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Morningstar | China Gas Holdings Reports Largely In-Line 1H Results; Positive Guidance Intact. See Updated Analyst Note from 28 Nov 2018

Stripping out HKD 198 million in gains from one-off items, narrow-moat China Gas Holdings' first-half fiscal 2019 (ending March) net profit of HKD 4.2 billion, up 24% year over year, was largely in line with our expectation. We have fine-tuned our valuation model to incorporate management’s guidance on margins and raised our fair value estimate to HKD 29 per share from HKD 25.50. We think near-term upside for CGH’s share price will be capped due to the lack of catalysts as the company’s strong growth outlook is already factored in by the market.

We continue to see robust natural gas sales (excluding the wholesale operation), which rose 28% year over year, underpinned by demand growth from all segments, minus the gas refilling stations that remained lackluster due to competition from electric vehicles. The industrial segment reported strong sales growth of 38%, followed by commercial segment’s 24%, mainly attributable to stringent environmental policies that encourage the replacement of coal with gas. Meanwhile, new residential connections of 2.5 million is on track to achieve the firm’s full-year target. Management remains confident on CGH’s growth outlook and kept its three-year guidance for key operating metrics unchanged.

Dollar margin for CGH was 4% lower year over year at CNY 0.625 per cubic meter. Nonetheless, management believes that dollar margin for fiscal 2019 can be maintained at CNY 0.61-0.62 due to smoother cost pass-through for the coming winter season compared with last winter, which saw a margin squeeze due to delays. We also note that CGH has separated the earnings for engineering design and construction from its gas connection segment. As a result, operating margin for gas connection declined to 36% from close to 50% in the past. We think the new reporting standard will provide more clarity on gas connection margin for regulators and this should reduce the risk of a connection fee cut.

On the liquefied petroleum gas front, core operating profit (excluding foreign exchange loss) was down 6% year over year, as the operating margin was affected by rising selling, general, and administrative expense on the back of higher startup expenses for expansion of business in new provinces. That said, we expect margins to recover when the economies of scale kick in. We also anticipate higher sales volume on lower LPG prices, in line with the recent fall in oil prices.

On the other hand, operating profit for the value-added services segment (such as sales of insurance and appliances) grew 18% year over year. Although the contribution is still relatively small (less than 10% of the group’s total earnings), we think this segment will be a new earnings growth driver as it offers abundant cross-selling opportunities from the group’s 32 million-customer base. In the longer term, CGH’s investment in new businesses such as distributed energy and electric charging posts will also provide more growth opportunities, in our view.