The enablers for rapid growth in CNG/PNG penetration in India are finally falling into place. We expect GGL to increase its presence across geographies well ahead of others (9 new cities in past 24 months), which should de-risk its earnings greatly. IGL, with the best execution track record and a stable revenue model, should continue to command premium over MGL.
CGD penetration set to increase
Assured APM gas supplies, weak imported gas price, improving pipeline infrastructure, and stable regulatory framework should accelerate CGD (city gas distribution) penetration. PNGRB’s target is to roll out CGD networks in 250-300 cities; at least 100-150 is achievable by 2020, almost 2x increase over the current operations.
IGL and MGL offer relatively stable earnings model
GGL is making efforts to diversify its sales mix and increase the share of B2C sales (CNG/domestic PNG). However, the higher share of B2B sales is expected to sustain over next 2-3 years. Thus, Ebitda margins should remain volatile and susceptible to industrial recovery. On the other hand, 80-85% of sales of Indraprastha Gas (IGL) and soon-to-be-listed Mahanagar Gas (MGL) are to the B2C segment that has a stable earnings profile.
IGL not cheap any more, but premium may sustain
Through FY16-18ii, we forecast GGL to report the highest earnings growth on the back of aggressive geographical expansion and falling gas prices. However, its valuations do not appear cheap. Nevertheless, considering its operating leverage, we envisage significant scope for earnings upsides. Further we expect IGL and MGL to register 10% and 1-2% pa growth over FY16-18ii. At CMP, IGL trades on par with regional peers (16.5x FY18ii) and it prices in near-term earnings adequately. MGL, assuming 20-25% listing gains, would still trade at 10-12% discount to IGL, which we think is appropriate, considering its higher reliance on third-party CNG dispensing infrastructure.Over the next few years, we expect a rapid increase in CNG/PNG penetration in India on the back of: (i) favourable gas allocation policy ; (ii) clarity over regulatory framework; (iii) fall in international gas prices engendering a weak outlook; and (iv) improving gas pipeline connectivity in India.
w CGD sector given priority status: In Q4FY14, GoI altered the gas allocation policy for domestically produced gas and prioritised CGD operations over power and fertiliser sectors. Assured allocation of gas has eliminated uncertainty in gas sourcing for CGD operations. Such availability of gas would boost operations of existing players.
w Clarity over regulations: In a landmark judgment in 2015, the Supreme Court clarified that the sector regulator PNGRB does not have the authority to determine end-product prices.
w Weak outlook on LNG prices: A correction in spot LNG prices in the past 18 months and successful renegotiation of long-term RasGas contract have narrowed gas premium to alternate fuels (fuel oil, etc).
w Strengthening of gas grid: GoI is focused on improving the gas transmission network. At FY16 end, India had a natural gas pipeline grid of 16,232 km with capacity of 431 mmscmd. This is likely to increase by 60% to 26,000 km over the next 4-5 years and capacity is expected to more than double to 940 mmscmd.
PBGRB has streamlined the CGD bidding procedure
As per the bidding rules, PNGRB determines the minimum work programme considering population and area of the GA and notifies the same while inviting the GAs for bidding. Bidders are required to bid for network tariff and compression charge to be charged over the licence period (25 years).
Even the 41 cities that have CGD operations are yet not fully penetrated. Moreover, within these, only a handful of geographies account for majority of the sales volumes. For example, the top three CGD companies GGL (Gujarat), IGL (Delhi and adjoining areas) and MGL (Mumbai and adjoining areas) account for 82% of total sales. These geographies have seen a gradual increase in sales over the past 12-15 years
The macro environment remains favourable for the CGD business. Nevertheless, large upfront investments and slower ramp-up resulting in depressed ROE in the initial period is often limiting competition among existing players.