Ganghua Gas will subscribe for 25% of Shanghai Gas's shares. After the transaction is completed, Shanghai Gas will also subscribe for 25% of Ganghua Gas's shares

It contributed about 2% to the net profit of Hong Kong Zhonghua Gas in 2019, with consolidated gas sales volume exceeding 34 billion cubic meters (the largest in China based on gas sales volume in 2019)

It has a positive impact on the valuation of second-tier urban gas operators

Form a cross-shareholding with Shanghai Gas

Hong Kong China Gas recently announced that its subsidiary Ganghua Gas (1083 HK, unrated) has signed a subscription agreement with Shanghai Gas. Among them: 1) Ganghua Gas will subscribe for 25% of Shanghai Gas's shares, with a total price of 4.7 billion yuan. Ganghua Gas has the right to nominate 1 member of the board of directors (composed of 5 directors), 1 member of the board of supervisors (composed of 3 supervisors), and part of the management team of Shanghai Gas; 2) Within one year after the completion of the above transaction, Shanghai Gas will subscribe for 25% of Ganghua Gas's shares at the same price (4.7 billion yuan), reflecting cross-shareholding between the two companies. Both deals will involve the issuance of new shares by both parties. As far as valuation is concerned, Shanghai Gas's net profit in 2019 was 620 million yuan, and the subscription cost corresponds to a price-earnings ratio of 30 times.

The combined sales volume of the two companies will rise to the top of China's retail sales volume after the transaction

All of Shanghai Gas's projects are located in Shanghai, with a market share of 95%. In 2019, its total gas sales volume reached 9.38 billion cubic meters, of which about 50% came from power plants, about 30% from industry and commerce, and the rest from housing. The company operates two liquefied natural gas receiving stations in Shanghai, with a total annual reception capacity of 4.5 million tons (or about 6 billion cubic meters). After the transaction is completed, Hong Kong China Gas will become the gas retail operator with the largest gas sales volume in China (34.9 billion cubic meters in 2019). The two liquefied natural gas stations of Hong Kong and China Gas and Shanghai Gas will also have a synergistic effect in terms of imports. Using FY19 as a benchmark, the transaction will boost the net profit of Ganghua Gas by 14% and the net profit of Hong Kong China Gas by 2%.

It has a positive valuation impact on second-tier urban gas operators

We believe this deal will have a positive valuation impact on second-tier urban gas operators such as Kunlun Energy (135 HK, purchase, target price: HK$7.6) and Tianlun Gas (1600 HK, unrated), as Shanghai Gas's subscription for 25% of Ganghua Gas's shares will provide a standard for their potential revaluation. According to Bloomberg's unanimous forecast, the valuation of Hong Kong China Gas is 27 times the price-earnings ratio for FY21, and the dividend ratio is 3%, while the valuation of Ganghua Gas is 7 times the price-earnings ratio for FY21.