Backed by ENN Group, ENN Energy primarily engages in gas sales, construction and installation, integrated energy business, and value-added businesses. Amid the slower-than-expected post-pandemic recovery of the gas industry and the downturn in the property market, the company maintained stable sales and relied on its high-margin integrated energy business and value-added business to sustain profitability. In 2022, the company achieved gas retail sales volume of 25.9bnm3, accounting for c.7% of China’s apparent natural gas consumption. As national natural gas consumption returns to an upward track in 2023, we expect the company’s gas distribution business to maintain steady growth in the long term.
　　Dollar margin recovery driven by improved sales mix and price-through policies. In 2022, affected by the upstream international gas price hikes and poor price-through policies enforcement, the company’s retail gas dollar margin dropped to Rmb0.48/m3. Since June, China has strengthened the implementation of a price linkage mechanism between upstream and downstream natural gas prices across the country. Residential gas retail prices in the firm’s key operating areas, including Hebei and Jiangsu, have increased by more than 10%. With a sharp fall in global gas prices in 2023, the consumption of high-margin industrial and commercial gas has been recovering. From January to September, despite lower power plant gas consumption, industrial and commercial gas still contributed 78% of the firm’s retail gas sales volume (-0.4% YoY). In 1H23, the company’s retail gas sales dollar margin rebounded to Rmb0.52/m3 (+Rmb0.02/m3 YoY). In the long term, we believe it can utilize its parent’s LNG receiving terminals and its own pipeline network facilities to strengthen the cost advantage, which will enable it to reduce gas intake costs and improve gas sales profitability.
　　Urban renewal projects to underpin the construction and installation business. In 2022, the number of new residential connections in its engineering installation business dropped by 536k from 2021. With the ongoing urban renewal in megacities, the shift from bottled to pipeline gas will unleash robust demand and support the steady development of the company’s construction and installation business. In 1H23, its engineering and installation business gross margin rebounded to Rmb1.526bn (+13.04% YoY). In the long term, we believe the company will continue to tap into the existing market, and expect the number of new residential connections to remain at c.1.8m households.
　　Continued expansion of the integrated energy and value-added businesses. In 1H23, integrated energy project sales volume reached 15.66bn kWh (+44.5% YoY), delivering revenue of Rmb6.99bn (+30.3% YoY) and gross profit of Rmb913m (+30.8% YoY). The firm is actively rolling out demonstration projects nationwide, and the integrated energy business will maintain robust growth. For the value-added business, we believe the company will leverage its broad base of residential gas users to provide integrated energy solutions. In 1H23, the segment delivered revenue of Rmb1.7bn (+46% YoY) and gross profit of Rmb1.14bn (+30% YoY), accounting for 15.9% of the total gross profit. At present, the penetration rate of the value-added business in existing customers is only 11.2%. With continued demand for quality life, we see substantial growth potential for value-added business.
　　Initiate with BUY. Given the positive long-term prospect of the natural gas distribution business, the steady recovery of dollar margins, and the rapid growth of integrated energy and value-added businesses, we expect the firm’s net profit to reach Rmb7.19bn in 23E, Rmb8.17bn in 24E and Rmb9.34bn in 25E, implying EPS of Rmb6.37, Rmb7.24 and Rmb8.28, respectively. The stock is trading at 7.2x 23E PE, 6.4x 24E PE, and 5.6x 25E PE. We believe the company’s profitability will continue to rebound after 2023 and expect the valuation of the urban gas sector to repair. Referring to the industry average valuation, we derive our target price of HK$69.60 based on 10x 23E PE. With a 38.2% upside, we initiate coverage with a BUY rating.
　　Risks. Gas price hikes; poor price-through implementation; slower-than-expected gas sales growth.