Core profit in 1H17 was largely flat YoY, meeting expectations
Strong gas volume was offset by a margin trim. Water utilitieswere slow, while new energy had a boost over a low base
A high quality company but rich valuation. Maintain Reduce
1H17 results were in line: Hong Kong & China Gas （HKCG） reported 1H17 netprofit of HKD4.47bn （+3.3% YoY）。 After stripping out one-off items, recurring profitwas flat YoY, accounting for 48% of our 2017 estimate. This set of results met ourexpectations. DPS was flat YoY with pay-out kept at 38%.
　　Hong Kong （48% of 1H17 EBITDA）： Revenue from Hong Kong was flat YoY andtotal gas sales volume grew 1% YoY （adjusted EBITDA: +1% YoY）。 HKCG hasraised gas tariffs by 4.3% from 1 August 2017 due to rising costs, with a plan to keeptariffs unchanged for the next two years. According to HKCG, opportunities in gascooling, diesel conversion and demand from new projects （e.g. hospitals） could bringin a total 1,290TJ after five years, implying 5% upside from current gas volumes.
　　Mainland China （44%）： Including subsidiary Towngas China （TCCL, 1083 HK,HKD5.13, TP: HKD6.1, Buy）， gas volume reached 9.7bcm （+13% YoY）， vs a guided+15% YoY for 2017. Dollar-margin edged off to RMB0.73/cm （1H16: RMB0.77/cm;2016: RMB0.73/cm）， due to a temporary hike in upstream costs during winter, whichwas reversed after 15 Mar 2017. New connections were 1.0m households （+2.9%YoY） – TCCL was 0.44m households （flat YoY） – on-track to meet the guided 2.1mhouseholds for 2017. Management sees opportunities in distributed energy system,energy conversion from coal to gas, and space heating, the combination of whichcould bring in 6bcm volume to HKCG （31% upside from 2017e-level）。
　　New Energy （7%）： Revenue and adjusted EBITDA were up 32% and 39% YoY, asvarious projects – e.g. coal bed methane, coal-chemical, etc. – are ramping up overhigher energy prices in the market. New investment of HKD2.2bn will go into five newventures that management expects will generate HKD0.6bn profits p.a. （3-yearpayback）。 These include hydro-treated vegetable oil, coal to ethylene glycol,agricultural waste treatment, asphalt oil to lithium battery anodes, etc.
　　2017 management guidance: Gas volume growth: 13% YoY （2016: +10%）， newconnections to no less than 2016-level （2.1mn households） with margins maintained.
　　Quality company but rich valuation: HKCG delivers resilient growth, qualitygovernance, and upside potential from new energy ventures. However, its 27x PEand 3.6x PB for 2017e look rich （Chinese gas utilities: 10-15x PE and 0.9-2.7x PB）。 Ifwe strip out our DCF-based intrinsic value for Hong Kong, the current price suggeststhe remaining businesses in Mainland China and elsewhere would trade at 25x PE.
　　We rate HKCG Reduce, with an HKD13 target price.
　　HSBC is hosting a non-deal roadshow for HKCG on 22-23 August in Hong Kong.