Indraprastha Gas: Piped up

Delhi-based city gas distributor Indraprastha Gas continued its good run in the recent December 2017 quarter. Healthy volume growth of 14 per cent Y-o-Y, combined with a 10 per cent increase in price realisation, helped the company grow its revenue by 25 per cent. Profit growth was lower, but still quite healthy at about 15 per cent Y-o-Y; this was due to increased gas sourcing and other costs in the quarter that were not fully passed on to customers. The company’s strong pricing power, though, gives it enough room to pass on cost hikes and bridge the gap.

Volume growth — about 13-14 per cent Y-o-Y for several quarters now — should also remain healthy. This is thanks to its near-monopoly position in Delhi and nearby areas, regulatory diktats that mandate use of natural gas, network expansion initiatives, entry into new markets and big price differentials of the company’s products vis-à-vis competing fuels. Cost advantage due to allocation of cheap domestic gas for a chunk of its business should also aid volume and profit growth.

After a weak patch, Indraprastha Gas has been doing quite well financially for more than two years now — profit grew about 36 per cent in 2016-17 and about 14 per cent Y-o-Y in the nine months ended December 2017 . The strong financial performance combined with buoyant market conditions has seen the stock rally strongly.

Despite some weakness in recent times, the stock has nearly tripled over the past two years. This has also resulted in a spike in its valuation. At ₹300, the stock now trades at about 33 times its trailing 12-month earnings, much higher than the average of 25 times over the past three years. But the stock has likely been re-rated and valuations should sustain around current levels. Prospects of robust earnings growth over the next few years should translate into substantial upside in the stock. Investors with a long-term perspective can buy the stock.

Volumes on growth path

Indraprastha Gas is the near-monopoly supplier of compressed natural gas (CNG) to vehicles and piped natural gas (PNG) to households and businesses in and around Delhi. Natural gas being considered a clean fuel, the company has gained from various regulatory diktats and measures ordered by the authorities and the courts, over the years, to curb pollution in the National Capital Region (NCR). This includes the crackdown on diesel vehicles, the experimental odd-even rule from which CNG-run vehicles were exempted, and the clampdown on use of polluting fuels such as furnace oil and petcoke. What has also helped is the significant and growing price differential between CNG and competing fuels such as petrol and diesel, and between PNG and domestic LPG.

Volume growth should remain healthy, thanks to a few factors. One, the gap between the prices of natural gas-based fuels and competing fuels has widened in recent months, with the price hikes in petrol, diesel and domestic LPG. This should encourage continued vehicle conversion to CNG and households shifting to PNG in Delhi and surrounding areas. Next, the Delhi Government’s plans to add to the city’s bus fleet; this should boost demand for CNG. Continued measures to combat air pollution in Delhi should also help.

Also, the company has made a foray and is expanding its footprint in new areas such as Gurugram and Rewari. Last month, it was granted authorisation for development of the city gas distribution network in Karnal. Besides, the government, to encourage the use of clean fuel, has ambitious plans of expanding the city gas distribution (CGD) across many cities in the country. This can present good opportunities for seasoned players such as Indraprastha Gas. All this should aid volume growth in the long run.

Indraprastha Gas also has 50 per cent stakes in Central UP Gas and Pune-based Maharashtra Natural Gas. These companies are doing quite well, with a combined profit of ₹34 crore in the December quarter.

Cost advantage

The Government’s thrust to promote clean fuel has resulted in favourable regulatory changes for CGDs such as Indraprastha Gas. Companies supplying CNG to vehicles and PNG to households have been given top priority in domestic gas allocation. Indraprastha Gas gets nearly 85 per cent of its volumes and revenue from these businesses.

The price of domestic gas fell significantly over the past few years, thanks to the formula-based pricing mandated by the government. Also, the price of imported gas used to supply PNG to commercial and industrial customers came down sharply, in tandem with the fall in crude oil prices. But in the recent revision, domestic gas price has risen somewhat. Also, international gas prices have gone up over the past few months. With Indraprastha Gas not passing on these and other cost increases entirely, its operating margin fell to about 25 per cent from 27 per cent in the year-ago period. This reflected in lower profit growth compared with revenue growth in the December quarter. But given the company’s strong pricing power aided by rising prices of alternative crude-oil based fuels, it should be able to recoup margins without impacting volume growth. Also, gas costs should be range-bound with sharp increases from current levels unlikely.

A strong balance sheet with zero debt gives the company enough muscle to fund its expansion plans.

Risks

The possibility of a shift to electric vehicles could disrupt the transportation and fuel markets. But given the many challenges — economic, technological and infrastructural — the shift, if it happens, will likely take quite a few years to materialise. In that scenario too, suppliers of clean fuels such as CNG should be better placed and may be able to hold their own than suppliers of more polluting fuels such as petrol and diesel. That said, investors should keep watch on developments in the space, and make course corrections if the need arises.

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