Mahanagar Gas: Promise in the pipeline

Since early November 2017, the stock of Mumbai-based city gas distributor Mahanagar Gas lost 34 per cent. A few factors have caused this reversal in fortunes of the stock that had more than doubled since its initial public offer (IPO) in June 2016.

One, volume growth in the September 2017 quarter was tepid. Next, profit-booking in the stock seems to have played a part. Then, the market volatility after Budget 2018 took a toll on many mid-cap scrips, including Mahanagar Gas.

Also, the rise in the price of gas and weakness in the rupee this calendar increased costs for the company; not passing them on fully to customers impacted profit growth in the March 2018 quarter. Finally, some stake sale in April by a promoter entity seems to have affected sentiment.

The stock’s fall though presents a good buying opportunity for investors with a long-term perspective. Valuations have moderated considerably. At ₹822, the stock now trades at about 17 times trailing 12-month earnings, compared with the average of about 22 times in the past three years, and the 27 times that Delhi-based peer Indraprastha Gas enjoys.

On the business front, the company is well placed. Volume growth recovered from the 4 per cent y-o-y seen in the September 2017 quarter to about 7 per cent in the March 2018 period. Profit growth in the March quarter though was subdued at about 5 per cent y-o-y.

This was because Mahanagar Gas adopted a wait-and-watch approach and refrained from passing on hikes in the cost of gas fully. But the company has good pricing power and it is in a comfortable position to increase the price of its products, as it has done in the past.

Its products — compressed natural gas (CNG) and piped natural gas (PNG) — have significant cost advantages over competing fuels such as petrol, diesel, LPG and some industrial fuels.

This gap has widened with the sharp increase in the prices of crude oil and its derivative products this year.

Despite the weak profit growth in the March quarter, the company’s profit for the full year 2017-18 grew a strong 22 per cent y-o-y to ₹478 crore. Operating margin increased to about 38 per cent in 2017-18 from about 34 per cent in 2016-17.

Growing volumes

CNG supply to vehicles is the major business of Mahanagar Gas, accounting for nearly 75 per cent of volumes. Domestic PNG supply to households is the next biggest segment, accounting for about 12 per cent of volumes. PNG supply to commercial and industrial establishments make up the rest.

The company’s volume growth has been driven by steady conversion of vehicles to CNG and more households opting for PNG.

In its mainstay market of Mumbai and surrounding regions, the company supplies CNG to more than six lakh vehicles and PNG to about 10.5 lakh households, 3,250 restaurants and about 230 industrial and commercial establishments.

There is still significant potential in the market with penetration estimated in the range of 32-35 per cent for vehicles, households and restaurants, and about 50 per cent for industrial and commercial establishments. Strong barriers to entry give incumbents in the city gas distribution (CGD) business such as Mahanagar Gas an advantage. New plans such as CNG supply to two-wheelers, if successful, could mean a significant market opportunity.

Besides, the government has ambitious plans to expand the CGD network across many cities; this can benefit seasoned players such as Mahanagar Gas. A strong balance sheet with negligible debt positions the company comfortably to fund expansion plans.

Low-cost supplies

The government’s thrust to promote clean fuel has resulted in favourable regulatory changes for CGDs such as Mahanagar Gas. Companies supplying CNG to vehicles and PNG to households have been given top priority in domestic gas allocation. Mahanagar Gas gets nearly 85 per cent of its revenue from these businesses. The price of domestic gas is much cheaper than imported gas, thanks to the formula-based pricing mandated by the government.

Risk

The possibility of a large-scale shift to electric vehicles could disrupt the transportation and fuel markets, and impact players such as Mahanagar Gas. But such a shift, if it happens, may take quite some time to materialise. Even then, suppliers of relatively clean fuels such as natural gas will be better placed to weather the disruption.

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