 "Clarity on marketing margins to trigger IGL re-rating")
The stock currently trades at 9.4 times FY15 estimated earnings, a 30-plus per cent discount to its average one-year forward price/earnings ratio of about 13 times (before the PNGRB issue).
Most analysts, however, are optimistic on the company’s prospects (strong volume outlook, its pricing power which protects margins) and believe IGL has a strong case against PNGRB. As the latter has admitted it does not have the authority to fix IGL’s marketing margins, analysts believe an extremely unfavourable verdict seems unlikely. The likely doubling of gas prices from April 1, however, is crucial and will retest IGL’s pricing power.
Of the 22 analysts polled by Bloomberg since February, 17 have a ‘Buy’, four a ‘Neutral’ and one a ‘Sell’ rating on the stock. Their average target price is Rs 323, up about 25 per cent from the current level of Rs 259.
The proposal to cap the gas marketing margin by PNGRB is subject to the Supreme Court’s verdict and is the key reason for the IGL stock’s underperformance in the past 18 months. Analysts say a favourable verdict is a must for significant re-rating of the stock. They, meanwhile, have started extrapolating the impact on IGL’s earnings and target price under different verdicts.
“IGL’s valuation would be contingent on the court’s verdict on the dispute. Our discussions with industry sources suggest the SC is working on a compromise formula, as a decision on either extreme end of the spectrum would have profound ramifications for the sector. Our scenario analysis suggests IGL’s fair value could range between Rs 205 and Rs 300, depending on the likely outcome,” says Dayanand Mittal, oil and gas analyst at Ambit Capital.
Some others, including the management, rule out an extremely negative verdict. The management says PNGRB has accepted that it does not have the right to regulate the marketing margins (final selling price). This removes a key overhang, of retrospective cuts/adjustments in IGL’s selling prices.
“Removal of the retrospective impact is a material positive and will remove a lot of uncertainty. The freedom to determine the final selling price, if upheld, is positive for the future prospects and will likely lead to a re-rating, based on large earnings upgrades,” says Probal Sen of IDFC Securities. IIFL analysts add the verdict is unlikely to have a material impact on earnings, as the case now focuses only on deciding whether PNGRB can determine network rates for IGL customers or only the third-party sales.
Higher pricing effect
After the ministry of petroleum and natural gas raised the allocation of domestic gas for city gas distribution (CGD) operations last month, IGL cut CNG prices by 20-30 per cent. This has made CNG attractive, by widening the price differential with other automobile fuels. Even with domestic gas prices set to rise from April, analysts are hopeful. “Domestic gas prices are poised to double and CGDs will be forced to reverse the price cut. This will be a highly unpopular move just ahead of elections and the government of India may opt not to raise input prices for CGDs (citing benefits and importance of CNG/PNG). If done, the benefit is likely to become permanent, and we think the recent muted growth will revive,” believes Anil Sharma of Nomura.
Analysts at ICICI Securities have factored in a 26.7 per cent rise in IGL’s average CNG prices to Rs 44.35 a kg in FY15. Nevertheless, a rise of 25 per cent in gas prices would still ensure CNG remains attractive, assuming diesel price deregulation continues. There is optimism regarding volume growth, too. The addition of 5,000 buses and 35,000 auto rickshaws over the next couple of years would support IGL’s growth, believe analysts. Thus, they expect IGL to post an eight to 10 per cent sales volume growth in FY15 and FY16 each.