China Gas Holdings - Record high free cashflow to support high dividend yield
- Downgrade to HOLD, with new TP of HKD6.40 after cutting FY26 earnings by 16%; trading at an unattractive >10x PE
- With unexciting gas distribution operations, VAS is the major driver, but core earnings expected to decline slightly in FY3/26;
- Record free cashflow to support high dividend payout of >80%, offering attractive dividend yield of 6.8%
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For gas distribution, total retail gas sales volume stayed flat, but dollar margin reached Rmb0.537/cm in FY3/25, up from Rmb0.50/cm in FY3/24. The hike was above expectations. Given macroeconomic and trade war risks, we remain cautious on gas volume growth in the industrial and commercial segments. We estimate total gas volume growth of 1.3% in FY3/26, mainly from recovering residential demand after a warm winter. Gas procurement costs are expected to remain stable, with PetroChina prices flat or slightly up, offset by declines from other suppliers. Coupled with ongoing cost pass through mechanism, we expect a further hike in dollar margin to Rmb0.548/cm in FY3/26, up from our previous estimate of Rmb0.524/cm. Nevertheless, the stable growth from gas distribution, driven by dollar margin hike, will be offset by estimated decline of c.20% in gas connection / engineering design and construction.
VAS revenue growth of 2% in FY3/25 was below expectations. On a positive note, operating profit climbed 10.6% with operating margin rising from 43% in FY3/24 to 46.9% in FY3/25, thanks to strategic shift in high-margin products. China Gas continues to expand its product offerings with innovative products / services, leveraging on its natural gas customer base to create a closed-loop ecosystem for household scenarios. For instance, the company is able to offer kitchen / bathroom upgrade / renovation services within 48 hours. It is also venturing into direct drinking water systems for residential and commercial complexes, enhancing convenience and enable further value-added services, like mineral-enhanced water. It is also developing smart energy devices. These initiatives, supported by AI-driven supply chain optimization and a closed-loop household ecosystem, aim to drive VAS profit growth of >10% in FY3/26.
In FY3/25, China Gas reported 8.7% growth in free cash flow, hitting a new record of HKD4.66bn, driven by a combination of lower capex and cash inflows from associated companies / JVs, despite a decline in net operating cash flow. The decline of >40% in net operating cash flow to HKD6.44bn in FY3/25 was largely due to a HKD1.97bn increase in contract assets related to state-funded pipeline subsidies, which temporarily impacted working capital. This contrasts with FY3/24, when contract assets fell by HKD1.64bn, resulting in a HKD3.6bn swing. The decline in operating cashflow was offset by drop of HKD1.36bn in capex to HKD4.64bn and HKD2.86bn inflow from associated companies through dividends, loans repayment, and asset restructuring. State-funded pipeline upgrades further reduced self-funded capex, boosting free cash flow.
In FY3/26, China Gas’ capex will further drop to HKD4bn, with HKD3–3.5bn allocated to gas projects and the remaining to integrated energy and LPG, aided by ongoing state-funded pipeline upgrades that minimize self-funded capex. Operating cash flow is anticipated to improve with declining contract assets following payments from the government. Cash inflows from associates and joint ventures are likely to continue supporting investing cash flow. Thus, we expect free cash flow to remain robust, sufficient to cover its high dividend payout of >80%.
To reflect the variances in FY3/25 results to our forecasts, we have lowered our turnover estimates by 8% and reduced profit from associated companies / JVs by 43%, leading to a 16% reduction in FY3/26 earnings forecasts. After the revision, we estimate core profit to decline marginally in FY3/26, before rebounding by 3.8% in FY3/27. Nevertheless, the high dividend payout ratio supports an attractive dividend yield of around 6.8%, limiting downside risk to share price. We downgrade our rating to HOLD with a new TP of HKD6.40, based on unchanged 10x 12-month rolling PE. The spinoff of Yipinghui is progressing well with listing expected to be in 2H2025 following approval by the China Securities Regulatory Commission. If Yipinghui is listed at higher valuation of 15-18x, this could improve China Gas’ valuation by HKD0.8-1.4/share.
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