Volume pressure, weak Q2 trigger earnings downgrades for Gujarat Gas

Continued weakness in industrial volumes is likely to negate the positive impact of lower domestic gas price and keep the stock under check

A weak performance in the latest September quarter, coupled with the rising volume pressures, has triggered a host of earnings downgrades on Gujarat Gas by leading brokerages. According to Bloomberg consensus estimates, the company's consolidated earnings per share for FY17 has been trimmed by 5% in November so far.

Weak volumes have been a major sore point for the company, and the demonetisation process will further aggravate this problem, believe analysts. Unlike utility players, whose demand elasticity is rather low, for Gujarat Gas the demand is dependent on the business prospects of its industrial customers. "Based on various news reports, demonetisation has impacted production in Morbi’s ceramic industry by about 20% which might hurt Gujarat Gas' volumes at least in the next couple of quarters," says Dhaval Joshi, analyst at Emkay Global. The recent reduction in selling prices to the ceramic industry by Rs 2.07 per standard cubic meter (scm) will hurt margins, he adds. 

Gujarat Gas put up a dismal show in the September 2016 quarter (Q2). Its sales fell 21.3% year-on-year to Rs 1,237 crore and missed Bloomberg estimates by 2.7% on the back of falling volumes. Strong growth in operating profits (due to lower gas prices) though aided net profit which grew 215% to Rs 72 crore. Still, this number fell short of Bloomberg estimates of Rs 76 crore.

These pressures will continue to weigh on the Gujarat Gas stock despite the fact that it has lagged the benchmark S&P BSE Sensex in the past few months. "With the continuing delay in volume ramp up in the industrial sector and the recent price cut taken at Morbi likely to offset the margin benefit in domestic CNG segment due to lower domestic gas costs, we see limited upside even from these levels," says Amit Rustagi, Oil and Gas analyst at IDFC Securities.

Unlike peers Indraprastha Gas and Mahanagar Gas, Gujarat Gas derives a large part (over 70%) of its volumes from the industrial segment and hence is witnessing a divergent financial performance compared to these peers. With government pushing industries towards environment-friendly inputs such as natural gas (as opposed to coal) and amid falling gas prices, industrial volumes could pick up in the longer term. However, things are likely to worsen before improving with demonetisaton pain impacting the second half of this financial year. The company's return ratios too could come under pressure from here on.

"High capex intensity would keep Gujarat Gas' return on capital (RoCE) at sub-10 per cent levels even as the expected revival in volumes over FY18-19 seems priced in," says Rohit Ahuja, analyst at Religare Capital Markets.

Positively, softening LNG prices and better sourcing arrangements (with its parent, GSPL) would aid the company's operating margins from here on. Gujarat Gas' endeavors to expand its city gas distribution network in newer geographies in Gujarat and Maharashtra (Jamnagar, Bhavnagar, Jambusar, Kutch (W), Thane) is another positive and could offset some pressure arising from weak industrial demand in the longer run. 

Given the near to medium term headwinds, Gujarat Gas scrip is likely to remain under pressure despite trading at undemanding valuations of 19 times FY17 estimated earnings.