CR Gas on buying spree to ensure its survival
China Resources Gas Group, the city natural gas distribution arm of state-backed conglomerate China Resources (Holdings), has outlined a 10 billion yuan (HK$11.57 billion) plan to triple the number of its projects in three years.
CR Gas aims to have more than 90 projects by 2013, compared to 32 currently, chief financial officer Ken Ong Thiam Kin said. The company announced earlier this month that it would buy nine projects from its parent for HK$2 billion, raising the number of projects to 41.
Ong said the 10 billion yuan expansion would see its total annual gas sales rising to 9 billion cubic metres from around 5 billion currently at its 32 projects.
The parent company owns 30 projects that have not yet been injected into CR Gas. In the next three years, Ong said, CR Gas plans to buy 20 projects from third parties as well as its parent's 30 projects.
CR Gas plans to fund the acquisitions half by bank loans and half by issuing shares or bonds. In the process, it is aiming for its net debt-equity ratio not to exceed 100 per cent. The ratio stood at 93 per cent at the end of June, and is expected to drop to 8 per cent after the issuance of 230 million shares to investors to fund capital commitments in earlier asset acquisitions and 187 million shares to its parent for the nine projects' purchase.
Ong said CR Gas, with the backing of its state-owned parent, had an edge over private enterprises in negotiating to buy projects from local governments, since local governments are after job-creating investments from large state firms.
He estimated some 75 medium to large city gas projects were still in the hands of local governments, and CR Gas aimed to buy a third of them.
CR Gas, which bought control of a 43.18 per cent stake in listed Zhengzhou Gas from the Zhengzhou municipal government, has offered to buy all the shares it does not already control at HK$14.73 each, plus a special dividend of 49 fen (57 HK cents) each.
Ong said the Zhengzhou government was willing to sell to CR Gas 80 per cent of a firm that owned the 43.18 per cent stake because it wanted CR Gas's parent, which operates in the property, retail and brewery sectors, to invest more in the city, which is the capital of Henan province.
Ong expected that in five years, when most large city gas projects will have been acquired by professional operators, so-called connection fees would likely be abolished, which would cut gas distributors' incomes and spark industry consolidation.
The bulk of distributors' connection fee income comes from residential users. The fees are levied when a property project is built, to pay for expensive infrastructure required to link households to gas sources. Such fees are lucrative, with more than 60 per cent in gross profit margin, higher than the 20 per cent on gas sales.
The fees are considered necessary when penetration of piped gas is low, to provide incentives for distributors to expand their pipeline networks, but they are expected to be rolled back once gas sales contribute the bulk of distributors' profits.
Ong said the industry's return on equity could be slashed to 8 per cent from between12 per cent and 16 per cent if connection fees were to be abolished.
Guangdong province had tried to terminate connection fees in late 2006 and to compensate distributors by allowing them to charge higher gas prices, but backed down after strong opposition from distributors.
Hebei province this month also regulated gas prices on a trial basis, with the aim of limiting distributors' return on equity to 8 per cent, based on average industry costs, though analysts said more efficient distributors could make a higher return.
While Ong did not expect this to spread to other provinces any time soon, as most wanted to encourage infrastructure building and gas consumption, he said once connection fees were banned, most of the several hundred distributors would not survive. 'We think only four to five companies will survive in the long term, and we hope we are one of them, and become a consolidator,' he said.
Without connection fees, the smaller distributors would not have enough bargaining power to obtain low enough gas prices to remain profitable, he added.
Those relying on the residential market will have a harder time as it is tougher to raise gas prices in this segment compared with industrial and commercial gas users, he said.
Ong expected Beijing to raise gas prices by roughly 10 per cent each year in the next four to five years to narrow the gap between domestic and international gas prices. This is necessary because China's reliance on imported gas will rise rapidly in the next few years, and prices must reflect a blend of lower domestic and higher international prices, he said.
Ong said CR Gas had been allowed to raise gas sales prices sufficiently to offset higher procurement prices since June on 90 per cent of its sales volume. The remainder will be subject to the result of public hearings. Two-thirds of its sales are to industrial and commercial users.
Size will matter
Profits from gas sales will need scale and negotiating muscle
CR Gas aims to triple its number of projects in the next three years to more than 90 by spending, in yuan: 10b yuan