HK/China Equity Long-Short

Osbert Tang, CFA

Equity Bottom-Up

We touched base with <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> to seek answers on five questions that we think are of significant interests to investors. These include topics on the impact of the rally in LNG price, mechanism for retail gas price adjustment, outlook for dollar margin, impact on the terminal and processing segment, gas volume availability and the future of the E&amp;P segment. These questions are all well answered by Kunlun's management.Overall, based on our discussions, the impact of higher LNG price on Kunlun's profitability and dollar margin should be manageable. It has secured enough gas sources and there should not be worries on shortage. We also anticipate the earnings volatility caused by the upstream E&amp;P business will be sharply lower in two to three years' time; and with better earnings stability and quality, Kunlun should continue to see re-rating.

We touched base with Kunlun Energy (135 HK) to seek answers on five questions that we think are of significant interests to investors. These include topics on the impact of the rally in LNG price, mechanism for retail gas price adjustment, outlook for dollar margin, impact on the terminal and processing segment, gas volume availability and the future of the E&amp;P segment. These questions are all well answered by Kunlun's management.Overall, based on our discussions, the impact of higher LNG price on Kunlun's profitability and dollar margin should be manageable. It has secured enough gas sources and there should not be worries on shortage. We also anticipate the earnings volatility caused by the upstream E&amp;P business will be sharply lower in two to three years' time; and with better earnings stability and quality, Kunlun should continue to see re-rating.

Kunlun Energy (135 HK): Five Questions to Management Get Answered

<a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> posted a very impressive 1H21 result with profit from continuing operations soared 249.9% YoY. All business segments recorded profitability improvement with very encouraging 46.7% YoY growth for its natural gas sales business. The exploration and production segment also achieved a good turnaround, thanks to a 28.3% YoY increase in average realised oil price.We believe the market should be happy with Kunlun's 1% increase in natural gas sales dollar margin even in a period of rising LNG price. Also, the solid momentum of new projects, which 16 were added in 1H21, compares well with peers. We think there is upside to our earnings forecasts and its current valuation of 11.5x PER (on continuing operations) for FY21 is appealing relative to peers. More updates will be provided after the post-1H21 result call.

Kunlun Energy (135 HK) posted a very impressive 1H21 result with profit from continuing operations soared 249.9% YoY. All business segments recorded profitability improvement with very encouraging 46.7% YoY growth for its natural gas sales business. The exploration and production segment also achieved a good turnaround, thanks to a 28.3% YoY increase in average realised oil price.We believe the market should be happy with Kunlun's 1% increase in natural gas sales dollar margin even in a period of rising LNG price. Also, the solid momentum of new projects, which 16 were added in 1H21, compares well with peers. We think there is upside to our earnings forecasts and its current valuation of 11.5x PER (on continuing operations) for FY21 is appealing relative to peers. More updates will be provided after the post-1H21 result call.

Kunlun Energy (135 HK): Our Initial Thoughts on 1H21 - Sharply Ahead of Expectations

<a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> should have a decent operating performance in 1H21, with good growth achieved for natural gas sales, LPG sales, LNG terminal and also the exploration and production segment. Their performance all look to be ahead of the full-year guidance put forward in FY20 result announcement in Mar 2021 - this is encouraging.Gas project M&amp;A momentum stays decent and, with IRRs of 10-12%, the returns are ahead of the hurdle level of 8%. Following <a href="https://www.smartkarma.com/entities/china-gas-holdings-ltd" target="_blank" data-smartkarma-citation="entities:14315:1" rel="noopener">China Gas Holdings' (384 HK)</a>  Shiyan gas explosion, local governments now prefer large SOEs to invest in projects given their more stringent safety standards, and this is an advantage of Kunlun. The gas industry also entails less regulatory risks amid government's heightened regulatory measures towards various industries lately. The recent pull-back has made valuations even more appealing, in our view.

Kunlun Energy (135 HK) should have a decent operating performance in 1H21, with good growth achieved for natural gas sales, LPG sales, LNG terminal and also the exploration and production segment. Their performance all look to be ahead of the full-year guidance put forward in FY20 result announcement in Mar 2021 - this is encouraging.Gas project M&amp;A momentum stays decent and, with IRRs of 10-12%, the returns are ahead of the hurdle level of 8%. Following China Gas Holdings' (384 HK)  Shiyan gas explosion, local governments now prefer large SOEs to invest in projects given their more stringent safety standards, and this is an advantage of Kunlun. The gas industry also entails less regulatory risks amid government's heightened regulatory measures towards various industries lately. The recent pull-back has made valuations even more appealing, in our view.  

Kunlun Energy (135 HK): Positive Takeaways from Discussion with Company

<ul>
<li>We think <a href="https://www.smartkarma.com/entities/kunlun-energy-co-ltd" target="_blank" data-smartkarma-citation="entities:10054:1" rel="noopener">Kunlun Energy (135 HK)</a> will see its operating momentum accelerate in 2H23, leading by better natural gas sales growth and sustained positive dollar margin performance.</li>
<li>It has strengthened its financial position in 1H23, with net cash amounting to 36% of market cap. This has demonstrated its cash-generating capability and controlled capex. </li>
<li>Its 7.0x and 6.6x PERs for FY23 and FY24 are inexpensive. Its annualised ROE of 10.6% is also attractive. There is room for the other businesses to recover in 2H23.</li>
</ul>


We think Kunlun Energy (135 HK) will see its operating momentum accelerate in 2H23, leading by better natural gas sales growth and sustained positive dollar margin performance.
It has strengthened its financial position in 1H23, with net cash amounting to 36% of market cap. This has demonstrated its cash-generating capability and controlled capex. 
Its 7.0x and 6.6x PERs for FY23 and FY24 are inexpensive. Its annualised ROE of 10.6% is also attractive. There is room for the other businesses to recover in 2H23.


Kunlun Energy (135 HK): The Story Is Still Going On

Thematic (Sector/Industry)

<ul>
<li>Except <a href="https://www.smartkarma.com/entities/enn-energy-holdings-ltd" target="_blank" data-smartkarma-citation="entities:316:1" rel="noopener">ENN Energy (2688 HK)</a>, many stocks in the China gas utilities sector are still underperforming the HSI and HSCEI YTD. Yet, industry fundamentals are improving. </li>
<li>More cities and counties will implement a gas price pass-through mechanism, with 90% of cities and counties to be completed by late 2024, benefiting sector profitability.  </li>
<li>Consensus forecasts are still conservative which places room for pick-up in share prices. <a href="https://www.smartkarma.com/entities/china-resources-gas-group-ltd" target="_blank" data-smartkarma-citation="entities:20525:1" rel="noopener">CR Gas (1193 HK)</a> and <a href="https://www.smartkarma.com/entities/china-gas-holdings-ltd" target="_blank" data-smartkarma-citation="entities:14315:1" rel="noopener">China Gas Holdings (384 HK)</a> are opportunities.</li>
</ul>


Except ENN Energy (2688 HK), many stocks in the China gas utilities sector are still underperforming the HSI and HSCEI YTD. Yet, industry fundamentals are improving. 
More cities and counties will implement a gas price pass-through mechanism, with 90% of cities and counties to be completed by late 2024, benefiting sector profitability.  
Consensus forecasts are still conservative which places room for pick-up in share prices. CR Gas (1193 HK) and China Gas Holdings (384 HK) are opportunities.


Hong Kong

Sinopec Kantons Holdings Limited trades crude oil, petroleum and petrochemical products.  The Company also operates a crude oil jetty and its ancillary facilities and petrol stations.

AAG Energy Holdings Limited is  an energy exploration and development company. The Company engages in coalbed methane exploration and development.

United Energy Group, Ltd. is engaged in the exploration and production of oil and natural gas. The Company owns and operates a producing oilfield Liaohe Province of the P.R. of China and owns an interest in an exploration field in Madura PSC, Java, Indonesia.  UEG mainly engages in the upstream oil and natural gas business.

Productive Technologies Company Limited provides productivity solutions to semiconductor and solar cell manufacturers. The Company is engaged in advanced manufacturing of equipment applied in semiconductor and solar power businesses, as well as operates a crude oil asset. Productive Technologies serves customers in China.

China LNG Group Limited is a holding company whose group's principal activities are investment in and trading of assets and engagement in the development of new  energy businesses including investment, construction and operation of LNG filling stations, terminals and related infrastructure, sales and conversion of LNG vehicles and vessels, providing financial leasing service to customers.

Yanchang Petroleum International Limited and its subsidiaries is principally engaged in investments in the oil, gas and energy related business. The Company also invests in oil and gas exploration and operation, and the trading of fuel oil.

Yanchang Petroleum International (346 HK)

Hans Energy Company Limited, through its subsidiaries, operates storage and transshipment of oil and liquid petrochemical products in China.  The Company also manufactures and sells corrugated paper packaging products as well as trades petroleum products.

SouthGobi Resources Ltd. mines metallurgical and thermal coal in Mongolia.  The Company sells its coal to customers in China.

Strong Petrochemical Holdings, Ltd. offers trades of crude oil, petroleum products, and petrochemical products.

JTF International Holdings Limited operates as a holding company. The Company, through its subsidiaries, refined and blended fuel oil, petrol, and petrochemical products. JTF International Holdings markets its products throughout China.

Idemitsu Kosan Co., Ltd. explores, imports, refines, and distributes petroleum and its related products.  The Company also manufactures and sells petrochemical products.

China Petroleum & Chemical Corporation produces and trades petroleum and petrochemical products. The Company offers gasoline, diesel, jet fuel, kerosene, ethylene, synthetic fibers, synthetic rubber, synthetic resins, and chemical fertilizers. China Petroleum & Chemical markets its products throughout China.

SK Innovation Co., Ltd. refines, markets, and distributes oil.  The Company produces a variety of petroleum products, such as gasoline, kerosene, liquefied petroleumgas (LPG), and diesel oil.  SK Energy also manufactures petrochemical p roducts, including paraxylene, synthetic resins, styrene monomer, and ethylene.

Washington H. Soul Pattinson & Company Limited is an investment holding company. The Company owns shares and properties, coal mining, bulk handling, commercial television licensee, telecommunications carrier, merchant banking, funds management, pharmaceutical retailing, manufacture, processing and marketing of biscuits and cakes.

Washington H. Soul Pattinson and Co. Ltd (SOL AU)

Shanxi Xishan Coal & Electricity Power Co., Ltd. mines and processes coal. The Company also generates electric power.

Range Resources Corporation is an independent oil and gas company  that explore, develops, and acquires oil and gas properties. The Company conducts operations primarily in the Southwestern, Appalachian and Gulf Coast regions of the United States.

Shanxi Lu'an Environmental Energy Development Co., Ltd. mines, processes, and markets low sulfur high quality coal. The company also researches and develops coal and environment protection related technologies.

Shanxi Lu'An Environmental Energy Dev.Co (601699 CH)

Antero Resources Corporation explores, develops, and produces oil and natural gas. The Company focuses on the acquisition, development, and production of unconventional oil and liquids-rich natural gas properties. Antero Resources serves customers in the United States.

Chesapeake Energy Corporation produces oil and natural gas. The Company's operations are focused on discovering, developing, and acquiring conventional and unconventional natural gas reserves onshore in the United States.

PDC Energy, Inc. produces and distributes petroleum products. The Company produces, develops, explores and markets crude oil, natural gas, and natural gas liquids. PDC Energy operates in the United States.

Kunlun Energy Company Ltd, through its subsidiaries, explores and produces crude oil and natural gas in China.

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Kunlun Energy (135 HK)