Gujarat Gas Ltd (GGL) adjusted PAT of Rs 759m, was up 30% y-o-y but below estimates of Rs 936m, driven by lower than estimated volumes (4% below est) and gross margins (7% below est). Sales volumes of 5.1 mmscmd (down 13% y-o-y) were below estimates of 5.4 mmscmd. Gross spreads of Rs 7.2/scm were up 25% y-o-y. Ebitda/scm of Rs 4.7/scm improved 25% y-o-y, but was below estimates of Rs 5.2/scm as lower volumes impacted margins.
Impact on financials: We leave our earnings and target price unchanged post results, with lower volume estimates offset by higher gross margin assumptions.
Valuations & View
Gujarat gas has underperformed the Sensex by 6% in last 3 months, on concerns of volume growth impacting earnings in near term. While we agree on a slower ramp up of volumes for the industrial segment from the existing areas, we nevertheless remain bullish on the long term strength expected in operational and financial metrics. A combination of more competitive prices, coupled with aggressive expansion plans and revival in industrial demand is expected to bring back volumes growth from H2FY17e while the weakness in LNG prices is likely to drive a 13% annualised decline in average gas costs for industrial segment over FY16-18e. The resultant improvement in affordability and geographical expansion is likely to drive 5% CAGR in volume growth over FY16-18e. We believe therefore that the next round of rerating in the stock will be driven by emerging clarity on the geographical expansion under way in the company. Reiterate outperformer with target price of Rs 650/sh. Stock trades at attractive multiples of 15.3x P/E to FY18e EPS of Rs 40.6/share.
Volumes — At trough levels
GGL saw volumes declining 13% y-o-y to ~5.1 mmscmd for the quarter, with continued weakness in prices of key competing fuels and a weak demand environment impacting volumes. The company has however guided to a recovery in volumes back to Q4FY16 levels of ~5.4 mmscmd in Q2FY17.
We believe that with the sharp decline in gas costs and the efforts by Gujarat Gas to leverage the same by aggressive price cuts as well as geographic expansion, the company will reverse the trajectory of declining volumes of the last few quarters over FY17-18e.
Expansion into new territories to help volumes
GGL is looking at expanding gradually into 10-11 new districts over the next few years; some of these districts are at various stages of development. The potential payoff from these new districts is material, with our estimates suggesting that GGL can grow to 1.5x current volumes over the next 5 years. Additionally, the latest bid rounds imply a further 5-6 new districts that have been won by GGL.
Crackdown on polluting coke gasifiers can boost industrial volumes
A recent directive by the Supreme Court to Gujarat State Pollution Control board (GPCB), MoEF and Central Pollution Board on the environmental concerns arising out of usage of coal based gasifiers by ceramic players in Morbi in Gujarat is a positive for GGL. The court has asked for clarifications within 6 weeks as to the non-implementation of an earlier Gujarat HC order which had given the GPCB 1 year to set up new standards for controlling pollution by these units. The usage of coal gasifiers has been a big reason for decline in industrial volumes for GGL—at peak we understand that Morbi district accounted for 4-4.5 mmscmd of industrial volumes, which has declined to 2 mmscmd currently. With the SC acting against pollution in the region, the continuation of these illegal gasifiers beyond near term looks unlikely.