Stock Call . Why Indraprastha Gas is a good buy

Delhi-based city gas distributor Indraprastha Gas, like most other businesses in India, had a difficult June 2020 quarter. Its consolidated revenue fell about 60 per cent y-o-y to ₹639 crore, while its profit crashed about 86 per cent to ₹ 35 crore. This was primarily due to the lockdowns that had a major impact on the company’s sales volumes. With most vehicles off the road, and operations of many industries and commercial establishments shut or curtailed for an extended period, the demand from key segments — compressed natural gas (CNG) for vehicles and piped natural gas (PNG) for businesses — had collapsed.

A silver lining was the continued demand for PNG from households, with many people holed up in their houses. But this relatively smaller segment could only partially offset the impact on overall volumes that fell about 56 per cent y-o-y in the June quarter to 2.7 mmscmd ('million metric standard cubic meter per day').

A positive was the sharp fall in gas prices — both locally and internationally — due to the global supply glut; this reduced raw material costs and aided the company’s gross margins. But significantly lower volumes meant that operating margin and net margin took a knock.

The washout in the June quarter due to extraordinary circumstances was in contrast to the good show posted by the company previously. Consolidated profit had grown about 48 per cent y-o-y in FY2020 to ₹1,249 crore and about 17 per cent y-o-y in FY2019 to ₹842 crore, aided by good volume growth and better margins.

The Covid tremors that led to a stock market meltdown in February and March also saw the Indraprastha Gas stock crash about 40 per cent from its February high of ₹522. Like many others, the stock recovered smartly from its March lows, recouping most of its losses by early June.

But then it has again seen a correction, partially due to regulatory concerns pertaining to the common carrier norms being proposed by the gas regulator PNGRB (Petroleum and Natural Gas Regulatory Board).

This correction though presents a good buying opportunity for investors with a long-term perspective. At ₹419, the Indraprastha Gas stock trades at about 28 times its trailing 12-month earnings, a tad higher than its three-year average of about 27 times. But the current valuation is despite the extraordinary fall in profit in the recent June quarter; had profits been as usual, the valuation would have been lower (about 23 times).

Growth drivers

Next, the company’s business has been picking steam again with the easing of the lockdowns — volumes have recovered to about 85 per cent of year-ago levels and could see further pick-up in the months ahead. That said, full recovery and growth may take some more time and FY2021, overall, could see decline in volumes.

But the long-term prospects of Indraprastha Gas seem sound, thanks to a few factors.

These include its near-monopoly position in Delhi and nearby areas, regulatory diktats that mandate use of natural gas (a relatively clean fuel), 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 help.

The company also has good pricing power, reflected in the three price hikes it has taken since June.

Even after these price hikes, its products remain price competitive compared with petrol, diesel and other competing fuels.

There seems to be good scope for volume and profit growth in the coming years. As the near-monopoly supplier of CNG to vehicles and PNG to households and businesses in and around Delhi, Indraprastha Gas is in a sweet spot — the market is still under-penetrated, especially in private vehicles.

The possibility of a pick-up in private vehicle sales in the wake of the pandemic and more conversion to CNG due to cost benefits could also benefit Indraprastha Gas. There is good scope for a rise in PNG volumes, too, to households and industries/commercial establishments.

The company has also been expanding beyond its core market of the National Capital Region (NCR); it has won the bids to develop the city gas distribution (CGD) network in four new geographical areas, including in Meerut and Kanpur districts. Indraprastha Gas also has 50 per cent stakes in Central UP Gas and Pune-based Maharashtra Natural Gas that cater to promising geographies.

Government push

The government’s push to encourage the use of natural gas and increase its share in the country’s energy mix should mean expansion of the CGD network across cities in the country in the coming years. This could present opportunities for seasoned players such as Indraprastha Gas.

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

Companies supplying CNG to vehicles and PNG to households have been given top priority in domestic gas allocation. Indraprastha Gas gets nearly 80 per cent of its volumes and revenue from these businesses.

Domestic gas is often much cheaper than imported gas due to formula-based pricing mandated by the government; the domestic gas cost is set to decline further to its lowest in more than a decade in the next reset applicable from October 2020 to March 2021.

Imported gas prices are also likely to be subdued in the near term due to the supply glut.

The regulatory overhang on the company’s stock may be overdone.

The PNGRB proposal, when finalised, could require CGD companies to keep 20 per cent of their capacity open for third parties. But this is likely to face resistance from CGD companies that will be adversely impacted, and also from higher powers that be as it could hamper the Centre’s plans to increase gas usage in the country.