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Newocean Energy Holdings (342.HK) - Vertical monopoly in Guangdong

12/18/2013

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NewOcean Energy Holdings is engaged in sale and distribution of liquefied petroleum gas (LPG) and sale of electronic products. The Company operates in three segments: sales and distribution of LPG through Zhuhai terminal and in the international market; sales and distribution of LPG through retail networks in the People's Republic of China and Macau, and sale of electronic products. It's main industrial customers include car manufacturers, chemical plants, aluminium mills or glass factories.

The company has become the largest LPG operator in the South China Region, supplying 24% of LPG for the Guangdong province ( industrial center of China, it represents more than a quarter of the country's exports and houses 100 mil. people). The Company wholly owns a Class 1 LPG sea terminal in Zhuhai, China for VLGCs (Very Large Gas Carriers) through which it conducts the majority of it's business by importing and re-exporting LPG to businesses and households.   The sale to end- users in done through 220 retail outlets, 16 bottling plants, 17 autogas refueling stations. They effectively own the storage, transportation, refueling and bottling of LPG in Guangdong, creating a top-to-bottom distribution network, in other words a vertical monopoly. This is a result of several years of heavy capital expenditures, which will now start to bear fruit. Consequently, many customers require high quality LPG in vast amounts, which only Newocean can supply.

The group is slowly switching it's business to household consumers, which offer a significantly higher margin (13% for car LPG, 35% for bottled) than industrials (6%). As Guangdong is the province with largest LPG consumption, NewOcean estimates that demand for LPG will grow by 8-10% in the coming years, driven by conversions from oil to gas and LPG's use as a chemical feedstock. In addition, the company started a marine bunkering business in Hong Kong (transporting fuel oil to ships) in May 2012, and already generated 940 mil. HKD of revenues (14% of total) in the first 8 months. Teir profit on these operations will increase significantly, as they completed a 70 000 barrel storage facility in Zhuhai just now. Recently, they signed an agreement with China's Sinopec to develop additional autogas refueling stations in Guangdong as well as began selling bottled LPG in Hong Kong for the first time. The company currently spots a ROE of 20%, P/E of 13 and a long-term growth rate of 20%. The days of big capital expenditures seem to be behind them, in 2013 the company restructured some of it's RMB loans to USD and achieved a more efficient operation, translating to: Decrease of inventory turnaround from 24 to 21 days, decrease in AR turnaround from 64 to 40 days and decreased net debt to equity from 33% to 14%. NewOcean Energy is very well positioned to profit from the continued industrial growth and energy demand of the wealthiest region in China. The stock is still undervalued despite it's huge run up and was recently purchased by one insider.

Risks

- The currency fluctuations can have significant impact on their bottom line.
- LPG is a commodity, fluctuations in price could significantly impact their revenues
- The company has placed a secondary offering to finance it's expansion, the number of shares increased by 5% as a result. They could tap the equity markets in the future again, which would temporarily drive the stock price down.
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