Friday, February 16, 2007
HK & China Gas (3): Take a Wild Guess?
Like PCCW, HK & China Gas, finally beginning to live up to its name serving China now, has a valuation that seems mind boggling, yet there has been a share repurchase programme, two privatization attempts (on Henderson Investment) and direct purchases by Mr. Lee, who's not known for buying high.
The business model of HKCG is about the simplest among all HK stocks, that of building pipelines and selling gas and equipment. It's a natural monopoly and there's no profit arrangement like the power companies, although it too faces political and public expectation to keep fees reasonable. As HK has become a mature city with limited population growth, it has diversified into property development and China, where major cities are moving toward using natural gas after PetroChina's west-to-east gas pipeline has commissioned operation.
HKCG has a market capitalization of about $97b, or $100b for simplicity. On average it made some $3b from selling gas in HK, fairly consistent. Future profits may become slightly higher after natural gas is increasingly used to replace coal (naphtha) in production of gas. Historical p/e before 2003 was between 15-18x (I chose pre-2003 as afterward property profit became part of recurring profit) and I'd arbitrarily give a 16x which is slightly higher than what I assigned to PCCW. This works out to be $48b or roughly half of HKCG's capitalization.
The question then becomes should the HK properties and China business worth as much as, or even more than, the HK gas business?
On the face of it the valuation is stretched as the HK operation has 140 years of history where HKCG only started investing in China since 2000. Segmental information in 2005 annual report showed China business took up a quarter of assets and contributed 3% of earnings before tax (increased to 7% in 2006 interim). Either way one looks at it it doesn't suggest a 50/50 split in valuation.
On the other hand the China market is huge as any China city, even 2nd-tier ones, can provide as big a market as HK. HKCG has laid pipelines in 34 cities, mostly in the Eastern region and Shandong, the receiving end of the giant gas pipeline. Once the supply issue is taken care of (it seems steady supply of gas is a problem now as demand is greater than anticipated) businesses should thrive, maybe exponentially.
However the China gas market is primitive both in terms of development and regulations. It's an open market and most cities would welcome anyone with the capital and skills to assume the responsibilities for laying and running the pipelines, in return for a share in the profit. So far a national operator with sufficient scale has yet to emerge but looking at the competitors so far, HKCG should have a higher chance mostly due to its reputation and financial capability.
Imagination can go very far, sometimes dangerously too far, so I try an educated guess as to how far we are now.
According to the 2005 annual report the China business had a NAV of $6.8b. Since earnings have yet to come one can only use p/b as a reference. After checking out Panva (I'll go into the Panva/HKGC deal later), Zhengzhou, Xinao, and China Gas, the p/b is from 2.3x to 3x. So at most HKCG can warrant a 3x p/b for its China business, although the ratio should actually be lower as HKCG can't grow as fast with the HK business dragging at its back (and so came the spin-off deal with Panva).
I worked out that the property interests had a book value of $6b (don't ask me how as it's a very rough guess too) Since these projects were either acquired at a low price (IFC centre and Grand Promenade) or self-owned site redevelopment (that in Ma Tau Kok), I'll give it a generous 2x p/b valuation so $12b in total.
Adding up the pieces I got $48b + $20.4b + $12b + $3b (securities investment on book) and $83.4b in total. This is 87% of the current market price. The 'imagination' premium is only 15% which is lower than I initially thought. And it may not even exist as the disclosure of HKGC is really inadequate and obscures any serious attempt of analysis. I wouldn't fault Mr. Lee for it though as he has been trying to buy up the company.
HKCG appears to be fairly priced now and is worth a second look when it 2006 results are out.
DISCLOSURE: I don't hold 3 at time of writing.
The business model of HKCG is about the simplest among all HK stocks, that of building pipelines and selling gas and equipment. It's a natural monopoly and there's no profit arrangement like the power companies, although it too faces political and public expectation to keep fees reasonable. As HK has become a mature city with limited population growth, it has diversified into property development and China, where major cities are moving toward using natural gas after PetroChina's west-to-east gas pipeline has commissioned operation.
HKCG has a market capitalization of about $97b, or $100b for simplicity. On average it made some $3b from selling gas in HK, fairly consistent. Future profits may become slightly higher after natural gas is increasingly used to replace coal (naphtha) in production of gas. Historical p/e before 2003 was between 15-18x (I chose pre-2003 as afterward property profit became part of recurring profit) and I'd arbitrarily give a 16x which is slightly higher than what I assigned to PCCW. This works out to be $48b or roughly half of HKCG's capitalization.
The question then becomes should the HK properties and China business worth as much as, or even more than, the HK gas business?
On the face of it the valuation is stretched as the HK operation has 140 years of history where HKCG only started investing in China since 2000. Segmental information in 2005 annual report showed China business took up a quarter of assets and contributed 3% of earnings before tax (increased to 7% in 2006 interim). Either way one looks at it it doesn't suggest a 50/50 split in valuation.
On the other hand the China market is huge as any China city, even 2nd-tier ones, can provide as big a market as HK. HKCG has laid pipelines in 34 cities, mostly in the Eastern region and Shandong, the receiving end of the giant gas pipeline. Once the supply issue is taken care of (it seems steady supply of gas is a problem now as demand is greater than anticipated) businesses should thrive, maybe exponentially.
However the China gas market is primitive both in terms of development and regulations. It's an open market and most cities would welcome anyone with the capital and skills to assume the responsibilities for laying and running the pipelines, in return for a share in the profit. So far a national operator with sufficient scale has yet to emerge but looking at the competitors so far, HKCG should have a higher chance mostly due to its reputation and financial capability.
Imagination can go very far, sometimes dangerously too far, so I try an educated guess as to how far we are now.
According to the 2005 annual report the China business had a NAV of $6.8b. Since earnings have yet to come one can only use p/b as a reference. After checking out Panva (I'll go into the Panva/HKGC deal later), Zhengzhou, Xinao, and China Gas, the p/b is from 2.3x to 3x. So at most HKCG can warrant a 3x p/b for its China business, although the ratio should actually be lower as HKCG can't grow as fast with the HK business dragging at its back (and so came the spin-off deal with Panva).
I worked out that the property interests had a book value of $6b (don't ask me how as it's a very rough guess too) Since these projects were either acquired at a low price (IFC centre and Grand Promenade) or self-owned site redevelopment (that in Ma Tau Kok), I'll give it a generous 2x p/b valuation so $12b in total.
Adding up the pieces I got $48b + $20.4b + $12b + $3b (securities investment on book) and $83.4b in total. This is 87% of the current market price. The 'imagination' premium is only 15% which is lower than I initially thought. And it may not even exist as the disclosure of HKGC is really inadequate and obscures any serious attempt of analysis. I wouldn't fault Mr. Lee for it though as he has been trying to buy up the company.
HKCG appears to be fairly priced now and is worth a second look when it 2006 results are out.
DISCLOSURE: I don't hold 3 at time of writing.
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