Incidents:

Baichuan Energy announced its report for the third quarter of 2019: the company achieved revenue of 3.637 billion yuan in the first three quarters, an increase of 17.67% over the previous year; total profit of 856 million yuan, an increase of 4.85% over the previous year; net profit attributable to shareholders of listed companies was 657 million yuan, a year-on-year decrease of 8.71%. The company achieved total gas sales of 836 million cubic meters, an increase of 38.22% over the previous year.

Commentary:

Income statement analysis: Revenue grew steadily, gross margin levels rebounded. Affected by financial expenses and income tax expenses, the mother's net profit declined year-on-year. In the first three quarters of 2019, the company achieved 3.637 billion yuan, an increase of 17.67% over the previous year; the net profit returned to the mother was 657 million yuan, a year-on-year decrease of 8.71%. The reason net profit growth rate is not as fast as revenue growth is mainly due to increased financial expenses and reduced income tax deductions: 1. Due to the increase in bank loans, the company's financial expenses increased to 62.67 million yuan in the first three quarters, an increase of 484.21% over the previous year; 2. Last year, the coal-to-gas business accounted for a relatively high share of project settlement revenue, with a lot of income tax deductions. This year, the share of this part of the business fell, and the corresponding income tax exemptions were reduced. Income tax expenses increased by nearly 100 million yuan in the first three quarters.

Furthermore, the company's gross margin level continues to rise. The company's comprehensive gross profit margin in the first three quarters was 30.10%, an increase of 0.75 pct over the semi-annual report, mainly due to the company's continuous optimization of the gas source structure to reduce gas consumption costs. The company's contract volume was sufficient this year, and it is expected that the gross margin of gas sales will remain high throughout the year.

Analysis of the cash flow situation: the pay-to-cash ratio is lower, the amount of cash on hand is lower, the amount of accounts receivable is high but the risk is manageable. In the first three quarters, the company received 3.189 billion yuan in cash from the sale of goods to provide labor services. The pay-to-cash ratio was 87.68%, a decrease of 7.82 pct over the same period last year. The company had monetary capital of 552 million yuan in hand at the end of the third quarter, a decrease of 366 million yuan from the beginning of the year. In addition to paying cash considerations for mergers and acquisitions, the company also paid more accounts payable during the reporting period, including to material suppliers and construction service providers. The total amount of notes and accounts payable fell from 557 million at the beginning of the year to 441 million. The reduction in account holdings also led to a corresponding increase in bank loans.

By the end of the third quarter, the company's bills receivable and accounts receivable were $1.37 billion, a decrease of 4.86% over the same period last year, and the company's repayment situation had improved. Currently, the amount of the company's accounts receivable is relatively high. The main reason is that there are many arrears in the Mura-Mura Connect project business. In 2018, the village-village transit project was basically completed, and the government's payment cycle was based on a three-year balance of repayment, which led to a high amount of accounts receivable in the past two years. However, most of the government's receivables have been included in the budget, and the certainty of repayment according to the plan is high, so the risk of accounts receivable is basically manageable.

Main business analysis: The natural gas sales business is growing rapidly, and epitaxial mergers and acquisitions continue to expand the scale of the main gas supply business.

The company achieved a total sales volume of 836 million cubic meters of natural gas in the first three quarters, an increase of 38.22% over the previous year. The gas sales business is showing a rapid growth trend. At the same time, the company continues to implement the development strategy of epitaxial mergers and acquisitions to expand the scale of its main business. Following the acquisitions of Jingzhou and Fuyang Gas, it also acquired Zhuolu Dadi Gas and Suizhong Dadi Natural Gas Pipeline Company in October this year. The transaction prices were 195 million yuan and 25.04 million yuan respectively. Further expansion of the business layout to regions such as Zhangjiakou, Cangzhou and Baoding will form strong synergies with the company's existing operating areas in pipeline network interconnection, gas source procurement, and operation management. The acquisition will expand the company's business scale, enhance the company's competitiveness and regional advantages in the Beijing-Tianjin-Hebei region, and further optimize the company's business expansion and layout.

LNG projects are progressing steadily, extension mergers and acquisitions plans are being implemented continuously, and future growth can be expected. In order to guarantee the supply of gas sources and reduce gas purchase costs, the company plans to invest 3.5 billion yuan to build the Suizhong LNG terminal receiving station. The project has been included in the “Special Plan for Construction Facilities for Natural Gas Storage Facilities in Liaoning Province” (2018-2022) and reported to the National Development and Reform Commission for review. During the reporting period, the company actively promoted the approval and preparation of the Suizhong LNG terminal project. The future construction of the LNG terminal will further reduce the company's procurement costs and meet the gas demand for business expansion, which is of great strategic importance. The company has continuously expanded its business scope and revenue volume through epitaxial mergers and acquisitions in the past two years. In the current environment where tight gas sources have caused most local gas companies to lose money, the company's epitaxial mergers and acquisitions have many potential targets and opportunities. It is expected that future epitaxial mergers and acquisitions will continue to be an important driving force for the company's performance growth. If it maintains a profit level of 1-2 billion dollars of mergers and acquisitions every year, epitaxial mergers and acquisitions will make an important contribution to the company's performance growth.

Profit forecasts and investment suggestions: The company is a high-quality regional gas operator. It is transforming into a national clean energy service provider with a diversified industrial mix. The scope of business and revenue scale have continued to expand in recent years, and will continue to achieve a national layout through outreach mergers and acquisitions. The future development momentum of the main business direction is good. This year and next two years, the company's cash flow situation is also expected to improve as repayments from the Mura-Mura Connect project business are gradually made. The implementation of the LNG terminal project and potential extension mergers and acquisitions will be an important driving force for the company's business growth, and long-term growth can be expected. The company has maintained a high dividend rate of more than 50% in the past two years. It is expected that the high-dividend dividend policy will continue in the future. Corresponding to the static valuation of 10 times in 2018, there is great investment potential. We expect that the net profit attributable to the company in 2019-2021 was 1,207, 1,381, and 1,596 billion yuan respectively, and the EPS was 0.84 yuan, 0.96 yuan, and 1.11 yuan respectively. The corresponding current stock price valuations were 870, 7.60, and 6.58 times, respectively. The rating was “Highly Recommended - A”. The target price would be 14.5 billion yuan based on the 2019 PE valuation 12 times PE, corresponding to the corresponding stock price of 1,005 yuan.

Risk warning: Payback of accounts receivable falls short of expectations; the progress and scale of mergers and acquisitions falls short of expectations; LNG terminals are advancing less quickly than expected; risk of rising gas purchase prices; general market systemic risks.