Mixed bag of Q3 earnings from gas marketing companies, sector in a sweet spot

Gas distribution companies reported an overall resilient growth in Q3 FY18 owing to an uptick in volumes both domestic as well as industrial. A sustained good demand from the fertilizer and power sectors also supported volume growth. With increased focus on a switch to natural gas, we stay positive on the growth outlook for the sector and recommend to keep the stocks on the radar. While we remain buyers of GAIL, we see IGL (Indraprastha Gas), MGL (Mahanagar Gas) and GG (Gujarat Gas) operationally healthy and recommend to keep a watch on these stocks in the volatile markets and accumulate on dips.

Company wise performance –

MGL –

MGL reported a healthy set of numbers on the back of decent uptick in volumes. Foreign exchange gains provided further traction to margin. However, a sharp rise in other expenses neutralized the gains. Revenue at Rs 638 crore was up 15 percent YoY and with a 150 bps margin expansion, the operating profits were up 20 percent YoY. CNG volumes at 185MSCM were up 7% YoY and 1% QoQ and PNG volumes at 68MSCM were up 8% YoY and 4% QoQ. Although the domestic gas cost increase by 16 percent during the quarter, the company was able to pass on the entire increase to customers. In fact industrial PNG price increased more than proportionally which led to margin expansion.

GAIL –

GAIL reported the strong performance mainly on account of higher natural gas transmission volumes due to increased off take from the power and fertilizer segments. The petchem segment reported flattish sequential volume growth mainly due to low capacity utilizations. A substantial reduction in the interest cost during the quarter supported profitability growth.

IGL –

IGL maintained the growth momentum for yet another quarter with volumes up 14 percent. CNG volumes were up 11 percent the PNG volumes saw a substantial 21 percent uptick during the quarter. Although the revenue grew 25 percent YoY and 5 percent QoQ, the operating profits saw a slight downtick with a 300 BSP margin contraction, mainly owing to inability to pass on the gas cost increase to customers. Substantial increase in other income provided traction to Net profits which were up 14 percent YoY.

With the governments push for cleaner fuels, especially in the IGL operated regions (Delhi etc), the volumes are expected to remain strong in the upcoming quarters.

Gujarat Gas –

Gujarat Gas surprised the street with a strong 27 percent uptick in revenues on the back of a healthy 19 percent increase in overall volumes (majorly industrial volumes) which had remained subdued for past quarters.

With state elections during the quarter, the entire LNG cost increase could not be passed on to the consumer completely, which resulted in a slight hit on margins which contracted 800 bps and suppressed EBITDA growth. However net profit saw a strong growth of almost 43 percent YoY.

Sector Trends -

Unified gas tariff to benefit sector companies -

Petroleum and Natural Gas Regulatory Board (PNGRB) has proposed consultation as a response to Gail’s proposal for unified tariff plan. Implementation of the same will provide a significant improvement in Gail’s performance.

It is a false notion that unified gas tariff might result in a hike in the gas bills for the consumers. However, the implementation of the unified gas tariff would bring in procurement freedom for the companies and benefit the company by reducing the gas procurement costs. According to the MGL management benefit from the lower procurement cost is expected to be much higher as compared to the cost increase so overall the move would be beneficial.

Oil trending upwards –

With oil pricing on an uptrend, natural gas automatically becomes a cheaper and a more attractive fuel option thus the demand for natural gas is poised to increase.

Environmental concerns and budgetary allocations –

Increasing pollution levels remain a concern and there has been a serious push from the government to encourage the switch to cleaner fuel especially natural gas. The current budgetary allocation were also aimed towards deeper penetration of the CGD projects (City Gas Distribution) across smaller towns and cities, which would bring in topline expansion in future.

Proposal to include natural gas under GST

There have been talks in the past for the inclusion of natural gas under the GST regime, and any move towards this would bring in cost saving with the availability of the Input tax credit benefits for the companies. This could potentially bring in some margin expansion and rerating for the stocks

Outlook

The gas distribution companies should benefit from regulatory, environmental, budgetary and global tailwinds. Both operational as well as macro policy environment seems to be in favor of the sector as a whole.

After a rally of over 30 percent in the past year, in the current volatile markets, the stocks of gas companies have corrected 5-9 percent in the past one month. However, at current prices, we find valuation a bit heady. While we are comfortable with the business model and valuation of GAIL at the current level, we would recommend keeping IGL, MGL and Gujarat Gas on the radar and accumulating them on correction.

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