Gas Utilities Sector: A best play in the longer-term

The Covid 19 pandemic will disrupt the performance of gas utilities companies in the short term but it is a positive play from a longer-term point of view. The growth drivers for gas consumption (stable regulations, improving last-mile connectivity, ease of imports, etc.) are intact. Thus, the gas utilities sector looks positive in general. City Gas Distribution (CGDs) are the best plays in the sector given superior revenue models (unregulated, attractive RoE, earnings growth, etc.).

Covid only defers, does not derail the macro theme:

The aspects necessary for improving Natural Gas (NG) consumption in India are still intact, regardless of the Covid 19-disruption; a stable regulatory system, expansion of pipeline network, last-mile connectivity, ease of gas imports and favourable economics vs. alternate fuels, etc, along with successful implementation of reforms in pipeline tariffs, would go a long way in increasing gas sales in India. Weak outlook on LNG pricing should augur well, at a time when economic activity remains weak. Thus, Covid 19-disruption only defers the growth theme, but does not derail it.

CGDs still best plays:

Gas sector looks positive, but CGD looks more attractive, as their revenue models are unregulated; they can generate superior cash flows and return ratios for a sustained period; and even when competition is introduced, due to their rich learning curve and through investment in technology, the operating matrix can remain unaffected.

Key developments to facilitate gas-sector growth in India:

Some of the key developments in this sector are

• Change in priority allocation: In 2014, the government of India (GoI) made CGD companies its top priority for allocation of cheap domestic gas for Compressed natural gas (CNG) and domestic Piped Natural Gas (PNG), to enable faster penetration.
• Changes in pipeline tariffs in 2018 to attract more investments: In order to attract more investments in creating an all-India gas grid, PNGRB revised its pipeline tariff regulations (peak capacity utilisation lowered, from 100% to 75%), allowing better returns for pipeline companies.
• Focus on last-mile connectivity: To boost the gas economy, Petroleum and Natural Gas Regulatory Board (PNGRB) is focussing on improving last-mile connectivity and, accordingly, has expedited auction of CGD licences. In the last 18 months, 136 new licences have been awarded (1.5x existing areas). PNGRB is also planning an 11th round, shortly. Further, the Regulator has revised bid parameters, to have a greater emphasis on infra rollout.
• Facilitating market development: A gas Exchange is planned for bringing market-driven pricing in the energy market of India. An Exchange would not only bring in more transparency to pricing, but also create a spot market to meet gas requirements.

Recommended Stocks

Our preference among CGDs is Gujarat Gas/ Indraprastha Gas (IGL) /Mahanagar Gas (MGL).

IGL is hopeful of a quick ramp-up in volumes, with easing of restrictions. In Apr-20, volumes declined to 20% of pre-Covid levels due to the lockdown. Since then, volumes have gradually picked up, increasing to 30% and 50% of normal levels, in May and June respectively. Margins are likely to remain firm, given low gas prices and management’s focus on cost controls in FY21E. The stock trades at 35.6FY21EPS

MGL management is hopeful of a faster recovery in volumes, on the back of its CNG segment, as restrictions on vehicle movement ease. The stock trades at 16.3x FY21EPS – at a significant discount to IGL.

Gujarat Gas (GGAS) has exclusive license to lay and distribute gas in 40 cities which provides long term volume growth visibility. Amid lockdown, volumes are likely to hit severely as industries account for bulk of sales (75-80%), however this will normalise with pick-up in economic activity. Stock trades attractively at 26.9x FY21E EPS and at a discount to IGL.

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