Volume growth, earnings prospects for gas distribution firms remain strong

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While the volatility in crude oil prices creates uncertainty for investors about the prospects of both upstream and downstream oil and gas companies, this is not the case for gas utilities (distribution companies).

With no overhang of subsidy, the latter’s earnings have been resilient to the volatility in crude oil, as well as swings in foreign exchange rates, given their seamless pass-through of pricing, say analysts.

Oil marketing companies tend to benefit in a falling crude oil scenario. However, there are concerns on refining margins being impacted by inventory loss, while their marketing margins are at risk, given a busy election season. For upstream (production and exploration) companies such as Oil and Natural Gas Corporation, the subsidy concern and falling net realisation has pushed the stock to a 52-week low.

In contrast, volume growth and earnings prospects for city gas distribution (CGD) players remain strong. Driven by robust piped gas demand from households, cleaner as well as cheaper fuel demand for automobiles, improving industrial demand to meet pollution curb norms and higher gas availability in the country.

Analysts see stable regulation, government push, assured allocation and geographical expansion as key drivers for companies such as Indraprastha Gas (IGL), Mahanagar Gas (MGL), and Gujarat Gas. Analysts at IIFL expect gas utilities to see volume-driven earnings growth of 5-25 per cent annually during FY19-21.

The recent rupee appreciation (from 74 a dollar on October 9 to 70 now) bodes well for the margin outlook at CGD companies, says Abhijeet Bora at Sharekhan. He expects a stronger rupee to bring down gas cost (denominated in dollars). The price increase during October in compressed natural gas (CNG) and domestic piped natural gas had factored a dollar at Rs 74; hence, a likelihood of retention of savings in gas cost from the recent rupee appreciation. This could aid operating profit margin during the second half of FY19, say analysts.

The strong expansion opportunity in the Delhi region keeps most analysts bullish on IGL. Fossil fuels contribute nearly a third of pollution in Delhi, say experts. Recent announcements by the Delhi government on control of pollution will accelerate the switch to gas from oil/coal, not only on a seasonal basis but also structurally, feel analysts. Morgan Stanley sees this as an opportunity for IGL to raise gas penetration and grow earnings at 14 per cent annually till 2020. Jefferies expects IGL to deliver a strong 13.5 per cent volume growth annually during FY18-23, helped by the addition of Gurugram to its network.
The company is expanding rapidly in other National Capital Region areas, too. Annual earnings growth is pegged at 16 per cent over the next four years, with the stock trading at a reasonable 23 times its FY19 price to earnings estimate.

Network expansion for IGL and MGL remains key, say analysts, as CNG is 75 per cent of their overall volumes. Approvals and space constraints for new stations, amid growing road traffic and population density in urban centres, remain important. In this context, Delhi is much better placed than Mumbai, helped by a concerted policy push which has been triggered by higher pollution levels. Gujarat, too, is well placed on these counts, believes Jefferies. Analysts prefer IGL over MGL.

Nevertheless, earnings growth for MGL is also expected to remain strong, led by margin expansion and demand growth. Bora its earnings growing 11 per cent annually over FY18-20. The stock is trading at 13.7 times its FY20 earnings estimate, at a discount to IGL. MGL has strong return ratios, with a return on equity at 23-24 per cent.

Gujarat Gas will benefit from strong industrial demand. It has been rapidly expanding its reach, securing licences to expand its CGD network across five new areas, making it to a total of 20 districts of Gujarat, Dadra & Nagar Haveli, Thane and Palghar in Maharashtra. Also, analysts at ICICI Securities expect it to buy a stake in Vadodara Gas, in future, which might augment its network. IIFL sees Gujarat Gas posting earnings growth at 25 per cent per annum during FY19-21.