Shenzhen Gas is an integrated city gas operator headquartered inShenzhen with a nationwide project coverage. With the Shenzhen projectlaying a solid foundation, the Company has two low-cost imported gassources to achieve wider price margins and channel expansion. Itsearnings quality is outstanding and the payout ratio outperforms peerssubstantially. We forecast the 2020E-22E EPS to be Rmb0.45/0.53/0.59,implying 15x/12x/11x PE, respectively. We initiate coverage with a “BUY”

    　　rating and a DCF-based target price of Rmb8.80.

    　　A solid foothold in Shenzhen

    　　Shenzhen Gas is a local state-owned enterprise (SOE) headquartered inShenzhen and mainly engaged in city gas operations with an extendedpresence in gas import, natural gas wholesale, and liquefied petroleum gas(LPG) import and distribution. 80% of its earnings is contributed by the gasbusiness in Shenzhen. As a scarce first-tier-city gas project, Shenzhen lays asolid earnings foundation for the Company.

    　　Volume and price to recover in the city gas businessWe believe that the 3-year-long gas supply squeeze and upstream pricehikes are being reversed and that the purchase price of gas from CNPC(West 2 Line) would decrease by about Rmb0.05/m3 per annum from 2020 to2022. We believe that most of the decrease in upstream prices will be usedby city gas operators to lower end-user prices, which could stimulate gassales and slightly widened the price margins. In this process, the Shenzhenproject may enjoy higher demand elasticity than peers.

    　　Expanded gas sources and an extended value chainSince 2H19, Shenzhen Gas has been developing its two low-cost importedgas sources, namely the Hua’an LNG peak-shaving station and the CNOOCDapeng receiving station under the terminal use agreement (TUA).

    　　Compared with the pipeline gas purchased from CNPC and CNOOC, theimported gas has substantial price advantages, and could help optimize thegas sources of Shenzhen Gas. In order to maximize the advantage of thelow-cost imported gas and minimize the impact of fluctuations in the pricemargins, Shenzhen Gas has been expanding its downstream sales channelsincluding city gas stations, gas-fired plants and offshore LNG stations so as tolock up and extend its value chain. We estimate that under steady operationsat full load, Hua’an LNG terminal and Dapeng TUA will contributeapproximately Rmb580mn/300mn in annual net profit, respectively.

    　　High-quality earnings and generous dividendsBenefiting from the unique gas pricing model in Shenzhen, Shenzhen Gashas the highest proportion of gas sales profit and the lowest proportion ofconnecting profit among major peers. At the same time, Shenzhen Gasgenerates abundant cash flow and enjoys decreasing capex, enabling it todeliver a significantly higher-than-peer payout ratio that is still increasing inrecent years.

    　　Potential risks

    　　Less-than-expected natural gas demand, a substantial increase in imported gasprices, and a decrease in terminal gas price or gas turbine on-grid electricity price.

    　　Investment recommendation

    　　Shenzhen Gas has a solid earnings foundation in Shenzhen, and has furtherextended its upstream and downstream value chains by expanding low-cost importedgas sources. We forecast its 2020E-22E EPS at Rmb0.45/0.53/0.59, implying threeyearPE of 15x/12x/11x, respectively. We initiate coverage with a “BUY” rating and aTP of Rmb8.80 based on the DCF method.

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