EUR 850.00 For Business Accounts Only

Morningstar | Adding Narrow-Moat ENN Energy to Our Best Ideas List; Shares in 4-Star Territory

We are adding ENN Energy to the Best Ideas list as we believe the shares are currently undervalued following what we think are unfounded concerns about the removal of connection fees for new residential town gas users. We reiterate our fair value estimate of HKD 83 per share along with our narrow moat and stable trend ratings.

ENN owns exclusive rights on its city gas operations in China with contracts that extend for decades, and the recent share price pullback on concerns of cancellation of connection fees nationwide presents a buying opportunity. The long-term contracts allow the firm to collect one-off connection fees as well as ongoing gas usage fees. We think the likelihood of any cancellation is low, given that penetration of city gas in China is still low at around 40%, and such a move would discourage investment in the sector.

As Chinese gas consumption increases, ENN's volumes and fees follow, providing it with rapid growth. We project China’s goal to ease pollution issues by increasing gas usage to 9% of the country’s energy sources by 2020 from about 7% currently will sustain long-term demand growth for gas. As such, we estimate ENN’s natural gas sales volume to grow at more than a 15% CAGR during 2017-21. We are confident that ENN will generate returns above its cost of capital over the next decade, supporting our narrow moat rating. In addition, ENN is a direct beneficiary of LNG imports and we expect it to stand out from its peers, given its ability to source LNG at competitive prices through the LNG receiving terminal in Zhoushan, Zhejiang province, which is owned by its parent company. ENN has entered into supply contracts with three international LNG suppliers for a period of 5-10 years with take-or-pay terms, which will supply approximately 1.44 million tons in total annually. Although this is only about 10% of ENN's gas sales in 2017, we think this will help the firm sustain margins comparable to its peers' during gas shortages.