City gas in China is entering phase 3.0, with 8-10% gas national gas consumption growth in 2020-25E, increasing competition from direct supply, and accelerating LNG import, in our view. We think natural gas’ role will be crucial to China’s carbon-neutral target, and abundant global LNG supply will likely to boost gas consumption in China. We expect city gas distributors to maintain rapid earnings growth, led by CGH and ENN. We initiate the gas distributing sector at OUTPERFORM rating, and initiate coverage on ENN and CRG at BUY and HOLD rating respectively. Our pecking order in the sector is CGH>ENN>TLG>CRG.
- City gas 3.0 era. City gas business is entering phase 3.0, with decent gas sales volume growth, slower residential connection pace, higher competition pressures from direct supply, and differentiating future growth path for more sophisticated natural gas applications. We expect gas distributors will seek new growth opportunities such as integrated energy services to facility gas users’ energy transformation, expanding service coverage from city to township and village, and exploring value-added services potential through residential customers’ consumer market value development.
- Natural gas will be critical to carbon-neutral. We think natural gas is critical for China to realize its carbon-neutral target by 2060, with 33%-50% carbon emission saving from replacing coal boilers and coal-based power generation. Other than that, we think natural gas also makes strong contribution to air quality improvement and serving as flexible peak shaving gas power generating units to support renewable energy development.
- Enriching LNG import to support gas consumption growth. LNG import had become an important supply to China since 2017. We see continuous LNG receiving capability growth and enriching global LNG supply to boost gas consumption in China. Based on conservative assumption, we estimate LNG processing capacity in China to increase with a CARG of 20.1% from 70.4mtpa in 2020E to 176.0mtpa in 2025E. In the long run, if all 47 LNG terminals are fully ramped up, we expect it will bring more than 350bcm natural gas supply to China.
- 14th FYP: we expect gas consumption CAGR at 8-10%. Our base case assumption is a consumption CAGR at 9%, bringing 177bcm additional gas consumption, with import dependency increases slightly to 45.1%, and makes natural gas 12.2% in primary energy mix by 2025E. We think energy safety concern is a major obstacle. As oil majors in China are increasing natural gas production growth with accelerating CAPEX plan from 2019 – 25E, we are not too concerned about energy safety. We also expect abundant global LNG supply to sustain competitive import pricing and healthy consumption growth in China.
- 2019-22E earnings CAGR at 10.1%-19.0%, led by CGH. We project CGH, ENN, TLG and CRG to have 19.0%/16.2%/15.2%/10.1% earnings CARG in 2019-22E, respectively. Considering earnings growth, ROE, earnings quality, ESG, company scale and management incentives, we think ENN is best in overall quality, followed by CGH, CRG and TLG.
- CGH is our sector top pick. We initiate China Gas Distribution at OUTPERFORM rating, based on optimistic natural gas consumption outlook and decent earnings growth projection. HK listed cross regional gas distributors in China are trading at forward PER range 5.7x-14.6x with average PER of 10.0x. Market exhibited a preference for company scale with significant valuation premium. Based on comprehensive consideration for earnings growth, quality, valuation upside, and market liquidity requirement, our top pick for the sector is CGH. Our pecking order for the sector is CGH > ENN > TLG > CRG.
- Initiate BUY on ENN. Supported by outstanding industrial client base, rapid growing integrated-energy business, and accelerating LNG trading volume, we expect ENN’s core profit CARG to reach 19.7% in 2019-22E, leading among gas distributing peers. We initiate ENN with BUY rating, and our TP for ENN is HK$120, reflecting 19.0x/15.9x PER in FY20/21E.
- Initiate HOLD on CRG. We project CRG’s operations to suffer drag from COVID-19 impacts in 2020E, especially from commercial gas sales and residential connections. We estimate CRG to have slower 3-yr earnings CAGR comparing with peers. We derive CRG’s TP based on DCF valuation at HK$42.00. Our TP reflects 20.0x/16.4x PER in FY20/21E.
