HK/China Equity Long-Short

Osbert Tang, CFA

Equity Bottom-Up

We expect <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> to experience a re-rating on the back of its efforts of strengthening its presence in the downstream gas distribution market. Kunlun Gas, its gas sales subsidiary, achieved a 30.6% YoY growth in 3Q20 profit, suggesting a powerful recovery from the negative impact of Covid-19 in 1H20. Gross margin in 3Q20 is also the highest in the last six quarters.The recent acquisition of 10 city gas projects in Xinjiang has added to its portfolio and will boost Kunlun Gas' profit by 4-5%. Kunlun Energy's share price was still down 8.8% YTD, despite a 107% rebound from trough, and the stock now trades on 0.89x P/B (1SD below average), which is undemanding both relative to industry peers and historical range.

We expect Kunlun Energy (135 HK) to experience a re-rating on the back of its efforts of strengthening its presence in the downstream gas distribution market. Kunlun Gas, its gas sales subsidiary, achieved a 30.6% YoY growth in 3Q20 profit, suggesting a powerful recovery from the negative impact of Covid-19 in 1H20. Gross margin in 3Q20 is also the highest in the last six quarters.The recent acquisition of 10 city gas projects in Xinjiang has added to its portfolio and will boost Kunlun Gas' profit by 4-5%. Kunlun Energy's share price was still down 8.8% YTD, despite a 107% rebound from trough, and the stock now trades on 0.89x P/B (1SD below average), which is undemanding both relative to industry peers and historical range. 

Kunlun Energy (135 HK): Kunlun Gas to Lead Re-Rating

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With industrial and commercial gas sales yet to fully recover from the negative impact of Covid-19 and lower contribution from connection fees, <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> registered a core profit growth of just 5.5% YoY for 1H FY20/21. Without the impact of Rmb appreciation, this would have grown by 7.8%. An interim DPS of HK$0.10 is declared, same as a year ago. 
Despite a slowing 1H, China Gas introduced its guidance for a 15-20% YoY growth in full-year core profit, suggesting a significant pick-up in 2H. Management expects this to be generated from accelerated gas volume recovery, YoY expansion in dollar margin, good progress on Smart MicroGrid and improving cash flow. The stock now trades on undemanding 3.1x P/B and 12.2x PER for 12-month forward. With our top pick <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> rallied by 40.6% since end-Mar, compared with 5.1% for China Gas and 23.9% for the overall sector, we see room for China Gas to catch up during this winter gas peak season. 
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With industrial and commercial gas sales yet to fully recover from the negative impact of Covid-19 and lower contribution from connection fees, China Gas Holdings (384 HK) registered a core profit growth of just 5.5% YoY for 1H FY20/21. Without the impact of Rmb appreciation, this would have grown by 7.8%. An interim DPS of HK$0.10 is declared, same as a year ago. 
Despite a slowing 1H, China Gas introduced its guidance for a 15-20% YoY growth in full-year core profit, suggesting a significant pick-up in 2H. Management expects this to be generated from accelerated gas volume recovery, YoY expansion in dollar margin, good progress on Smart MicroGrid and improving cash flow. The stock now trades on undemanding 3.1x P/B and 12.2x PER for 12-month forward. With our top pick ENN Energy (2688 HK) rallied by 40.6% since end-Mar, compared with 5.1% for China Gas and 23.9% for the overall sector, we see room for China Gas to catch up during this winter gas peak season. 


China Gas Holdings (384 HK): Slower 1H Growth but Positive Guidance from Post-Result Call

We believe the 18.5% drop in core profit in 1H20 for <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> is largely a result of the loss at the E&amp;P segment.  The swing from profit to loss at E&amp;P amounted to Rmb830m, well accounted for the Rmb780m reduction in 1H20 reported profit. While the other segments are mostly weaker YoY, the magnitude is generally manageable (except LNG processing and terminal). At the same time, the contraction in dollar margin is disappointing.In our view, the weak result is within expectation. We expect sequential improvement in 2H20, as higher oil price reduces E&amp;P loss, gas sales growth stays solid, dollar margin improves slightly and LNG gasification volume rebounds. Meanwhile, we think the near-term catalyst will be the progress of its sale of pipeline to PipeChina, and the potential special dividend as resulted. At 0.95x 12-month forward P/B multiple, which is 1 SD below the average since 2016, we view Kunlun's valuation as inexpensive. We put Kunlun at HK$9.00 per share based on sum-of-the-parts valuation.

We believe the 18.5% drop in core profit in 1H20 for Kunlun Energy (135 HK) is largely a result of the loss at the E&amp;P segment.  The swing from profit to loss at E&amp;P amounted to Rmb830m, well accounted for the Rmb780m reduction in 1H20 reported profit. While the other segments are mostly weaker YoY, the magnitude is generally manageable (except LNG processing and terminal). At the same time, the contraction in dollar margin is disappointing.In our view, the weak result is within expectation. We expect sequential improvement in 2H20, as higher oil price reduces E&amp;P loss, gas sales growth stays solid, dollar margin improves slightly and LNG gasification volume rebounds. Meanwhile, we think the near-term catalyst will be the progress of its sale of pipeline to PipeChina, and the potential special dividend as resulted. At 0.95x 12-month forward P/B multiple, which is 1 SD below the average since 2016, we view Kunlun's valuation as inexpensive. We put Kunlun at HK$9.00 per share based on sum-of-the-parts valuation.

Kunlun Energy (135 HK): Weak 1H20 Expected, Near Term Focus on Pipeline Disposal

<a href="https://www.smartkarma.com/entities/china-resources-gas-group-ltd" target="_blank" data-smartkarma-citation="entities:20525:1" rel="noopener">China Resources Gas (1193 HK)</a> reported a set of weak 1H20 result with profit dropped by 18.2% YoY and overall gas sales volume down 5.3%. While gas sales segment profit edged up 6.5% YoY, other segments including gas connection, gas appliances and gas station all recorded sharp plunge in profit. Gas connection is the worst segment with a 42% YoY decline in profit.Along with other China gas utilities, we believe 2H20 outlook will improve for CR Gas. However, its heavy exposure to industrial customers, significant proportion of connection revenue and small contribution from distributed energy are challenges. Also, its 15x 12-month forward PER does not look particularly cheap. We maintain our preference on <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 the China gas utilities sector and expect near-term pressure on CR Gas given its weak result.

China Resources Gas (1193 HK) reported a set of weak 1H20 result with profit dropped by 18.2% YoY and overall gas sales volume down 5.3%. While gas sales segment profit edged up 6.5% YoY, other segments including gas connection, gas appliances and gas station all recorded sharp plunge in profit. Gas connection is the worst segment with a 42% YoY decline in profit.Along with other China gas utilities, we believe 2H20 outlook will improve for CR Gas. However, its heavy exposure to industrial customers, significant proportion of connection revenue and small contribution from distributed energy are challenges. Also, its 15x 12-month forward PER does not look particularly cheap. We maintain our preference on ENN Energy (2688 HK) in the China gas utilities sector and expect near-term pressure on CR Gas given its weak result.

CR Gas (1193 HK): Sharp Contraction in 1H20 Profit Is Disappointing

We take <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>'s 13.8% YoY growth in core earnings in 1H20 positively, especially amid the tough operating environment facing the industry. While gas sales profit has slowed, this was partly offset by higher contribution from integrated energy. We are also delighted to see a 5.2% expansion in gas sales dollar margin and a 1.9pp expansion in overall gross margin. Management revealed good gas sales recovery momentum in the last three months and guided for full-year core earnings growth of 15% but we believe this is likely conservative. In 2H20, further contribution from integrated energy, lower input costs, recovery in gas consumption and execution of new projects are the major drivers for ENN. Also, we are comfortable with its financial position, with 40% gearing in 1H20. ENN stays as our top pick in the China gas utilities sector, despite its sharp outperformance against peers YTD.

We take ENN Energy (2688 HK)'s 13.8% YoY growth in core earnings in 1H20 positively, especially amid the tough operating environment facing the industry. While gas sales profit has slowed, this was partly offset by higher contribution from integrated energy. We are also delighted to see a 5.2% expansion in gas sales dollar margin and a 1.9pp expansion in overall gross margin. Management revealed good gas sales recovery momentum in the last three months and guided for full-year core earnings growth of 15% but we believe this is likely conservative. In 2H20, further contribution from integrated energy, lower input costs, recovery in gas consumption and execution of new projects are the major drivers for ENN. Also, we are comfortable with its financial position, with 40% gearing in 1H20. ENN stays as our top pick in the China gas utilities sector, despite its sharp outperformance against peers YTD.  

ENN Energy (2688 HK): Key Takeaways from Post-1H20 Result Call - Still Best Placed in the Sector

Hong Kong

Kunlun Energy Company Ltd, through its subsidiaries, explores and produces crude oil and natural gas in China.

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Kunlun Energy (135 HK)