Mahanagar Gas. Why the stock of Mahanagar Gas is a good buy

Mumbai-based city gas distributor Mahanagar Gas (MGL) had a tough June 2020 quarter – like many other companies in India Inc., and also its peer Delhi-based Indraprastha Gas (IGL). MGL’s revenue in the June quarter fell about 65 per cent y-o-y to ₹ 262 crore while its profit crashed about 73 per cent to ₹45 crore.

This was primarily due to a sharp 62 per cent y-o-y fall in sales volumes to 1.113 mmscmd (million metric standard cubic meter per day) – a fallout of the lockdown that continued for much of the June quarter and saw most vehicles were off the road and businesses shut. Sales volumes of CNG (compressed natural gas) for vehicles fell about 68 per cent y-o-y.

PNG (piped natural gas) volumes fell 21 per cent with reduced supply to industries and commercial establishments more than offsetting the increased supply to households. It didn’t help that MGL’s operating and net margins also fell in the quarter despite lower gas input prices; this was a result of the sharp fall in volumes, especially that of high-margin CNG.

The sharp fall in profit in the June quarter was in contrast to the healthy profit growth seen in the earlier quarters. The company’s profit in FY 20 had risen 45 per cent over FY 19 to Rs 793 crore – this was thanks to good margins, and steady, even if slow, volume growth except in the March 2020 quarter when the lockdown took a toll.

The market crash in February and March, following the Covid outbreak, saw the MGL stock fall more than 40 per cent from its January high of ₹1,237. With the market rallying , the stock recovered from its March lows, recouping more than half its loss. But the stock has again slipped sharply over the past month and half and now trades at ₹823.

This is partially due to regulatory concerns pertaining to the common carrier norms being proposed by the gas regulator PNGRB (Petroleum and Natural Gas Regulatory Board), and also perhaps due to concerns about the slow volume growth at MGL compared with peer IGL.

In FY 20, for instance, MGL’s volume growth was flat compared with IGL’s 9 per cent growth. Even if the troubled March 2020 quarter was excluded, MGL’s low single-digit volume growth in the nine months ended December 2019 was much lower than the early-teen volume growth posted by IGL. Also, unlike IGL, MGL did not win new geographical areas in the latest rounds of city gas distribution auctions.

These dampeners have seen widening of valuation gap between the stocks of MGL and IGL. The MGL stock currently trades at about 12 times its trailing twelve month earnings, compared with IGL’s 25 times. A couple of years back, in October 2018, the MGL stock was trading at about 16 times compared with the IGL stock’s 22 times.

The MGL stock’s valuation is now below its three-year average of about 17 times – this despite the sharp fall in earnings in the June 2020 quarter that should have ideally lifted up the price-to-earnings ratio.

Given the sharp fall in valuation, investors with a long-term perspective can consider buying the MGL stock. One, the downside in the stock could be limited from these levels.

Scope for growth

Two, with the easing of the lockdowns, economic activity has started picking up. The company’s volumes in the remaining quarters in FY21 should be much better than in the June quarter though full recovery and growth may happen around the end of FY21 or in FY22. As earnings improve, there may be upside potential in the stock even if valuations stay subdued.

Three, there is potential for faster volume growth at MGL in the coming years. The Mumbai market, while it has high vehicular density, still has good growth potential with penetration still about 35 per cent for CNG; there is scope for increasing PNG penetration too. The big price differentials of MGL’s products vis-à-vis competing fuels such as petrol and diesel could translate into more CNG conversion by vehicles.

Plans to induct CNG buses by the city’s bus operator BEST will also help. Any regulatory diktat to use cleaner natural gas, similar to that in Delhi, could also mean more business for MGL. The areas around Mumbai also have growth potential.

Four, a few years down the line, the Raigad market should also offer scope for MGL to grow volumes. The government is pushing for expansion of the CGD (city gas distribution) network across the country and more auctions are likely.

New geographic areas that MGL manages to win in future auctions should aid its growth prospects. A strong balance-sheet with no debt, and cash and equivalents of about ₹ 1,000 crore (as of July 2020) should help MGL fund expansion plans.

Five, the cost advantage to city gas distributors such as MGL, thanks to priority allocation of cheaper domestic gas for a chunk of their volumes, seem likely to continue. This gives the companies good pricing power and also aids the bottom line with good margins.

In the recent price revision, domestic gas price has declined to its lowest in more than a decade. Also, imported gas prices are likely to be subdued in the near to medium term due to the supply glut.

Six, the regulatory overhang on CGD stocks may be overdone. The regulator’s planned proposal on open access for a part of the capacity is likely to face legal resistance from incumbent CGD operators; there could also be possible pushback from higher powers as it could slow down CGD rollout plans in the country. The first mover advantage also offers CGD incumbents an advantage.

Besides, MGL is a regular dividend payer; the current dividend yield (based on usual annual dividends of about ₹ 20 a share and excluding special dividend of ₹ 15 a share for FY20) is about 2.5 per cent.

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