Beijing Enterprises Holdings, or BEH, following the company’s full-year 2018 results that were in line with our expectations. Net profit rose 10% year over year, with decent growth across segments. Gas demand was robust, with gas transmission volume on Shaanxi-Beijing pipelines, SJ pipelines, rising 28% and distribution volume in Beijing up 15% from a year ago. This, along with a 22% jump in profit contribution from 25%-owned associate China Gas, helped offset the negative impact from the tariff cut on SJ pipelines, leading to flat earnings from gas operations. In addition, profit from Yanjing Brewery also improved 170% to HKD 222 million, a nice turnaround after three consecutive years of decline. This is a positive sign that BEH’s brewery business is benefiting from expanded premium offerings. We continue to expect decent growth at BEH’s gas and brewery segments, but we think earnings from its Russia oil and gas associate VCNG will fall in 2019, due to a lower crude-oil price assumption. We estimate BEH’s net profit to rise 5% to HKD 8 billion in 2019, and we anticipate little change to our five-year net profit CAGR of 7% between 2019 and 2023.

We think the shares, trading at only 0.6 times price/book, are undervalued, well below our valuation of 1.0 times price/book and its 10-year average of 1.4 times. We think the market does not currently appreciate its decent growth outlook and robust cash flows. We expect BEH’s net profit to grow at a 7% CAGR over the next five years, underpinned by China’s switch to use more natural gas over coal. Although BEH’s earnings growth rate is lower than our the forecast 10%-15% for major gas distributors we cover, we think BEH’s low valuation, compared with the 3-4 times price/book for China’s pure-play gas utilities, represents an attractive risk-reward for the company.

Driven by coal-to-gas conversion projects in Beijing’s outer suburbs, BEH’s gas consumption volume rose 15% year over year to 16.8 billion cubic meters in 2018. This is quite impressive compared with the lackluster 2.5% growth in 2017. While this slightly missed management’s guidance of 17% full-year growth, we think this is still decent, given the high base that Beijing’s natural gas consumption constitutes at about 30% of its total energy consumption, making it the world’s second largest natural gas user. We expect Beijing’s gas distribution volume to continue to rise 8% in 2019. While future growth will slow amid the completion of coal-to-gas projects in Beijing, we think the company’s expansion in broader Beijing-Tianjing-Hebei areas, and stricter air-quality controls in these cities, should still drive 6%-8% annual volume growth over the next five years.

SJ pipeline IV came on grid in November 2017, further lifting the total gas transmission volume by 28% year over year to 49 billion cubic meters, an uptick in growth versus 14.8% in 2017. We expect the volume to continue to rise 15% year over year in 2019. The transmission tariff fell to CNY 0.201 per cubic meter from CNY 0.281 per cubic meter, following the tariff cut on SJ pipelines. In addition, management also indicates that PetroChina would like to raise city gas prices even during nonpeak season to compensate for higher-cost LNG. This suggests the weak bargaining power against PetroChina, and this further squeeze SJ pipelines’ margins. Nevertheless, management advises that the tariffs on SJ pipelines will be reviewed every three years, and the company will be actively negotiating with the NDRC for a higher rate in the next reset cycle, as the unfavorable gas mix, with a higher portion of short-distance transmission, has resulted in returns below the NDRC’s guidance.