Delhi-based city gas distribution company Indraprastha Gas (IGL) received a major blow on Monday when the sector’s regulator ordered a cut in rates (network and compression charges) by 60 per cent, a move estimated to cut its profits by 50 per cent.
The regulator has also ordered IGL to refund the excess charges on a retrospective basis (effective April 2008), which translates into an estimated Rs 900-1,100 crore. Not surprisingly, the stock fell 34 per cent to close at Rs 229.8 on Tuesday. While the company plans to approach the high court, most analysts have already trimmed their estimates for IGL and lowered their target price, to Rs 150-296. While IGL still continues to enjoy freedom over charging marketing margins, analysts believe even if these are increased substantially, it will not be able to compensate for the loss.
Marketing margin
The Petroleum and Natural Gas Regulatory Board (PNGRB) has lowered IGL’s network rate by 63 per cent to Rs 38.58 per million British thermal units (mBtu) and the compression charge by 58.7 per cent to Rs 2.75 per kg with immediate effect. This is in sharp contrast to the company’s recommendation of Rs 104 per mBtu and Rs 6.66 per kg, respectively.
| MARGINS HIT | |||
| In Rs crore | FY12E | FY13E | FY14E |
| Revenues | 2,534 | 2,668 | 2,872 |
| Y-o-Y change (%) | 45.3 | 5.3 | 7.7 |
| Ebitda | 632 | 355 | 385 |
| Y-o-Y change (%) | 27.4 | -43.8 | 8.4 |
| Net profit | 306 | 88 | 113 |
| Y-o-Y change (%) | 17.9 | -71.3 | 28.9 |
| Book value (Rs) | 85.1 | 89.0 | 93.3 |
| E: Estimates Source: HSBC Research | |||
| IMPACT ON PROFITABILITY | ||
| Rs/standard cubic metre | Before | After |
| Gross margins | 8.00 | 5.00 |
| Operating expenses | 2.90 | 2.90 |
| Ebitda | 5.10 | 2.10 |
| Decline in operating profits (%) |
- | |
In this backdrop, analysts expect IGL’s Ebitda (earnings before interest, taxes, depreciation and amortisation) margins to fall 50-60 per cent and net profit by 70-80 per cent in 2012-13. Saurabh Handa of Citi says, “IGL has been earning a gross margin of Rs 7.8 per standard cubic metre or scm (including marketing margin) over the last few quarters (trailing four-quarter average). After accounting for operating expenses of Rs 2.7 per scm, this leads to Ebitda of Rs 5.1 per scm, on average. Due to the Rs 4.7 per scm cut in tariffs (rates) and adding back marketing margins of, say Rs 1-2 per scm, IGL’s Ebitda could now decline to Rs 1.5-2.5 per scm versus our forecasts of Rs 4.5-4.6 per scm (would almost entirely be a function of the marketing margin IGL is allowed to earn).”
While the company will try to make good this loss by charging higher marketing margin (unregulated, as of now), any such move will only provide temporary relief. The regulator has already begun the process of reviewing marketing margins of gas players and could restrict these in future.
Apart from the option to challenge this ruling in the court, renegotiation with PNGRB is an option. The net impact for IGL, thus, would vary, based on the outcome of these moves.
Road ahead
Incorporating the revised rates, most analysts have significantly pruned their earnings estimates and target price for IGL. Kumar Manish and Puneet Gulati of HSBC Research say in a note, “We now value IGL on a DCF (discounted cash flow) basis and lower our target price from Rs 366 to Rs 150. We also lower our EPS (earnings per share) estimates for FY13 and FY14 by 74 per cent and 70 per cent, respectively.”
Considering the new rates, both, return on capital employed and return on equity are expected to slide to 13 per cent (from 32 per cent) and six per cent (from 24 per cent), respectively.
This development curtails the key factor that enabled IGL to maintain its margin, namely pricing power. In response to rising liqufied natural gas prices, IGL had taken six price rises in FY12 and kept margins intact. The ruling also casts a shadow over the underlying business prospects such as strong volume growth in new regions.
In this backdrop, the stock is likely to remain under check in the near term, with any relief from the higher courts or favourable rate renegotiations the likely catalyst.
