- CFY is a Canadian owned and listed natural gas distribution company in China
- Business growth performance and ROE are in line with industry norms
- EV/EBIT of 4.9x vs Chinese industry 26.3x
- CFY has partnered with large multinational energy companies (lectricit de France) to diversify into new energy infrastructure
- Recently announced another RMB 180M ($36M CAD) project (71% owned) to produce an integrated energy infrastructure solution
- Catalyst is a dual listing on the HKSE to increase liquidity and valuation to industry norms (summer/spring 2019)
- Conservative valuation is $4 CAD/share vs current price of $0.9 CAD
Changfeng Energy Inc. is a natural gas service provider with operations located throughout the People's Republic of China. The Company services industrial, commercial and residential customers, providing them with natural gas for heating purposes and fuel for transportation. The Company has developed a significant natural gas pipeline network as well as urban gas delivery networks, stations, substations and gas pressure regulating stations in Sanya City & Haitang Bay. Through its network of pipelines, the Company provides natural gas to both homes and businesses. The Company is headquartered in Toronto, Ontario and its shares trade on the Toronto Venture Exchange under the trading symbol "CFY".
Quantitative Performance The historic performance since CFY issued their IPO at $38M CAD ($0.60 CAD/share) in 2008 was as follows:
- 10 year revenue growth of 19% (14.6M CAD to 83.4M CAD);
- High gross (>40%) and operating margins (>15%);
- TTM earnings from continuing operation of $10M CAD (as of 2018 Q2) on $41.4M CAD equity (Q2 2017) = 24% ROE;
- ROE average ~15% without a year under 10%;
- Current cash position to $21.2M CAD without issuing additional equity;
- Total debt $33.4M CAD funded by government green energy bonds; and
- Therefore, ROE ~ ROA since there is actually very little net debt.
Quantitatively, what I described above is a very good company that compounds well at its ROE and has had very consistent results for the past 10 years.
--Market Price-- The current price is illiquid, but priced below $65M (@ $1 CAD/share).
- EV: At $65M market cap plus $12.2M net debt, the EV is $77.2M.
- TTM EBIT* = $10M net income + $5.6M (Tax + Interest) = $15.6M CAD
- EV/EBIT* = $77.2/$15.6 = 4.9x
- P/E* = $65M/$10 = 6.5x
- P/B = 1.1
- P/S = 0.7x
- P/FCF = N/A**
*from continued operations, ignoring discontinued earnings
**Due to the recent sales of assets and the repayment of debt within joint ventures, the cash flow statements from the last two quarters show negative FCF. Talking with management, FCF should return positive in the subsequent quarters.
--Valuation Comparables From NYE Stern Business School-- --China Green & Renewable Energy-- - Number of firms = 17
- EV/EBIT = 19.2x
- Current PE = 119.80
- Trailing PE = 42.50
- Forward PE = 13.23
- Expected Growth next 5 years = 22.80%
- PEG Ratio = 0.75
--China Oil and Gas Distribution-- - Number of firms = 8
- EV/EBIT = 26.3x
- Current PE = 64.15
- Trailing PE = 40.76
- Forward PE = 23.49
- Expected Growth next 5 years = 18.90%
- PEG Ratio = 1.32
--Example of a Chinese Comparable-- --ENN Energy in China-- - Market Cap = $14.8B CAD
- ROE = 17.65%
- EV/EBIT: 24.5x
- P/E = 20x
- P/B = 3.44x
- P/S = 2.16x
--US Green & Renewable Energy-- - EV/EBIT = 69.09x (EV/EBITDA = 15.13)
--US Oil and Gas Distribution-- Qualitative Performance --Strategy-- Changfeng is starting to shift from an exclusive gas distribution company to diversified energy infrastructure business.
The following three sectors will be
Changfeng’s main business lines through 2019:
- natural gas downstream distribution, including urban city pipeline gas distribution, gas refueling stations, and LNG distribution;
- integrated smart energy system to distribute power, heat, cooling, and hot water; and
- natural gas mid-stream infrastructure.
--Existing Projects-- Currently the Company has six projects in operation: two pipeline natural gas distribution projects, two liquefied natural gas (“LNG”) supply distribution projects, and two compressed natural gas (“CNG”) vehicle refueling stations. Most of the projects have long infrastructure concession rights (30 years).
--Gas Sales Last Quarter-- Three Months Ended (RMB‘000)
- Q2 2018: 58,749
- Q2 2017: 35,886
- Change: 22,863 (64%)
Six Months Ended (RMB‘000)
- Q2 2018: 122,714
- Q2 2017: 87,155
- Change: 35,559 (41%)
--Pipeline Installation and Connection— Three Months Ended (RMB‘000)
- Q2 2018: 27,879
- Q2 2017: 31,773
- Change: -3,894 (-12%)
Six Months Ended (RMB‘000)
- Q2 2018: 53,619
- Q2 2017: 54,884
- Change: -1,265 (-2%)
--CNG Vehicle Refueling Stations-- Three Months Ended (RMB‘000)
- Q2 2018: 14,180
- Q2 2017: 14,630
- Change: -450 (-3%)
Six Months Ended (RMB‘000)
- Q2 2018: 28,605
- Q2 2017: 28,208
- Change: 397 (1%)
The latest quarterly report also highlights the specific regional gas sales, residential and commercial growth, and the vehicle refuelling stations, which you can analyse in depth. But in summary, everything is going well except the refueling station in “Changsha, dropping by 29% and 25% for the second quarter of 2018 and six months ended June 30, 2018 respectively. CNG sales volume from Sanya CNG vehicle refueling station experienced an increase of 11% and 18% for the second quarter of 2018 and six months ended June 30, 2018 respectively.” However, net there is significant net growth in gas sales.
--New Projects-- --Haitang Bay Integrated Smart Energy Project-- - This project is conducted through a 50:50 joint venture established between Changfeng and the lectricit de France (EDF Group).
- The project signing was formally witnessed by Chinese President Xi Jinping and French President Emmanuel Macron.
- Consists of four large water holding tanks (football field sized) where water is heated and cooled using of multiple clean energy sources, such as solar, hydro, electricity, and natural gas, to supply cooling, heating, and hot water to hotels, shopping centers, and households in the Haitang Bay area (Hainan Province).
- In December 2017, the Sanya Municipal Government and the JV signed the 30-year concession right agreement which gives the right to build, own, and operate the energy processing stations in Haitang Bay.
- Development has started, contracts with customers are currently being negotiated, and commencement of commercial operation is expected by the end of 2018.
- The joint venture has a registered capital of 100 million RMB, approximately $20M CAD, or $10M CAD from Changfeng (@50% ownership)
- Changfeng historic operating cash flow on capital assets = ~15%***
- Therefore, assuming continuance of return on capital assets: 15% of $10M CAD is $1.5M CAD or with 65M shares is 2-3 cents in cash flow per year
--Meishan Integrated District Energy Distribution Project-- - The Meishan Project is in the Meishan New Economic Development Zone, an economic zone situated next to central urban area of Meishan City, Sichuan province
- The Meishan New Economic Development Zone will be a hub for manufacturers of drugs, supplements, medical equipment, and other medical related supplies.
- The year-round constant demand of steam necessary to produce drugs makes the Meishan New Economic Development Zone an ideal platform for integrated district energy distribution.
- The Meishan Project is planned to be developed in two or three phases.
- Effectively 71% owned by Changfeng through wholly owned and partially owned subsidiaries
- RMB 180M ($36M CAD) projected capital injected to complete project (71% of $36M = $25.56M CAD)
- Changfeng historic operating cash flow on capital assets = ~15%***
- Therefore, 15% of $25.56M CAD is $3.85M CAD or with 65M shares is 5-6 cents CAD in cash flow per year
Note: There are other projects in the works like the recently announced LNQ Canada-China import activity and the powerplant in Zhaoqing City, Guangdong Province.
Outlook in China I extracted all information from the following, created in April 2017:
Titled: Current and Future Natural Gas Demand in China and India
https://www.beg.utexas.edu/files/energyecon/think-corner/2017/CEE_Research_Paper-China_and_India_Current_Future_Natural_Gas_Demand-Apr17.pdf “Economic growth has led to serious urban air pollution problems in China, which they are attempting to address. Although environmental issues could lead to increased demand for natural gas at the expense of coal, it is not clear how much China is willing to pay to internalize environmental externalities, including those associated with carbon.”
“The electric power and industrial/commercial sectors account for over 60% of total natural gas demand. Industry/commercial is by far the largest consumer of electricity, 72% in China in 2015. Residential gas demand, the next largest gas consuming sector, is driven by increasing urbanization which in turn is linked to economic growth.”
“China’s gas infrastructure is not well-integrated. Numerous regional pipeline bottlenecks exist, distribution is inadequate in some places and the country has insufficient storage. There are many bottlenecks in moving regasified LNG from import terminals to demand centers. However, further gas pipeline and storage development is required to (1) expand natural gas deliveries to new and/or underserved demand centers; (2) to expand CGD networks in more cities and to integrate regional and local CGD networks with LNG regasification terminals and the national trunk lines, and (3) possibly to accommodate future gas deliveries from Russia’s Siberian gas fields in 2018. China has plans to double the size of its pipeline network by 2020 but it is not certain that they will do that given the current economic situation. Its state-owned oil and gas companies, especially PetroChina, are under severe financial pressures from imported gas losses, the low crude oil price and the November 2015 gas price reduction.”
--China Macro Summary-- “In our view, there is gas demand growth potential in the city gas distribution sector of China which could be realized if there is continued strong investment in the expansion of distribution and transport infrastructure. We think there will be continued strong policy support for renewables in power generation to achieve environmental goals. As a result, our expectation of natural gas demand growth in those two sectors is at the lower end of the forecasts (~5%). If there are difficulties in accommodating renewables in power sector transmission grids, there may be a possibility for gas to play a greater role in generation. Environmental policies will not assure growth in natural gas use. In all likelihood, they would mainly serve to foster alternative energy approaches.”
The findings in this report align with the strategic changes made by
Changfeng to diversify to more renewable infrastructure energy projects such as the Haitang Bay Integrated Smart Energy Project. The findings of this report align with other information I have obtained on the Gas outlook in China.
Valuation Assessment From a quantitative standpoint,
Changfeng appears to be priced around 1/5 of its Chinese competitors. I believe this is a result of perceived risk from the following:
1) Being listed in Canada, who’s population perceive a high country risk;
2) Illiquidity of the shares (big funds can't buy into it); and
3) Low market cap perceived risk (i.e. microcap - it's priced low because it's priced low).
I haven’t seen anything from an operational risk perspective that would lead me to believe that
Changfeng sees more operational risk than a larger Chinese gas distribution company. In addition, I do not see as great a country risk as what the average Canadian or American might see in China. For example, Buffett and Munger wouldn’t be investing so much in China if that were the case.
I do believe there should be a size discount to the large pipelines. Therefore, an EV/EBIT of 15x would be almost half the valuation of a comparable Chinese gas distribution company. This would yield a valuation of (not including future projects):
--Calculation-- EV/EBIT = (Market Cap + Debt)/EBIT
15= (Market Cap + 12.2)/15.6
- An EV/EBIT of 15, Market Cap = $222M CAD or $3.41 CAD/share
- An EV/EBIT of 20 Market Cap = $300M CAD or $4.61 CAD/share
- An EV/EBIT of 25 Market Cap = $378M CAD or $5.81 CAD/share
These numbers obviously ignore any additional revenue and earnings from the Haitang Bay Integrated Smart Energy Project, the Meishan Project, or organic growth in current assets. These two new projects will add an expected additional ~$5M EBIT, or ~$1-2 CAD/share in value. At fully valued and incorporating future earnings, I would put the value range at $5.4-8.8. I would say today a $4 CAD per share valuation is very conservative.
Catalysts
In order for Changfeng to realize its potential valuation, CFY identified a plan to dual list on the Hong Kong Stock Exchange (HKSE) and the Toronto Stock Exchange (possibly moving up from the venture exchange) in order to improve liquidity and valuation. Initially, this was targeted for the spring of 2018, however delayed to 2019 to take advantage of further growth in earnings. Although the delay to the dual listing was unfortunate for short term investors (my original estimate was $2), it was better to ensure any equity raises occurred at a higher potential valuation to incorporate these new projects and limit share dilution.
Conclusions
If you buy CFY and the dual listing is further delayed or the value doesn't jump up, just as what happened for the past 10 years, the earnings will continue to compound while you wait. Therefore, holding CFY means more earnings growth and higher returns once value is eventually realized in the market. Either way, this stock is extremely undervalued and offers significant upside.