PRC gas sector: strong prospects
We are positive about the PRC gas sector, as rising gas sales should
support high earnings growth in 2007-09 and reduce reliance on the
one-off connection fee income. Our analysis on connection fee
cancellation shows immaterial impact on NPVs of gas companies.

Benefit from government's plan to triple natural gas consumption
The government aims to increase the percentage of natural gas consumption to total
energy usage from 3% currently to 6% by 2010 and 10% by 2020, given the growing
concerns about environmental pollution and to ensure a more balanced fuel mix for
the PRC energy sector in the long term. We believe this will hasten the development
of city gas projects as natural gas penetration increased. Moreover, we see
opportunities for city gas companies to invest in upstream and midstream gas
businesses to secure natural gas resources.
Stronger gas sales should drive earnings and improve earnings quality
We believe the shift in city gas companies’ focus to increased gas sales should
outweigh the margin squeeze and result in high earnings growth in 2007-09. Also,
with reduced reliance on one-off connection fee income, their earnings should
become more recurrent and, hence, less sensitive to potential connection fee
cancellation. Overall, we estimate China Gas will deliver the highest 2008-09 EPS
CAGR of 50%, followed by Towngas China (32%) and Xinao (25%).
Concerns about possible connection fee cancellation seem overdone
We believe investors are overly concerned about the possibility of connection fee
cancellation. Of all the suggestions in the market, the 'two-tier tariff mechanism'
appears the easiest to adopt. If 40% of the connection fee were to be paid by
property developers when connected to new customers and the other 60% by endusers
as a capacity tariff in two-year instalments, we estimate it would lower 2008
earnings of city gas companies by only 11-26% and would have an immaterial impact
on their NPVs.
Buy Xinao, China Gas, HKCG and Enric
Within the sector, we see maximum upside potential in the share prices of Xinao and
China Gas, as they are trading at the steepest NPV discounts. HKCG is not a pure
play on the PRC gas business but, given its sound brand name in China and solid
balance sheet, its expansion in the PRC water business could emerge as another
earnings driver. If investors want to avoid the risk of connection fee cancellation, we
advise them to buy Enric, as it could benefit indirectly from the booming gas industry
by providing equipment for natural gas storage and gas refuelling stations.

Contents
U T I L I T I E S 1 2 J U N E 2 0 0 7 2
V A L U A T I O N C O M M E N T
Investment snapshot 3
Valuation and recommendation 4
We are positive on the PRC gas companies, as we forecast their 2008-09 EPS
CAGR will remain high at 11-50%, benefiting from the fast-growing natural gas
industry. Our top picks are Xinao, China Gas, Enric and HKCG.
DCF-based valuation 4
Ratio-based valuation 4
How to invest in the PRC gas sector 5
I N D U S T R Y D Y N A M I C S
Fast-growing natural gas industry 7
Driven by environmental issues and energy diversification, demand for natural gas
is rising. We believe this will accelerate the development of city gas projects, and
midstream and upstream natural gas businesses.
Increasing consumption 7
Upstream development: more gas fields to be discovered 8
Midstream development: accelerating investment in natural gas infrastructure 9
Downstream development: encouraging the use of natural gas vehicles 12
I N V E S T M E N T V I E W
Stronger gas sales should drive earnings 13
We believe the focus on boosting gas sales should outweigh the margin squeeze for the
city gas companies and result in high earnings growth in 2007-09F. Further, earnings
quality should improve from reduced reliance on...
Robust growth in gas sales 13
Improving earnings quality 13
Margin decline slowing 14
Strong turnover growth outweighs margin squeeze 14
Earnings sensitivity 15
Concerns about possible cancellation of connection fee seem overdone 17
We expect a two-tier tariff mechanism to be adopted to compensate for the loss
from the possible cancellation of connection fees. We expect long-term earnings
and intrinsic values of gas companies to be marginally...
Scenario analysis 17
C O M P A N Y P R O F I L E S
Company profiles
HK & China Gas 21
Xinao Gas Holdings 33
China Gas 44
Towngas China 54
Enric Energy 65
A P P E N D I X
1. Valuation comparison 72
2. PE band charts 73
3. PBV band charts 74
4. Winners and losers 75