China Gas Holdings is one of the top 3 national natural gas distributors in China. The Company has been actively expanding through rural coal to gas replacement market, aiming at seizing winter gas heating market in North China. Recent share price decline after 1HFY20 results indicated market concerns on CGH’s business and earnings sustainability. We believe CGH not only can sustain its (Coal to Gas replacement) CTG connection, but is also blessed with future growth drivers. We initiate coverage on CGH with BUY rating.
- CTG business to sustain at least in the next five years. We believe CTG connection is not simply a short term earnings growth booster, but will also contribute long term value to CGH. We estimate that a total of 80mn rural households would convert from bulk coal burning to clean heating. Based on 40% CTG penetration and 4mn household CTG connection pace per year, we expect CTG connection can last for at least five years till 2024. Other than that, we expect rural CTG to contribute significant gas sales volume with improving receivables and subsidy metrics in the coming years.
- NE China: entering golden era. Russian gas’ supply from 2 Dec 2019 will unlock massive growth potential in NE China where CGH had made prospective investments. We expect CGH to achieve high double digit gas volume growth in NE China in FY20-22E（25-35% vs. national average 10-15%）and to unleash new market potential through heating service connection by establishing JVs with local heating companies. NE China will be a long term growth driver to CGH.
- Net profit CAGR to reach 17.5% in FY19-22E. We project CGH to have earnings of HK$9,841/11,458/13,342mn in FY20-22E, respectively. Our earnings forecasts is lower than CGH’s refreshed option’s earnings target of FY19-22E net profit CAGR at 19.4% due to conservative assumptions. We believe CGH’s earnings target is challenging yet still achievable..
- Initiate BUY with a TP of HK$38.00. We estimate CGH’s organic business is worth HK$31.47 per share and NE business is worth HK$6.53 with a 20% valuation discount for growth uncertainties. We believe CGH’s share price will increase as the Company releases its growth potential. We initiate coverage on CGH with a BUY recommendation. Our TP is HK$38.00, reflecting FY20/21E PER of 20.2/17.3x, and 31.9% upside.
- Risk factors: policy risks, gas price hike, and gas shortage.
