The company's urban combustion industry started in Hong Kong and has now spread all over the country. Hong Kong Zhonghua Gas Co., Ltd. was established in 1862 and listed in Hong Kong as early as 1960. In 1995, the company entered the mainland market, began nationwide exploration and layout, and has now developed into one of the five major national urban gas enterprises. As of the first half of 2024, the company's business has spread across 29 provinces, municipalities and autonomous regions. The mainland has 321 urban gas projects, and the number of gas users exceeds 40 million. 1H24 sells about 19.03 billion of natural gas in Hong Kong and the Mainland of China (including 0.43 billion in Hong Kong), accounting for about 8.9% of the country's apparent natural gas consumption.

The profit of the Hong Kong business is stable, and there is still room for price increases in the future. The Hong Kong gas market has entered a mature period, and the number of the company's users is growing moderately and steadily.

In 2023, the number of users covered by the company in Hong Kong exceeded 2 million, with a market coverage rate of 75%, mainly residential and commercial customers.

In Hong Kong's gas sales structure in 2023, residential, commercial and industrial accounts for 54%, 40%, and 6% respectively. As residential and commercial gas demand increases, we estimate that until the end of 2028, there is still room for a 7% increase in gas sales in the Hong Kong business compared to the end of 2023. The company is highly autonomous in price adjustment in Hong Kong. It can increase gas terminal prices according to cost changes, and is highly profitable and highly stable.

In August 2024, the monthly maintenance fee, which has remained unchanged for many years, was increased by HK$0.5/month, and the basic price also increased by HK$0.013/MJ. Looking forward to the future, as electricity prices in Hong Kong have risen more than gas, the cost performance ratio of gas continues to be prominent, and there is still room for further price increases in the long term.

Mainland business sales grew steadily, and margin improvements continued to fix gross margins. As of the first half of 2024, the company directly and through its subsidiary Ganghua Smart Energy had controlled a total of 321 gas projects in mainland China, which were widely concentrated in densely populated and economically developed regions in East China, South China, and central China, and had significant location advantages. In 2018-2023, the company's gas sales CAGR reached 8.56%. In 2023, the company's industrial, commercial, residential, distribution and other gas use accounted for 45%, 14%, 22%, and 19%, respectively. The scale of gas consumption in industries such as electric vehicles, lithium batteries, and photovoltaic products is growing rapidly, which is expected to drive the company's gas sales to continue to increase. Starting in the second half of 2023, the country will vigorously promote the implementation of the household gas price mechanism. Among the cities covered by the company's gas business, provincial capitals such as Nanjing, Xi'an, and Jinan have completed price adjustments one after another. The gross margin of 1H24 sales rose significantly to 0.47 yuan/m, an increase of 0.05 yuan/m over the previous year. Driven by a sharp rise in quantitative profit, the company's profitability in the mainland gas market is expected to continue to increase.

More blossoms will inject new momentum into the company's development. In terms of expanding its business, the company focuses on residential users, and its wholly-owned subsidiary Famous Family mainly creates one-stop lifestyle service solutions for customers. The company covers more than 41 million users and 2 million users in the Mainland and Hong Kong respectively, providing a solid customer base for the development of extended business. In the first half of 2024, the extended business contributed HK$0.19 billion in profit, of which Hong Kong and Mainland businesses contributed HK$0.14 billion and HK$0.05 billion respectively. In terms of the renewable energy business, the company has accumulated a large number of high-quality park industrial users after being deeply involved in the gas field. Based on this, the company began developing distributed photovoltaic and energy carbon services in 2022, benefiting from the company's lean operation management and good project development strategies. Since 2023, the company's renewable energy business has turned losses into profits. Production capacity is rising steadily, and diversified development can be expected in the future. The company actively lays out the renewable energy sector, including the production and sale of sustainable aviation fuel, green methanol and hydrogenated vegetable oil. Over the long term, the company's production capacity in terms of sustainable energy is gradually rising, and it is expected that the company's performance will continue to increase.

First coverage, giving a “buy” rating. Based on the company's steady growth in mainland gas sales, steady restoration of gross margin, and continued expansion of profitability in Hong Kong, we forecast the company's net profit to mother for 2024-2026 will be HK$6.207, 6.713 and 7.094 billion, respectively, and EPS of HK$0.33, 0.36, and 0.38 HKD/share, respectively. Hong Kong's China Gas dividend policy has been stable for more than 20 years (HK$0.35 per share per year). The stock price has anchored US bond yields for a long time. During the US dollar interest rate cut cycle, as risk-free returns declined, the reduction in dividend rate return requirements helped the company's valuation increase. At the same time, as the operating stability of the urban gas industry gradually increases, performance will gradually return to a period of steady growth. As urban fuel's cash flow gradually increases, DCF valuation can further reflect the room for valuation improvement brought about by the company's rising fundamentals. According to estimates, we gave the company a target price of HK$7.77, with room for an increase of 31.7% compared to the current stock price. First coverage, giving a “buy” rating.

Risk warning: risk of high fluctuations in natural gas prices, falling short of expectations in domestic net prices, lower than expected growth in gas sales