Since its initial public offer (IPO) this June, the stock of Mumbai-based city gas distributor Mahanagar Gas has rallied 66 per cent. A few factors helped. The company is a near-monopoly supplier of compressed natural gas (CNG) and piped natural gas (PNG) in and around Mumbai. Cheap, assured supplies for a chunk of its business, strong demand growth potential and an attractive offer price worked in the stock’s favour. So did the robust show by the company in the June quarter.

Despite the rally, investors with a long-term perspective can buy the stock. One, the valuation is still reasonable. At ₹700, the stock trades at about 20 times its trailing 12-month earnings,

at a discount to Delhi-based city gas distributor Indraprastha Gas that quotes at about 25 times . While Indraprastha Gas is a larger entity, there is scope for the Mahanagar Gas stock to narrow the valuation gap, given its better profitability ratios and the high business potential in and around Mumbai.

Boost to bottomline In the June 2016 quarter, Mahanagar Gas registered strong growth in volumes, margins and profit. Total sales volumes grew 7.5 per cent year-on-year to 2.50 mmscmd, led by CNG supply to vehicles (about three-fourth of the business) and PNG supply to households (about a tenth of the business).

Despite a dip in revenue due to passing some of the cost benefit to customers, the company’s operating profit margin increased to 31.5 per cent from 24.6 in the year-ago period and net profit rose 19 per cent to ₹93 crore.

Additions to the customer base and dip in gas sourcing costs aided the company’s performance. The healthy profit growth, after flat to tepid growth in the past few years, indicates return of pricing power.

CNG and PNG domestic supply have been given top priority by the government since 2014 in the allocation of domestic gas, which is much cheaper than imported gas. This has aided Mahanagar Gas and Indraprastha Gas that supply predominantly to these segments. Domestic gas price, which is being reset every six months by the government, based on a formula, has come down sharply over the past two years.

The recent 18 per cent cut in price, applicable from October 2016 to March 2017, adds to the advantage. These cost cuts, some of which are passed on to customers, increase the price competitiveness of CNG and PNG v is-à-vis competing fuels such as petrol, diesel and LPG. Also, the price of imported gas which is used for PNG commercial and industrial supply has been benign. A low-cost environment should aid margins.

Expansion plans The Mahanagar Gas management expects overall volumes to grow 7-8 per cent or more in the coming years, driven by CNG and domestic PNG. Continued conversion of vehicles to CNG (around 6,000 to 7,000 a month) along with expected spike in auto rickshaw permits in Mumbai should help. Besides, the possibility of Uber and Ola cabs being mandated to run on clean fuels such as CNG should aid volumes.

Over the next five years, company plans to add 83 CNG stations (currently 193); 20 to 25 of these are planned in 2016-17 and a similar number in the next fiscal.

It also plans to step up the reach of its domestic PNG network (currently about 9 lakh households) in Mumbai and Thane, that are still under-penetrated. Operations in Raigad district, when they commence in a few years, should add to volume growth.

Strong cash flows along with a healthy balance sheet that has little debt should help fund these expansion plans.

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