In an effort to comply with the Supreme Court directive aimed at curbing air pollution, IGL has completed setting up 90 CNG stations across the NCR. Thus, its CNG volume growth is likely to accelerate over the next few quarters, says a Religare report. It’s Volume growth has picked up after close to three slow years. Higher volumes coupled with margin expansion from lower gas prices are likely to shore up earnings growth over FY17/FY18. Therefore, IGL is a strong re-rating candidate – maintain BUY. Here are other important highlights from the report:
1) New CNG stations to fuel volume growth: The Delhi government’s anti-pollution drive is now beginning to reflect in IGL’s CNG volumes, with >6% YoY growth currently. Growth is expected to pick up to 8-10% in FY18 as the volume contribution from new CNG stations ramps up. Another positive is a recovery in industrial volumes (+3-4% YoY in Q4 FY16) compared to declines over the last few quarters, driven by low LNG prices.
2) Higher margins from Q1FY17: IGL seems to be following a pricing strategy similar to that of consumer companies, i.e. of taking only a marginal cut in CNG prices against a steep cut in domestic gas prices, which it has consistently followed over the past few instances of domestic gas price changes. We see this pricing strategy as sustainable, given that concerns over IGL’s pricing freedom have been considerably alleviated after a favourable Supreme Court judgment. We thus expect IGL’s EBITDA/scm to improve and sustain above Rs 5.5/scm over the long term.
3) Structurally positive: We maintain our DCF-based fair value of Rs 710/sh for the stock, set at 15.8x FY18E EPS. Consolidated earnings could be higher by 10%+ for FY16 if we extrapolate IGL’s Q4FY16 earnings share of Rs 1/sh from MNGL and CUGL. This would be visible in the FY16 annual report and could offer additional valuation triggers (by Rs 40/sh upsides possible to our fair value).
1) Reduction in allocation of domestic gas for CGD could be a major concern. If domestic gas production continues to decline, there is a case for the government to consider reallocation of gas from CGD to the power or fertiliser sectors. However, we note that the Supreme Court has ruled in favour of CGD companies for domestic gas allocation. Considering various anti-pollution initiatives, it is unlikely that the government will cut back this allocation.
2) Lower-than-expected volume growth for CNG and PNG.
3) PNGRB regulations on marketing exclusivity in Delhi are still ambiguous. The decline in domestic gas prices has led to attractive CNG retailing margins and hence many companies could vie for a share of this market. However, a small player would find it difficult to compete given the high penetration of IGL’s CNG infrastructure across Delhi. Further, with promoters such as GAIL and BPCL, we don’t foresee any major competition from oil PSUs.