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THE HONG KONG AND CHINA GAS COMPANY LIMITED (中华煤气)


EAST ASIA SECURITIES COMPANY LIMITED
9/F, 10 Des Voeux Road Central, Hong Kong. Dealing: 3608 8000 Research: 3608 8097 Facsimile: 3608 6132

Analyst: Paul Sham

HONG KONG RESEARCH th 27 March 2008

THE HONG KONG AND CHINA GAS COMPANY LIMITED (中華煤氣)
Sector HKSE Code Market Price Shares Issued Mkt. Cap. 52 weeks Hi/ Lo HSI Main Business : : : : : : : : Utilities 0003 HK$21.85 (26/03/2008) 6,059.6m HK$134,402.3m HK$24.30 / HK$16.00 22,617.01 (26/03/2008) Towngas supply Chairman Managing Director CFO : Dr. Lee Shau Kee : Mr. Alfred Chan Wing Kin : Mr. John Ho Hon Ming

SUMMARY OF THE FINAL RESULTS FOR THE YEAR ENDED 31ST DECEMBER 2007 Final Results Highlights FY2007
HK$ million
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FY2006
HK$ million Change

Revenue Operating profit before returns on investments Investment income Other gains Interest expense Share of results of associates Share of results of jointly-controlled entities Profit attributable to shareholders EPS Final DPS Total DPS

14,225.5 5,303.0 364.3 2,258.4 (364.0) 1,130.0 1,616.3 9,269.6 1.530 0.23 0.35

13,465.3 5,169.1 527.2 0.0 (310.2) 316.1 1,102.0 5,862.6 0.967 0.23 0.35

+5.6% +2.6% -30.9% NA +17.3% +257.5% +46.7% +58.1% +58.2% +0.0% +0.0%

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Hong Kong & China Gas (“HKG”) reported a 58.1% increase in net profit to HK$9,269.6m for FY07, beating market consensus of HK$7,918.7m. Excluding non-cash gain from Panva Gas deal, property sales and property revaluation gain, recurring net profit was up only 3.2% to HK$3,215.8m, on a higher contribution from its Mainland operations. In 2007, HKG recorded several non-recurring items which boosted the overall net profit, including: 1) Acquisition of shares in Panva Gas Holdings Limited by way of asset injection, amounting to HK$2,235.7m; 2) Sales of properties in Grand Waterfront, Grand Promenade and King’s Park Hill, amounting to HK$2,775.0M; 3) Revaluation surplus from investment properties, amounting to HK$1,460.4m. EPS was HK$1.53 for FY07 while recurring EPS was HK$0.53. Meanwhile, final DPS was maintained at HK$0.23 and the full-year dividend payout ratio for FY07 was 22.9% (FY06: 36.9%). HKG also proposed a 1 for 10 bonus issue. As of 31/12/2007, HKG recorded net debts totalling HK$2,940.3m (31/12/2006: HK$6,415.8m). Its net debt-to-total equity ratio declined remarkably to 10.0% as of 31/12/2007 from 30.2% as of 31/12/2006.

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This report has been prepared solely for information purposes and we are not soliciting any action based upon it. Neither this document nor its contents shall be construed as an offer, invitation, advertisement, inducement or representation of any kind or form whatsoever. The information is based upon information which we consider reliable, but accuracy or completeness is not guaranteed. Opinions expressed herein are subject to change without notice. At time of this report, East Asia Securities Company Limited has no position in securities of the company or companies mentioned herein, while its group companies may from time to time have interests in securities of the company or companies mentioned herein.

EAST ASIA SECURITIES COMPANY LIMITED
Business Review

FY2007 Gas sales before fuel cost adjustment Fuel cost adjustment Gas sales after fuel cost adjustment Equipment sales Maintenance and services Water sales Property sales Rental Income Other sales Total revenue Total revenue (ex-Property related income) 7,524.0 1,021.5 8,545.5 770.1 272.1 260.9 3,806.3 9.6 561.0 14,225.5 10,409.6

FY2006 6,988.9 1,359.4 8,348.3 784.8 255.9 209.6 3,366.5 0.0 500.2 13,465.3 10,098.8

Change

60.1% 5.4% 1.9% 1.8% 26.8% 0.1% 3.9% 100.0%

62.0% 5.8% 1.9% 1.6% 25.0% 0.0% 3.7% 100.0%

+2.4% -1.9% +6.3% +24.5% +13.1% NA +12.2% +5.6% +3.1%

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Total revenue amounted to HK$14,225.5m, up 5.6%, while total recurring revenue (ex-Property related income) was up 3.1% to HK$10,409.6m, on higher gas sales and water sales in China. In Hong Kong, gas sales was flat, with Towngas volume sales increased at a meagre of 0.03% to 27,041.0m MJ. The volume of commercial and industrial gas sales increased by 2.1% y-o-y due to the thriving hotel and restaurant sectors, but was offset by the residential gas sales which decreased by 1.6% y-o-y, due to keen competition in the energy sector. Number of customers increased by 1.5% to 1.646m. Net profit contribution from Mainland operations was up 82.8% to HK$664.6m (or 20.7% of HKG’s recurring earnings ex-Property sales). Gas volume sales from piped city-gas projects in the Mainland jumped 114.9% to 4,555m m3, while customer base also rose 95% to 8.2m. Revenue from HKG’s water projects (Wujiang in Jiangsu province, Wuhu in Anhui province and Suzhou Industrial Park in Jiangsu province) increased 24.4% y-o-y to HK$260.9m. HKG recorded property sales of HK$2,775m from the sale of the residential units at Grand Waterfront in Ma Tau Kok (HKG owns 73% interest) and its share of profits amounted to HK$866.3m. The sales of Grand Promenade (HKG owns 50% interest) in Sai Wan Ho also generated HK$1,829m in profit. Revaluation gain of HK$1,269.4m was being booked re. its 15.8% owned International Finance Centre.

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Outlook & Prospect ? Unexciting Hong Kong business Stagnant earnings growth in the Hong Kong Towngas business is expected as the sales volume growth remains flat for the past few years. Earnings growth in HK may only materialize with a tariff hike, which has not been announced yet. Furthermore, property sales from Grand Promenade and Grand Waterfront can provide little help in cash flow as the cumulative GFA sold from these two projects have reached 95.9% and 95.8% respectively. Mainland earnings momentum should sustain Profit contribution from the Mainland increased at a CAGR of 90.3% from HK$14m in 2001 to HK$664.6m in 2007, and represented 20.7% of HKG’s total profit in FY08. Earnings growth from China remains the key earnings driver for HKG. New business line in clean energy Since 2008, HKG has stepped up its interest into clean energy businesses in both Hong Kong and China. Projects in HK include LPG filling stations, landfill gas

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EAST ASIA SECURITIES COMPANY LIMITED
project and an aviation fuel facility while projects in China include methanol projects and coalbed gas liquefaction joint venture. Even though these projects are still far from contributing sizable income to HKG, they provide future growth prospects to the company, just like its investment in China few years ago which now provides more than 20% of total earnings. ? Rich valuation not justified HKG is currently trading at 14.3x FY07 P/E. However, if we strip out all the non-recurring items, including property sales which is unlikely to repeat in 2008, valuation of HKG would reach 40x, which is very demanding when compared with other two blue-chip HK utility plays CLP and Hongkong Electric, whose FY07 P/Es are at mid-teen only. Even assuming that the current momentum of 90% growth in China can be maintained, the incremental earnings increase will not be able to offset the loss of earnings from property. Therefore, we believe its China growth potential is overly reflected in the share price. In addition, its dividend yield of 1.6% is the lowest among the 3 main utility stocks. We therefore recommend investors to “Sell” the counter.

Recommendation:

Sell

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EAST ASIA SECURITIES COMPANY LIMITED Important Disclosure / Analyst Certification / Disclaimer This document is published by East Asia Securities Company Limited, a wholly-owned subsidiary of The Bank of East Asia, Limited (BEA). The research analyst primarily responsible for the content of this report, in part or in whole certifies that the views on the companies and their securities mentioned in this report accurately reflect his/her personal views. The analyst also certifies that no part of his/her compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in this report. This report has been prepared solely for information purposes and has no intention whatsoever to solicit any action based upon it. Neither this report nor its contents shall be construed as an offer, invitation, advertisement, inducement or representation of any kind or form whatsoever. The information is based upon information, which East Asia Securities Company Limited considers reliable, but accuracy or completeness is not guaranteed. Information and opinions expressed herein reflect a judgment as of the date of this document and are subject to change without notice. Any recommendation contained in this report does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This report is not to be taken in substitution for the exercise of judgment by respective readers of this report, who should obtain separate legal or financial advice. East Asia Securities Company Limited and / or The BEA Group accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or further communication given in relation to this report. At time of this report, East Asia Securities Company Limited has no position in securities of the company or companies mentioned herein the report, while BEA along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this report. BEA and its associates, its directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. BEA and/or any of its affiliates may beneficially own a total of 1% or more of any class of common equity securities of the subject company or companies mentioned in this report and may, within the past 12 months, have received compensation and/or within the next 3 months seek to obtain compensation for investment banking services from the subject company or companies mentioned in the report. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country or other jurisdiction, publication, availability or use would be contrary to law and regulation.

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