For the first time, Hong Kong Gas and mainland urban fuel companies were covered with a “buy” rating

Hong Kong China Gas is the first public utility company in Hong Kong. It has three core sectors: Hong Kong Gas, Mainland Utilities, and Extended Business. By the end of 2023, the number of customers covered by the company in Hong Kong/Mainland reached 2.02 million/40.19 million; among them, the size and profit margin of the Hong Kong gas market was stable; the mainland's utility demand recovered and profit margins were restored, and the company's leading position in urban fuel was strong; the restructuring and integration of famous companies to expand their business in Hong Kong and the mainland, injecting new growth points into the asset-light model. We expect the company's net profit to be HK$62.1/6.90/7.47 billion in 2024-2026, and HK$3.19/3.21/3.26 for BPS. Referring to the average PB value of 2.4x in the company's history, the company's profit and free cash flow are expected to increase, and to create space to enhance dividend payments, the company will be given 2024E 2.4xPb, with a target price of HK$7.66, which covers the “buy” rating for the first time.

Hong Kong Gas: The basic company that competes with electricity in the stock market and contributes profits is the only gas supplier in Hong Kong. Fees and profits are not regulated by the Hong Kong government. In 2013-23, the number of gas customers increased from 1.799 million to 2.02 million, the CAGR was +1.2%, and the residential gas coverage rate remained around 74%; average household gas sales fell from 15.88GJ to 13.43GJ, CAGR was -1.7%, and gas sales dropped from 28,556TJ to 27,125TJ, and CAGR was -0.5%. Gas faces competition in the electricity market, but with the comparative advantages of low price and low carbon, the company's gas price fully conveys changes in upstream procurement prices, labor and operating costs. We expect revenue from the Hong Kong segment to be relatively steady in 2024-2026, while the EBITDA margin is expected to remain around 50%.

Mainland public use: Demand has recovered and profit margins have been restored, and the company, which has a strong position as an urban gas faucet, began developing gas projects in the mainland in 1994. In 2023, the company's urban gas sales reached 34.7 billion **** meters, +8% year-on-year, thanks to rapid growth in gas distribution volume and recovery in industrial and commercial gas demand. The company's share of the gas market in mainland cities has been rising steadily. In 2023, gas sales accounted for 8.9% of mainland natural gas sales. Since 2016, it has remained above 8.1%, and has continued to increase for the past three years. Due to the reduction in gas extraction costs and the improvement of favorable price mechanisms in some regions, the company's price spread rose 0.02 yuan/**** meter year on year in 2023. Price gap repair and renewable energy are beginning to contribute positive returns, and we expect the EBITDA margin of the Mainland's public sector to rise above 15% year by year in 2024-2026.

Extended business: Focusing on smart service scenarios, the Hong Kong and Mainland business integration company launched a famous restructuring in 2023, with the aim of integrating extended business in Hong Kong and the Mainland. The total revenue from the extended business in 2023 was HK$9.2 billion, of which famous companies accounted for 45%; Hong Kong/the mainland accounted for 41%/59% respectively in the famous business. The operating profit of Famous Home in 2023 was HK$490 million, and the operating profit margin was 12%. In 2023, the company's market share of gas appliances/cabinets in Hong Kong reached 80%/30%, thanks to good product reputation and brand awareness. The company's mainland user market coverage rate is far lower than the Hong Kong market. Home Insurance 20%, Home Safety 6%, Smart Kitchen 10%, and the potential market space is broad.

Risk warning: Hong Kong's gas demand falls short of expectations; Mainland gas demand falls short of expectations; borrowing cost control falls short of expectations.