HK/China Equity Long-Short

Osbert Tang, CFA

Equity Bottom-Up

<ul>
<li>3Q22 result of Kunlun Gas is weaker than expected, but this is due to lower other income and surge in non-operating expenses. Without them, profit growth is actually more encouraging.</li>
<li>While there is gross margin squeeze on higher input costs, Kunlun managed to reduce operating costs by 14.1%, successfully mitigated the negative impact.</li>
<li>Kunlun Gas contributed 62.5% of 1H22 net profit of <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a>. Its solid 36.2% 9M22 earnings growth still points to healthy underlying momentum for its parent.</li>
</ul>


3Q22 result of Kunlun Gas is weaker than expected, but this is due to lower other income and surge in non-operating expenses. Without them, profit growth is actually more encouraging.
While there is gross margin squeeze on higher input costs, Kunlun managed to reduce operating costs by 14.1%, successfully mitigated the negative impact.
Kunlun Gas contributed 62.5% of 1H22 net profit of Kunlun Energy (135 HK). Its solid 36.2% 9M22 earnings growth still points to healthy underlying momentum for its parent.


Kunlun Energy (135 HK): Kunlun Gas 3Q22 Masked by Non-Operating Factors

<ul>
<li>With an 18.6% growth in 1H22 profit from continuing operations, <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> has not disappointed us. Natural gas sales segment is a bright spot with solid growth.</li>
<li>Net cash swelled to Rmb10.2bn at end-Jun, about 2x more than the level at end-FY21. We estimate this roughly equals to 19% of the current share price. </li>
<li>New project momentum looks healthy and the market seems to have underestimated FY22 earnings. Its 8x and 7.5x PERs for FY22 and FY23 are clearly attractive. </li>
</ul>


With an 18.6% growth in 1H22 profit from continuing operations, Kunlun Energy (135 HK) has not disappointed us. Natural gas sales segment is a bright spot with solid growth.
Net cash swelled to Rmb10.2bn at end-Jun, about 2x more than the level at end-FY21. We estimate this roughly equals to 19% of the current share price. 
New project momentum looks healthy and the market seems to have underestimated FY22 earnings. Its 8x and 7.5x PERs for FY22 and FY23 are clearly attractive. 


Kunlun Energy (135 HK): An Excellent Show

<ul>
<li>Core net profit rose a healthy 10.9% at <a href="https://www.smartkarma.com/entities/enn-energy-holdings-ltd" target="_blank" data-smartkarma-citation="entities:316:1" rel="noopener">ENN Energy (2688 HK)</a> in 1H22 despite challenges from pandemic lockdowns and surge in input costs.</li>
<li>We expect to see sequential improvement in both dollar margin for gas sales and overall gross margin in 2H22. Excellent integrated energy pipeline should add to earnings momentum.</li>
<li>Gearing improved 2.2pp in 1H22 and there is more room to deleverage in 2H22. While the stock's valuation is not particularly cheap, it has probably already hit the trough. </li>
</ul>


Core net profit rose a healthy 10.9% at ENN Energy (2688 HK) in 1H22 despite challenges from pandemic lockdowns and surge in input costs.
We expect to see sequential improvement in both dollar margin for gas sales and overall gross margin in 2H22. Excellent integrated energy pipeline should add to earnings momentum.
Gearing improved 2.2pp in 1H22 and there is more room to deleverage in 2H22. While the stock's valuation is not particularly cheap, it has probably already hit the trough. 


ENN Energy (2688 HK): Seeing Sign of an Upturn

<ul>
<li>We continued to be cautious on <a href="https://www.smartkarma.com/entities/china-gas-holdings-ltd" target="_blank" data-smartkarma-citation="entities:14315:1" rel="noopener">China Gas Holdings (384 HK)</a> given the challenges faced. It guided for a flat dollar margin in FY23 but we think this is optimistic.</li>
<li>Connection fees are likely to stay under pressure after a 42.1% decline in FY22. It only projects 2.6-2.9m new residential connections for FY23, compared with 2.9m in FY22.</li>
<li>Although China Gas is now the cheapest Hong Kong-listed China gas utilities company, it takes time to regain market confidence. At similar valuation, <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> looks more interesting. </li>
</ul>


We continued to be cautious on China Gas Holdings (384 HK) given the challenges faced. It guided for a flat dollar margin in FY23 but we think this is optimistic.
Connection fees are likely to stay under pressure after a 42.1% decline in FY22. It only projects 2.6-2.9m new residential connections for FY23, compared with 2.9m in FY22.
Although China Gas is now the cheapest Hong Kong-listed China gas utilities company, it takes time to regain market confidence. At similar valuation, Kunlun Energy (135 HK) looks more interesting. 


China Gas Holdings (384 HK): Not Giving It the Benefit of Doubt

<ul>
<li>Healthy 17.2% growth in 1Q22 net profit of Kunlun Gas, the most important subsidiary of <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a>, provides a welcoming evidence to ease market concerns on costs.  </li>
<li>While gross margin was down 0.2pp YoY, it expanded by 0.4pp QoQ. Key cost items including selling, administrative and R&amp;D are all under control, boosting EBIT margin by 0.5pp YoY.</li>
<li>1Q22 is a record quarter for Kunlun Gas, and gearing stays comfortable with strong operating cash flow. We believe such set of result signals good 1Q22 for Kunlun Energy. </li>
</ul>


Healthy 17.2% growth in 1Q22 net profit of Kunlun Gas, the most important subsidiary of Kunlun Energy (135 HK), provides a welcoming evidence to ease market concerns on costs.  
While gross margin was down 0.2pp YoY, it expanded by 0.4pp QoQ. Key cost items including selling, administrative and R&amp;D are all under control, boosting EBIT margin by 0.5pp YoY.
1Q22 is a record quarter for Kunlun Gas, and gearing stays comfortable with strong operating cash flow. We believe such set of result signals good 1Q22 for Kunlun Energy. 


Kunlun Energy (135 HK): A Record Quarter for Kunlun Gas

Hong Kong

KunLun Energy is an integrated oil and gas service company engaged in the exploration, development, and production of crude oil and natural gas. It operates natural gas pipelines, processes and stores liquefied natural gas (LNG), and sells LNG and liquefied petroleum gas (LPG) across China. The company is headquartered in Hong Kong and was founded in 1994.

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KunLun Energy (135 HK)