China Gas Sector: Which stock offers most value and lowest risk to ESG investors?
- Improving visibility of decarbonisation along with transformation into integrated energy plays
- Maintaining energy affordability is the highest social risk
- Stronger economic growth in 2H to drive gas consumption
- Top pick: ENN (2688 HK) for its stronger growth outlook and better visibility in decarbonisation
ENN has the lowest risk in our assessment of key sustainability factors. Our assessment of key sustainability factors of gas distributors under our coverage indicates that 1) ENN (2688 HK) and Towngas Smart Energy (TSE) (1083 HK) have better visibility of their decarbonisation pathway with slightly faster progress in transforming into an integrated energy player; 2) lower spending on operation safety has relatively less impact on cashflow of ENN and Tian Lun Gas (TLG) relative to China Gas Holdings (CGH) and TSE; 3) maintaining energy affordability imposes the highest social risk on China Resources Gas (CRG) and CGH with higher downward pressure on dollar margins, particularly given the high volatility in LNG prices, while ENN outperformed on this front; and 4) ENN has better governance practice than its peers.
Better gas volume growth expected in 2H. Gas consumption growth was flat in China in 6M2022, due to COVID lockdowns. Thus, we expect gas distributors to report lower earnings in 1H2022 with <10% growth in gas volume and dollar margin squeeze of Rmb0.04 to Rmb0.105 per cubic meter (cm). However, the government’s stimulus policies will drive economic growth and we expect to see a rebound in gas consumption in 2H. This could partly offset downside risk on dollar margin from high LNG prices amid the Russia-Ukraine crisis.
ENN as our sector top pick. After integrating the above analysis on key sustainability factors into our financials, we have fine-tuned our assumptions on dollar margin, cashflow and valuation. ENN is our sector top pick and we have raised our TP as we expect ENN to deliver the highest growth in gas volume and core earnings with good visibility in its decarbonisation roadmap. We have downgraded our rating on CRG to HOLD because of its weaker outlook in dollar margin and gas volume growth. We maintain our BUY rating for TSE and CGH as we see improving ESG performance with attractive valuation.
