Thursday, April 05, 2007

Clean Energy China Stock Pick - CHNG

Based in the city of Xian in China’s north-central province of Shaanxi, China Natural Gas distributes natural gas (to approximately 50,000 households, as well as commercial buildings) and compressed natural gas (CNG) (to CNG wholesales and retail automobile filling stations). Recently CHNG has introduced its own network of retail filling stations to sell CNG directly to consumers—by the end of 2006, CHNG operated 17 filling stations in or near Xian. The company also owns a 70-mile high pressure gas pipeline, which connects CHNG’s distribution

network to the government-owned high-pressure pipeline serving the province. In 2007, CHNG plans to construct its own liquid natural gas plant, which will allow the company to expand the geographic market it serves. CHNG came public in the US via a reverse merger in December 2005. Although CNG currently represents only about three percent of China’s energy consumption, it is becoming an increasingly important source of fuel in the PRC. CNG is the cleanest burning fossil fuel (reducing the environmental impact of the increasing use of internal combustion vehicles in China), China has significant domestic natural gas resources (reducing the need for imported fuels) and CNG costs less per unit of energy content than gasoline or diesel fuel. The Chinese government is actively encouraging increased use of CNG via various incentives for CNG-related exploration and infrastructure development, which, combined with CNG’s other attributes, will likely lead to increased demand for CNG for the foreseeable future. (Because CNG is less expensive than either gasoline or diesel, drivers of dual-fuel vehicles will likely use CNG unless only gasoline or diesel are available in the area they are traveling in.) CHNG plans to fill the current gap between demand for CNG and retail supply in Xian by continuing to build its own CNG filling stations (at a cost of approximately US$600,000

each), while at the same time providing gas to filling stations owned by its competitors.

CHNG is focusing on expanding its retail CNG filling stations network because this business offers higher gross profit margins (approximately 39 percent) compared to the gross profit margin of the residential natural gas business (approximately 18 percent). As of the end of 2006, CHNG owned 23 filling stations (including six still under construction, all of which dispense CNG), with plans to have a total of 30 stations in operation by the end of 2007. Due to the fact that wholesale and retail CNG prices (and, therefore, gross profit margins) are set by the Chinese government, the key to increasing revenues and profits in the CNG business will be continuing expansion

of gas volume sold via increasing the size of the company's retail and/or wholesale distribution networks. CHNG is also working on expanding its facilities to include processing liquefied natural gas (LNG), which can be transported via trucks (rather than pipelines), allowing the company to increase the geographic size of its market. Management expects construction of the LNG plant will require $19 million in additional capital once the plant is approved by provincial and city government regulators.

As of August 2006, CHNG has 23.9 million shares outstanding. The company’s chairman owns approximately 25 percent of CHNG’s common shares; CHNG’s CEO owns nine percent. Approximately six percent of CHNG’s shares are held by institutions. For the quarter ending, September 30, 2006, CHNG received 80 percent of its revenues from the sale of natural

gas, of which 93 percent was sales to competitors’ CNG filling stations and seven percent was to household and wholesale consumers. The remaining 20 percent of revenues were related to CHNG’s construction of natural gas pipelines. (In China, customers have to pay approximately 60 percent of the construction cost of new pipelines upfront; the remainder is included in future monthly natural gas charges.) For the quarter ending September 30, 2006, CHNG reported net income of $2.5 million on revenues of $6.5 million, which represented year-on-year growth of 520 percent and 368 percent, respectively. Fully-diluted earnings per share increase 350 percent (to $0.09 per share). CHNG has a very strong balance sheet with $5.0 million in cash and total assets of $25.6 million. The company has a current ratio of 4.9 X, no long term debt and stockholders

equity of $23.4 million.

Industry: Energy


Sector: Natural Gas Distributor


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