China Gas Utilities: ENN Energy’s Operating Performance a Mixed Bag; Sector Undervalued

ENN Energy’s third-quarter 2023 operating data was largely in line with our expectations, but we see a softer outlook in certain segments which can be negative for peers. After reviewing our assumptions, we lower China Gas Holdings’ 00384, China Resources Gas’, and ENN Energy’s fair value estimates to HKD 12.60, HKD 31.00, and HKD 102.00 from HKD 13.70, HKD 32.00, and HKD 107.00, respectively. The reduced valuation largely reflects the lower gas sales forecasts and a slower-than-expected recovery in the real estate sector, which negatively affects new residential connections. After the recent selloff due to concerns about the growth outlook, we believe the sector is undervalued now. We think the sector will be rerated if the dominant players can deliver consistent improvements in earnings. China Gas Holdings will announce its first-half fiscal 2024 (ending March) results in late November 2023, and this should be closely watched. Our preferred pick is ENN Energy given the firm’s share buyback plan and potential in the integrated energy and value-added businesses.

While ENN kept most of its 2023 guidance intact, there are a few key highlights. First, the dollar margin declined to CNY 0.50 per cubic meter in the third quarter, from CNY 0.52 in the first half. Management attributed the drop to discounts given to customers to boost demand. While ENN’s 2023 dollar margin guidance of between CNY 0.50 and CNY 0.51 remains achievable, we see less upside surprise as it shows that demand recovery is still slow. Second, ENN lowered its 2023 LNG trading gain target to CNY 1.2 billion from CNY 1.5 billion due to higher oil prices, which increased its contract costs. Third, about 38% of gas sales to the residential segment have completed pass-through (versus around 40% for peers, according to management) and ENN is targeting 50% by year-end. Fourth, ENN forecasts that winter gas costs should see a mild increase of about 6% year on year, providing support to its dollar margin.