20150708-大和证券-Upgrading__recovery_on_the_next_tariff_cut,_and_set-up_of_SHPGX_17页_652kb_652kb

ENN Energy Summary

Core Content

ENN Energy is a leading city-gas distributor in China, with a focus on provinces such as Guangdong, Shandong, Jiangsu, and Hunan. The company has 142 projects as of December 2014. The document outlines a positive outlook for the company's share price and financial performance, based on upcoming changes in the natural gas market.

Main Points

• Tariff Cut and SHPGX Impact: A potential city-gate tariff cut in 3Q15 and the establishment of the Shanghai Petroleum and Gas Exchange (SHPGX) are expected to expand ENN's unit dollar margin of gas sales.
• Gas Sales Growth: ENN achieved only 10% YoY growth in retail gas sales for 5M15, below its full-year target of 20% YoY growth, but above the sector average of 2% YoY.
• Residential Connections: Management aims to increase residential connections to offset the weak gas sales volume growth.
• Rating Upgrade: ENN's rating has been upgraded to Buy from Hold, with a new target price of HKD50 and an upside of 20.3%.
• Valuation: ENN is currently trading at a 14x 2015E PER, which is 0.9SD below its 9.5-year average of 16.8x, indicating an attractive valuation.

Key Information

• Target Price: HKD50 (up from HKD48)
• Upside: 20.3%
• Current Price (8 Jul): HKD41.55
• Market Cap: USD5.80 billion
• Shares Outstanding: 1,083 million
• Major Shareholder: ENN Group (30.4%)

Financial Highlights

• Revenue Growth: Expected to grow at a CAGR of 21% for 2013-16, down from 25% due to weak Chinese economy.
• Net Recurring Profit Growth: Projected to rise at a CAGR of 17% for 2013-16, up from 14%.
• EPS Forecast: Revised to be 2-5% higher than consensus due to increased residential connection and unit dollar margin assumptions.
• Net Profit: Expected to increase from 2,808 million CNY in 2015E to 3,764 million CNY in 2017E.
• Core EPS (Fully Diluted): Projected to rise from 2.414 in 2015E to 3.236 in 2017E.

Valuation Metrics

• PER (12-month forward): 14x for 2015E, 11.8x for 2016E, 10.3x for 2017E
• Dividend Yield: 2.2% in 2015E, increasing to 2.9% in 2017E
• DPS (Dividends per Share): Expected to rise from 0.724 in 2015E to 0.971 in 2017E
• PBR (Price to Book Ratio): 2.6x in 2015E, decreasing to 1.9x in 2017E
• EV/EBITDA: 7.2x in 2015E, decreasing to 5.1x in 2017E
• ROE (Return on Equity): Maintained at 21.5% for 2015E and 2016E, slightly declining to 21.3% in 2017E

Key Risks

• Lower-than-expected city-gate tariff cut
• Fewer residential connections than anticipated

SHPGX Impact

• The SHPGX, launched on 1 July 2015, allowed ENN to purchase gas at a 7% discount to the city-gate tariff.
• The exchange is expected to create a spot trading market in coastal provinces, enabling ENN to secure cheaper gas and expand margins from 2H15.
• The document estimates that around 2% of China's total gas sales could be conducted through the SHPGX in 2H15.

Tariff Cut Analysis

• The next city-gate tariff cut is expected in September-October 2015, reflecting a 16% HoH drop in refinery oil product prices in 1H15.
• The cut is projected to be around 16%, enabling natural gas to regain competitiveness against competing fuels.
• The discount for industrial gas is expected to increase from 13% premium to 4% discount, and for vehicular gas from 14% to 25% discount.

Recommendations

• Upgrade ENN to Buy with a 12-month DCF-based target price of HKD50
• Recommend investors to look for a steady rerating in 2H15 due to the expected tariff cut and SHPGX benefits
• The company's financial performance and valuation are seen as attractive, especially given the potential for margin expansion and increased gas sales

Conclusion

ENN Energy is expected to benefit from the upcoming city-gate tariff cut and the SHPGX, which could expand its unit dollar margins and increase its competitiveness in the natural gas market. The company's financial performance is projected to improve, with a target price of HKD50 and an upside of 20.3%. Despite a weak Chinese economy, the company is expected to see growth in industrial and vehicular gas demand.