Climbing on falling gas price: CGD firms, power producers to benefit

The ceramic tiles sector, too, is among the main beneficiaries
The regular decline in the global natural gas price means the price of domestic gas sold under the administered pricing mechanism (APM) may also be revised downwards starting October 1, 2020. The government reviews the domestic gas price after every six months, based on the average gas price in countries, such as the US, the UK, Canada, and Russia, during a specified period. Analysts expect the APM gas price to be lowered to less than $2 per mmBtu (million British thermal unit) -- the third cut in a row. Notably, the current price at $2.39 prevailing during the April-September period is already at the lowest ever set since the New Domestic Gas Policy was announced.

 
While city gas distribution (CGD) companies are expected to be among major beneficiaries, other beneficiaries include fertiliser manufacturers, ceramic tile makers, and even power producers that use gas as feedstock.

 
CGD players, such as Indraprastha Gas (IGL), Gujarat Gas, and Mahanagar Gas (MGL), have continued to benefit from the low gas price, boosting their profitability and demand. Gas being a cheaper alternative to other auto fuels has helped boost the demand for CNG (compressed natural gas). Being a cleaner fuel, it has led to high demand from industries, too. Besides, the expanding distribution infrastructure is boosting piped natural gas (PNG) demand.

 
Analysts at HDFC Securities estimate an incremental demand of 5.3 million tonne (mt) per annum over FY21-FY23 which translates to 10 per cent annual growth. Further, the LNG price should continue to stay low because of excess LNG liquefaction capacity (39 mmtpa over CY20-22) due to demand reduction triggered by Covid-19.

 
Though the pandemic has seen CGD companies lose on volumes as reflected in their June quarter performance, these companies are now seeing demand recovery. Among the aforementioned three, Gujarat Gas has already seen volumes normalising to pre-Covid levels because of large industrial supplies. The stock, too, has rebounded 38 per cent from May lows, outperforming peers. Analysts say though all the three will benefit from the lower gas price, leading to gross margin expansion, gains at the operating level will maximise only when their volumes normalise. Thus, for IGL and MGL, CNG volumes picking up in metro cities is crucial.

 
IGL has a strong presence in Delhi-NCR and is also benefitting from geographical expansion and pollution curbs in the NCR. However, the stock has always traded at a premium valuation, which is also a reason for its recent underperformance versus peers. MGL, followed by Gujarat Gas, is the preferred pick of Abhijeet Bora of Sharekhan, over IGL, looking at their valuations.
The fertiliser sector, on the other hand, has seen only a limited impact of the lockdown, being classified as an essential commodity. The good rabi crop, followed by normal monsoon supporting kharif sowing, has benefitted it further. The lower gas price should boost prospects of fertiliser producers using natural gas as key feedstock to manufacture urea. Gas accounts for 50-80 per cent of the raw material cost, say experts. The fertiliser industry is the leading consumer of domestic natural gas and stands to benefit the most.

 
Of 31 urea plants in India, 28 are gas-based; three use naphtha as feedstock. According to CARE Ratings’ estimate, a 26 per cent fall in the natural gas price can potentially lead to a 12.5 per cent decline in the cost of urea's production, thus decreasing working capital intensity of fertiliser manufacturers. This can lead to an increase in their earnings, say analysts.

 
Nagarjun Fertilizers, Chambal Fertilisers, Rashtriya Chemicals & Fertilizers (RCF), Coromandel International, and Tata Chemicals have seen up to 115 per cent jump in their stock prices since March lows and there could be more upside looking at expected benefits from the lower gas price.

 
The ceramic tiles sector, too, is among the main beneficiaries. Binod Modi at Reliance Securities says since the gas cost will be about 30 per cent of operating costs, a reduction in its price shall boost margins. This is positive news for players, which should also benefit from the government's focus on affordable housing. Considering valuations, Modi prefers Somany Ceramics to Kajaria Ceramics.

 
Lastly, the subdued prospects of power generators, too, can see some improvement. Not much domestic gas had been available to power producers earlier and large players, such as Torrent Power, have been depending on long-term LNG contracts. Rupesh Sankhe at Elara Capital thereby feels that continued softness in the gas price can lead to renegotiation of LNG contracts with international suppliers, benefitting such players over time. The benefit from the low domestic gas price, however, will accrue more to state generation companies like Gujarat Industries. NTPC, too, may benefit to a small extent given that most of its plants are coal-fired.


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