Why Kunlun Energy is the biggest disappointment in 1H14

Most of its segments showed earnings declines.

Kunlun Energy has recently announced its 1H14 results, with net profit dropping 13.8% y-y to HKD3,171mn, lower than Nomura’s expectation of a single digit earnings growth.

According to a research note from Nomura, among the gas distribution sector, only Kunlun Energy showed an earnings decline during 1H14.

As shown in the segment reporting, except for the gas transmission business which recorded an immaterial PBT growth, all other segments showed earnings declines.

Here’s more from Nomura:

Consistent with the view in our previous report, we remain our negative stance on the company’s prospects, given:

1) the city-gate price hike effective on 1 September 2014 will put higher pressure on the LNG refuelling station business’ margin;

2) the E&P business will subject to downward margin trend with increasing unit production costs; and

3) we see the recent share price performance is supported by the potential parent’s asset injection which actually there is no definite time line to happen.

We maintain our Reduce rating on the stock and our TP of HKD11.5, with downside potential of 11%.

While we are still awaiting more updates and guidance from the company, several key areas are worth noting:

Natural gas sales business – During 1H14, the company served an additional 9,100 LNG vehicles, which was lower than the previous years’ growth of >15K LNG vehicles for six-month. Overall, the company recorded 0.1% gas sales volume growth in 1H14 to 3.155bcm. That said, profits before tax for this business segment dropped by 14.8% y-y to HKD999mn. We believe this was mainly due to a delay in the gas cost pass through, leading to a loss situation for the LNG refuelling station business – We expect this situation is likely to be continued in the near term given the LNG refuelling station is a new business, in which Kunlun Energy at this stage may pursue volume growth first by keeping LNG prices competitive (ie, not fully pass through the increasing gas costs to the LNG users). In addition, we may even see the loss situation to worsen upon the city gate gas price hike effective on 1 September 2014.

LNG processing and terminal – Despite the increase in the LNG processing volume given two more LNG processing plants were commissioned in 1H14, the PBT also showed a decline by 48.6% which we expect was due to low plants utilization. On the other hand, the LNG terminal’s gasification volume also showed a significant drop by 23.1%, which resulted in a 38.2% PBT decline. As per the company’s results announcement, the LNG terminal is used to safeguard the natural gas resources for the parent company. As such, we may expect the profitability of the terminal business will be subject to the parent’s company gas production plan, which may involve significant uncertainties and volatility.

Gas transmission business – The gas transmission business is the only positive for the company, in our view. During 1H14, the gas transmission volume recorded a 22.2% y-y growth, to 15bcm, ahead of the management’s previous guidance of 19% growth. However, this volume growth only translated to 1.4% increase in the PBT overall.

E&P business – The drop in oil price, together with the currency depreciation for the Kazakhstan project, were in line with our expectations. We continue to maintain our cautious stance on the E&P business, with margins likely to be on a downward trend, given the rising production spending is required to maintain the oil production volume.