EUR 850.00 For Business Accounts Only

Morningstar | China Resources Gas’ 1H Earnings Underpinned by Robust Sales and Cost Savings; Raising FVE. See Updated Analyst Note from 20 Aug 2018

Narrow-moat China Resources Gas, or CRG's, first-half 2018 net profit of HKD 2.65 billion, up 25% year over year, was above our expectation mainly attributable to stronger-than-expected sales volume and effective cost management, with percentage of administrative, selling and distribution expenses to revenue declining to 14.0% from 16.5%, a year ago. After updating our valuation model and increasing our 2018-20 earnings estimates by 8%-10%, we raise our fair value estimate to HKD 36.50 from HKD 32.50. While there is upside to our fair value estimate, we prefer to buy CRG with a higher margin of safety given our high uncertainty rating as the industry is still in the fast growth phase in China and margins may swing.

CRG's natural gas sales volume beat our expectation, rising 22.9% year over year and above the industry growth rate of 17.5%. While gross dollar margin fell to CNY 0.62 per cubic meter from CNY 0.64 a year ago, this was an improvement from CNY 0.58 for full-year 2017 as margin recovered after the impact of last winter's gas shortages subsided. Although management expects gas shortages again in the coming winter, they guided that profit margins will be better for full-year 2018 as the firm has taken steps such as expanding gas storage and entering into advance purchase contracts to mitigate the impact.

Gross margin for CRG has dropped to 28.3% from 32.2% a year ago as revenue from sales of gas grew faster than the higher margin gas connection business. CRG's new residential connections of 1.1 million in the first half was down 13.6% year over year. The slowdown is mainly due to timing issues and management is confident CRG's new connections growth will pick-up, revising its growth target to 5%-10% in 2018 from flat, previously. In addition, gas sales volume growth target was also increased to more than 20% for 2018, from 15%-20%.

We think these targets are achievable as CRG's penetration rate at 49% is one of the lowest among its peers, while the firm's gas sales volume growth in July remained solid at 21% year over year.