Attractive valuations of city gas distributors after recent price fall

Recent price cuts by city gas distribution (CGD) companies and a statement issued by the petroleum minister citing high profits have had a negative impact on sentiment about the sector. It has resulted in sharp dips in the share prices of Mahanagar Gas (MGL), Indraprastha Gas (IGL), and Gujarat Gas.

However, the Petroleum and Natural Gas Regulatory Board (PNGRB) has subsequently clarified that it does not intend to regulate CGD margins. Also, there has been a fall in liquefied natural gas or LNG prices, which is being passed on in the price cuts. As a result, we could make a case that the market has overreacted.

Low spot LNG prices partially offset the under-allocation of low-cost Administered Price Mechanism (APM) gas for CNG/domestic piped natural gas (PNG) segment and improves the competitiveness of gas versus alternative liquid fuels. This is likely to boost domestic LNG demand.

The total CGD demand is flat month on month as the reduction in APM allocation has been offset by higher LNG consumption. January 2024 consumption was 37.5 million metric standard cubic metre per day (mmscmd) vs. 38.1 mmscmd in December last year.

Domestic gas consumption in CGD declined to 26.5 mmscmd in January (vs. 28 mmscmd on December 23 and a peak of 30.2 mmscmd in October 2023) due to the reduction in administered price mechanism allocation. But LNG consumption rose to 11.1 mmscmd in January this year vs 10.2 mmscmd in December. This is still lower than historical LNG consumption of 13-15 mmscmd due to an incremental allocation of HPHT (High pressure high Temperature) gas.

MGL and IGL announced price cuts of Rs 2.5/kg each based on lower LNG prices which are now trading below $9/metric million british thermal unit (mmbtu) (the Jan-Feb average was $9.2/mmbtu) and versus an average of $15.2/mmbtu in Q3FY24. The cuts will not really impact margins for CGDs. Gujarat Gas has also reduced Morbi industrial prices by Rs 3.9/standard cubic metre (scm) to pass on lower LNG prices. At retail, CNG still trades at a 50 per cent discount to petrol (roughly 40 per cent discount to diesel) which is very comfortable for the vehicle sector.

The Maharashtra State Transport (MSRTC) plans to add 800 CNG buses which will drive volume growth for MGL. While there may be margin compression through FY25 and FY26, the valuations are below historical levels.

For IGL, the impact of the electric vehicle policy in Delhi (50 per cent of new 4-wheeler registrations have to be EVs by year 3 and 100 per cent by year 5, and all vehicles by April 2030) cannot be minimised. This is significant as it would impact growth in the long term. Nevertheless, there is some upside from current price levels, according to analysts.

Gujarat Gas has higher valuations which implies it may be more richly valued. Volatility in propane prices and lower return ratios due to high capex are overhangs for the company.

The PNGRB said MGL’s Mumbai monopoly ended in April 2021 but new entrants who ride the network, if any, cannot market at stations where MGL already dispenses, and there are pending court cases about the matter, which could hold up open access.

Also, the monopoly could be extended by up to ten more years, going by precedents. MGL remains debt-free with cash of over Rs 200 crore on the balance sheet. It has completed the Unison Enviro (UEPL) acquisition in three geographical areas in Maharashtra and Karnataka.

The threat of EVs is real in the long-term but it may take a while to come through. The complaints about high margins may be election-related campaigning.

In the meantime, CNG remains at an attractive discount versus petrol/diesel. Analysts seem somewhat divided on the sector but there are buy calls on MGL, IGL, and Gujarat Gas, as well as sell calls. The price corrections make valuations look attractive in the medium term.