Strong recovery, incentive to land; maintain "buy"

Hong Kong China Gas 1H21 recorded revenue of HK $7.77 billion, an increase of 40 per cent over the same period last year, and a net profit of HK $778 million, an increase of 34 per cent over the same period last year, and natural gas sales rebounded sharply by 32 per cent to 7.26 billion cubic meters. Taking into account the strong performance of gas sales and extension business, we have raised the 2023 home return net profit forecast of 20211x2022max to HK $1.81 billion / 2.04 billion / 2.32 billion (previous value: HK $1.64 billion / 1.86 billion / 2.07 billion), CAGR is 17% and CAGR is HK $0.59 and 0.67, respectively. The company officially launched the share incentive scheme to improve the long-term management mechanism. We raise the target price to HK $7.14, based on 2021 12xPE, slightly lower than the historical average of 12.9x, mainly considering that Hong Kong China and Shanghai Gas are still in a running-in period. Maintain the buy rating.

The gas sales business has grown sharply, benefiting from the economic recovery and clean energy policy. Hong Kong China Gas 1H21 gas sales revenue rose 40 per cent year-on-year to HK $6.5 billion, and gas sales rose 32 per cent to 7.26 billion cubic meters. Benefiting from the economic recovery and clean energy policy, we expect gas sales to grow by 21% year-on-year in 2021 (previous value: 15%), of which industrial / commercial / residential / distributed energy use will grow by 28x22max / 832% year-on-year. Taking into account the base effect, we expect the growth rate of 2H21 sales to decline.

In view of the significant increase in upstream gas prices, we have lowered our profit margin forecast for 2021 gas sales to 8.8% (previous value: 10.5%).

The incremental contribution of extended business is expected to offset the slowdown in connection growth.

Revenue from the company's 1H21 natural gas connection / extension business increased by 152 per cent year-on-year to HK $9 billion / 3.6 billion.

There are 210000 new connections to 1H21, and as the ventilation rate of domestic urban residents tends to be saturated, we expect the growth of gas connections to slow down from 2022 to 2025. Hong Kong China Gas has a strong customer base, with 14.56 million customers (as of June 2021). The acquisition of a 25 per cent stake in Shanghai Gas was completed in July 2021, and the total number of customers is expected to increase by a further 6.4 million. We expect the growth of the extended business in 2022-2025 to offset the slowdown in connection volume growth.

Be optimistic about the growth space, and the valuation is attractive.

Considering the growth of natural gas sales, the relatively stable profit margin of gas sales and the improvement of unit operating expenditure, we are optimistic about the growth space of the company. The target price of HK $7.14 is based on 12 times the 2021 forecast PE (previous value:

HK $6.61, based on 12 times the 2021 forecast PE), which is slightly lower than the historical average of 12.9 times; in view of the uncertainty of the integration effect of Hong Kong and China Gas and Shanghai Gas, we think the valuation is reasonable. The current share price corresponds to 8.6 times the 2021 forecast PE (according to Huatai forecast), which is significantly lower than its historical average, and we find the valuation attractive.

Risk hint: China's natural gas sales growth is slowing, and industrial user demand is weakening.