Gujarat Gas results set off downgrades

Continued weakness in industrial volumes likely to offset lower gas prices and keep stock in check

Weak performance in September quarter and rising volume pressure have set off profit downgrades on Gujarat Gas, a city gas distribution firm. Bloomberg consensus estimate has cut consolidated FY17 profit by five per cent in November. Weak volumes have been a major sore and note ban has added to this problem, believe analysts. Unlike utility space, where demand is largely insensitive to price because the services offered are essential, Gujarat Gas's volumes hinge on industrial clients. "Going by news reports, note ban has resulted in 20 per cent production fall in ceramic sector at Morbi, Gujarat. This may hurt Gujarat Gas's volumes at least in the next couple of quarters," says Dhaval Joshi, analyst at Emkay Global. The recent cut of Rs 2.07 per standard cubic metre in prices to the sector will hurt operating profit margin, he adds. 

September quarter results were dismal, with sales down 21.3 per cent year over year to Rs 1,237 crore, and lower than Bloomberg consensus estimate by 2.7 per cent, on falling volumes. Strong growth in operating profit, due to lower gas prices, aided net profit, up 215 per cent to Rs 72 crore year over year. Still, it fell short of estimate of Rs 76 crore.

These will continue to pressure the Gujarat Gas stock, which has been lagging the Sensex over the past few months. "Low industrial demand and price cut at Morbi are likely to offset benefit from lower domestic gas costs. Hence, we see limited potential, even from these levels," says Amit Rustagi, analyst at IDFC Securities.

Unlike peers Indraprastha Gas and Mahanagar Gas, Gujarat Gas gets a large part (over 70 per cent) of its volumes from the industrial segment; hence, its financial performance is diverging from those of its peers. 

But with the government push towards environment-friendly inputs such as natural gas amid falling gas prices, industrial demand could pick up in the long term. However, things are likely to worsen before improving. The company's return ratios could come under pressure.

"High capital expenditure would keep return on capital employed under 10 per cent, even as expected revival in demand over FY18-19 seems priced in," says Rohit Ahuja, analyst at Religare Capital Markets.

Softening prices and better sourcing arrangements through its parent would aid the operating profit margin. Expansion to new areas in Gujarat and Maharashtra is another positive and could offset some pressure from weak industrial demand. Near-term headwinds will pressure Gujarat Gas stock, which trades at undemanding valuation of 19 times the company's FY17 estimated net profit or earnings.