Elevator Pitch

I maintain my Neutral rating on China Gas Holdings (OTCPK:CGHOF, OTCPK:CGHLY, 384:HK), a Hong Kong-listed Chinese gas distribution company.

This is an update of my initiation article on China Gas published on July 8, 2019. The share price has declined by -21%, from HK$31.55 as of July 5, 2019 to HK$25.05 as of July 10, 2020, since my initiation. China Gas trades at 12.2 times consensus forward next twelve months’ P/E, which represents a discount to its historical mean five-year and 10-year consensus forward next twelve months’ P/E multiples of 15.3 times and 16.5 times, respectively. It also offers a consensus forward FY2021 (YE March) dividend yield of 2.3%.

China Gas’ new LPG micro pipeline network business could be a medium-term growth driver, with a FY2021 target of 500,000 residential household connections versus a 90 million addressable market. On the other hand, the company’s FY2020 results were not as good as expected, and its FY2021 guidance was slightly disappointing. China Gas is guiding for a +15% YoY growth in gas sales volume for city and township projects in FY2021, as compared to the +25% YoY gas sales volume growth registered in FY2019.

After the company reported FY2020 results and provided FY2021 guidance on June 26, 2020, its share price fell by -12% from HK$27.20 as of June 26, 2020 to HK$23.90 as of June 29, 2020, before subsequently staging a recovery to close at HK$25.05 as of July 10, 2020. The market is disappointed by its FY2021 gas sales volume growth guidance. With China Gas’ share price correction and relatively low P/E valuation pricing in such negatives, I think that my Neutral rating on the stock is justified.

Readers have the option of trading in China Gas shares listed either on the Over-The-Counter Bulletin Board (OTCBB) as ADRs with the tickers CGHOF and CGHLY or on the Hong Kong Stock Exchange with the ticker 384:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $70 million, and market capitalization is above $16.8 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors which own China Gas shares listed in Hong Kong include Capital Research Global Investors, The Vanguard Group, BlackRock, and Norges Bank Investment Management, among others. Investors can invest in key Asian stock markets either using US brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

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New LPG Micro Pipeline Network Business

At the company’s FY2020 earnings call on June 26, 2020, China Gas disclosed that it has entered into a new business referred to as “LPG micro pipeline network”, which the company claims is an “asset-light pipe-to-gas business” that will disrupt the future of the country’s pipeline network development. In its FY2020 financial results presentation slides, China Gas refers to the new LPG micro pipeline business as the construction of “small LPG supply units and distributed pipeline networks to put in place centralized piped gas supply system for small residential communities and township gas users nationwide”.

China Gas’ LPG Micro Pipeline Network Business

(Source: China Gas’ FY2020 Results Presentation Slides)

China Gas started to build the first four LPG micro pipeline network model projects in China (Hubei and Qinghai) in 2018, and this year will mark the beginning of the company’s expansion of the LPG micro pipeline network across the country. Notably, China Gas imported the technologies relating to LPG micro pipeline networks eight years ago, so it has been a long journey for the company in making this new business viable.

The new LPG micro pipeline network business is positive for China Gas in multiple ways.

Firstly, the company’s new LPG micro pipeline network business is asset-light, implying lower capital expenditures and high profit margins. Also, it only takes approximately between one and three months for the construction of small LPG supply units and distributed pipeline networks. In contrast, conventional pipe-to-gas projects are much more capital-intensive, which require the building of medium- and high-pressure pipelines and centralized pipeline networks.

More importantly, asset-light LPG micro pipeline networks have great potential in the southern part of China because it is much more challenging to build conventional pipe-to-gas projects on mountainous terrain, which is more common in South China.

Secondly, China Gas has an edge over competitors in competing for new LPG micro pipeline network projects, thanks to the backing of the Chinese authorities. As mentioned earlier, China Gas is the pioneer for LPG micro pipeline network projects in China, being the first company to be authorized to construct such projects in China in 2018 as a showcase.

Notably, it was also the company that drafted the “Technical Standards for Small Butane Storage Tank for Gas Supply” that has been since put into law in China and governs the construction of LPG micro pipeline network projects in the country. In addition, the company has 15 patent rights with respect to its in-house design and manufacturing of small LPG tanks, which represent barriers to entry for competitors and other new entrants.

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Thirdly, there is a long growth runway for the LPG micro pipeline network business. China Gas is targeting 500,000 residential household connections in FY2021 for this new business, but the company expects the total addressable market to be approximately 90 million.

On the flip side, it could be too early to judge the success of China Gas’ new LPG micro pipeline network business. The company’s execution of its plans to expand LPG micro pipeline network projects on a larger scale in FY2021 will be closely watched.

FY2020 Results Not As Good As Expected And FY2021 Guidance Disappoints

China Gas’ FY2020 core net profit grew +16% YoY to HK$9.5 billion in FY2020, but this was mainly driven by a +500 basis point improvement in gross profit margin, from 23.7% in FY2019 to 28.7% in FY2020, with increased revenue contribution from higher-margin, value-added services. The company’s revenue increased by a marginal +0.3% YoY, from HK$59.4 billion in FY2019 to HK$59.5 billion in FY2020.

China Gas’ gas sales volume growth for city and township projects in FY2020 was only +6% YoY, as the company’s gas sales volume fell by -13% YoY in 4QFY2020 (January to March 2020 period) due to the negative impact of COVID-19. Specifically, commercial gas sales volume growth slowed from +30.1% YoY in FY2019 to +5.2% YoY in FY2020, while industrial gas sales volume growth went from +22.5% YoY in FY2019 to -9.1% YoY in FY2020.

The company is guiding for a +15% YoY growth in gas sales volume for city and township projects in FY2021, but this is significantly slower than the +25% YoY gas sales volume growth registered in FY2019. Notably, China Gas’ gas sales volume growth has recovered to +8% and +10% YoY in April and May 2020, respectively.

Also, of the expected +15% YoY gas sales volume growth for FY2021, or a 23 million cubic meter increase, an estimated 900 million cubic meters is expected to be derived from an additional 1.8 million new household connections secured for rural coal-to-gas conversion projects. The significant incremental revenue contribution from rural coal-to-gas conversion projects in FY2021 could potentially be a drag on China Gas’ overall profitability, due to the lower gas consumption per household and relatively higher costs for such projects.

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Valuation And Dividends

China Gas trades at 14.2 times trailing twelve months’ P/E and 12.2 times consensus forward next twelve months’ P/E based on its share price of HK$25.05 as of July 10, 2020. As a comparison, the stock’s historical mean five-year and 10-year consensus forward next twelve months’ P/E multiples were 15.3 times and 16.5 times, respectively.

Market consensus expects the company’s ROE to slightly decline from 24.5% in FY2020 (YE March) to 23.9% in FY2021.

China Gas offers consensus forward FY2021 and FY2022 dividend yields of 2.3% and 2.7%, respectively. The company proposed a final dividend of HK$0.40 per share for 2HFY2020, which brought full-year FY2020 dividends per share to HK$0.50. This represents a +13% YoY growth in absolute terms and an increase in the company’s dividend payout ratio from 27% in FY2019 to 28% in FY2020.

As per the peer valuation comparison table below, China Gas is trading at a discount to two of its peers based on forward P/E, despite a relatively higher forward ROE.

Peer Valuation Comparison For China Gas

Stock Consensus Forward Next Twelve Months’ P/E Consensus Forward One-Year ROE Consensus Forward One-Year Dividend Yield
China Resources Gas (OTCPK:CGASY, OTC:CRGGF, 1193:HK) 16.0 18.2% 2.4%
ENN Energy Holdings (OTCPK:XNGSF, OTCPK:XNGSY, 2688:HK) 15.1 21.2% 2.2%
Towngas China (OTCPK:TGASF, OTC:TGASY, 1083:HK) 7.6 7.6% 4.0%

(Source: Author)

Risk Factors

The key risk factors for China Gas Holdings are the new LPG micro pipeline network business performing below expectations and weaker-than-expected gas sales volume growth going forward.

Note that readers who choose to trade in China Gas shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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