China Gas Utilities:Official policy confirms our positive stance

Connection fee appears not to be included in the regulation: Although not directlyaddressed, looks like connection fees would not be included in the calculation of the7% ROA cap. Based on the official notice and press conference scripts betweenNDRC and reporters published by Xinhua News (22June), price regulation applies onthe gas distribution, while only assets related to this business would be taken intoaccount. We believe this implies connection fees and wholesale gas are excluded.

    Stock implications: In our recent report "Wind strengthens, gas looks good, solareclipsed" (14June 2017), we mentioned that final terms of this ROA regulation couldturn out to be better than expected. However, we continue to believe bigger cities(e.g. Tier 1-2), whose penetration and returns are higher, would be exposed to higherrisks than emerging cities/towns (e.g. Tier 3or below). Based on our analysis,Towngas China (low ROA operator) and Beijing Enterprises Holdings (no connectionfees in Beijing) are least impacted. ENN estimates it has three projects (15% of totalgas volume) delivering ROA higher than 7% excluding connection fees, which couldimpact its earnings by -5%. We lack sufficient data to perform a similar test on CRGas, but we believe 45% of its gas projects are located in Tier 1-2cities (peers: 5-6%), implying higher downside risks under a regulated ROA model. China Gas’ (384HK, not rated) ROA for gas distribution is less than 3% excluding connection fee,based on FY16results.