Extensive business scope and promising long-term outlook. China Gas is one of the largest cross- regional integrated energy suppliers in China. It is primarily engaged in gas sales and connection, LPG sales and value-added services, and is actively developing an integrated energy business. The company operates 661 piped gas projects nationwide, with a dominant advantage in the Northeast, North, Central, and South China regions. In FY2021/22, the company’s gas sales totalled 36.7bnm3, representing a market share of c.10%. In 1HFY2022/23, the company’s gas sales increased 7.4% YoY.
　　With the imports of Russian gas into Northeast and Northern China and the development of urban heating projects in the southern market, we believe its natural gas sales will grow steadily.
　　Gross margin to recover due to diversified channels and effective price-through measures. Due to the upstream gas price hikes, the dollar margin of gas sales fell to Rmb0.50/m3 in FY2021/22 （- Rmb0.11/m3 YoY）。 In 1HFY2022/23, it rebounded to Rmb0.54/m3. We believe the company’s dollar margin will bottom out for the following reasons. 1） Diversification of gas sources reduces the risk of gas price fluctuations. The company has signed LNG SPAs with an annual supply of 3.7mt, and its subsidiary has participated in the construction of the West Yantai LNG Terminal （with an annual turnover of 5mt）。 2） With the optimisation of the gas pricing mechanism which better connects downstream prices to upstream costs, we believe gas price fluctuations will be transmitted to end users in a timelier manner. Meanwhile, the NDRC requires a secured supply and stable prices of residential gas, which will help avoid the situation that costs beat sales prices.
　　Diversified approaches to attract incremental LPG users. As the largest vertically integrated LPG operation service provider in China, China Gas has established a comprehensive business mix ranging from gas transportation, warehousing to distribution and sales. The company owns seven LPG terminals with an annual turnover capacity of over 10mt. In FY2021/22, the company’s LPG sales volume reached 4.27mt （+0.5% YoY）， of which the wholesale gas accounted for 83%. The company also invests in the construction of three storage and depot projects, which will bring 3.5mtpa of incremental LPG trading. In addition, the safe, convenient and low-initial-investment LPG MicroGrid business was mentioned in the central government’s No. 1 Document twice. We see a broad development space in rural areas of southern China.
　　Value-added service creates a second growth curve. The company has been developing high- margin VAS since 2015, which now makes outstanding contributions to its revenue and profits. In FY2021/22, VAS revenue reached HK$6.8bn, with a gross margin of 48.6%. Smart Living, which innovatively introduces e-commerce services, gives full play to the advantages of an integrated platform and continuously mines the value of gas users. It has now grown into the core of the firm’s VAS business. As the user penetration rate and single-customer revenue of Smart Living continue to increase, we estimate VAS gross profit will continue to increase.
　　Initiate with BUY. We forecast net profit of HK$6.00bn in FY2022/23E （-21.7% YoY）， HK$7.49bn in FY2023/24E （+24.8% YoY） and HK$8.58bn in FY2024/25E （+14.5% YoY）， implying EPS of HK$1.10, 1.38 and 1.58, respectively. The stock is trading at 9.5x FY 2022/23E PE, 7.6x FY 2023/24E PE, and 6.7x FY2024/25E PE. Referring to the industry average PE, we derive our target price of HK$13.77 based on 10x FY2023/24E PE. With 31.2% upside, we initiate coverage with a BUY rating.
　　Risks. Strong volatility of fossil energy price fluctuates highly, lower-than-expected gas connection.