Strong demand to drive gains for stocks of city gas distributors

An interesting opportunity could be opening up in the city gas distribution (CGD) space. Share price of CGD companies, such as Indraprashtha Gas (IGL), Mahanagar Gas (MGL) and Gujarat Gas (GGL), have corrected sharply since the start of the Russia-Ukraine war as international gas prices have shot up due to fears of supply disruption.

The administered price mechanism of domestic gas has also been revised upwards. GAIL has come under pressure since it is not receiving contracted liquefied natural gas (LNG) cargoes and it is being forced to buy LNG at much higher prices. Rupee depreciation has added to pressures.

The CGD companies have captive demand in the sense that transporters using compressed nature gas (CNG) can't switch to more expensive petrol and diesel. Households also can't switch.

These are priority sector with fixed prices. However, gas consumption by power plants and ceramics industry has more or less ceased.

High spot LNG rates could impact demand further. Balanced against that, revised domestic prices in October and possible pricing reforms could improve margins. Market reports indicate that the delivered gas cost for August-September 2022 has dropped considerably compared to July. Gross margins for September should be about 25 per cent higher than in the first quarter of the 2022-23 financial year (FY23).

IGL, MGL and GGL have invested in capex to expand network, and sustain volume growth. Their balance sheets are healthy with marginal debt for Gujarat Gas and debt free for IGL and MGL. This is because they have strong cash flows. The operating cash flow to earnings before interest, tax, depreciation and amortisation is consistently at 80 per cent or better.

In case of IGL and MGL — over 40 per cent of net worth is in cash. The debt on the books is largely due to security deposits from consumers.

In 2021-22, volume growth was above 15 per cent. In the 2-3-year timeframe, volume growth could be in the range of 9-10 per cent, given capex and the resulting expansion in networks. Over a five-year period, demand could double. Margins could remain volatile. An ability to lock-in supplies through long-term LNG contracts at reasonable rates could be critical – this may look a tough ask at the moment but it is possible if the Ukraine situation settles down. 

The government policy of pushing the gas component in the energy mix implies that there will be policy support as the CGD players expand their geographical networks.

The government targets pushing gas consumption to around 15 per cent of the energy mix in 2030 from around 7-8 per cent now. In geographical terms, the authorisation for CGD network expansion has been extended to 295 geographical areas covering 98 per cent of India’s population.

There’s been significant growth in the number of domestic piped natural gas (PNG), industrial and commercial connections along with a ramp-up in setting up of new CNG stations.

Over the last five years, domestic PNG connections grew at 21 per cent annually from 3.6 million in 2016-17 to 9.3 million in 2021-22 while the number of CNG stations grew from 1,233 stations, as of 2016-17, to 4,433 stations by the end of 2021-22.
Industrial/commercial connections grew at 11 per cent annually over FY17-22.

Analyst valuations for IGL are in the range of Rs 520 with Gujarat Gas at Rs 565, and MGL at Rs 950. All three stocks could offer an upside.