IPO review: Mahanagar Gas priced reasonably

Govt thrust on environment-friendly fuels and expansion in other cities are key positives for Mahanagar Gas and IGL

Mumbai-based city gas distribution (CGD) company Mahanagar Gas (MGL) has a similar business model to that of listed peer Indraprastha Gas (IGL). Both enjoy near-monopoly status in their respective areas of operation.

MGL operates in Mumbai and adjoining Thane and Raigad. It is the third largest in CGD. Second largest is IGL, covering Delhi and other places in the National Capital Region.

Both derive higher revenues (74-77 per cent) from a retail-focused compressed natural gas (CNG) business. Their relatively lower exposure to the low-margin and cyclical industrial piped natural gas (PNG) segment – 15 per cent for MGL and 18 per cent for IGL -- is a key positive. Notably, CNG is an environment-friendly automobile fuel over petrol and diesel. With the government’s thrust on CNG and domestic PNG increasing, these companies are well poised to benefit.

High entry barriers in the CGD business in the form of huge capital expenditure needs, time taken to set up a pipeline network (including last-mile connectivity) and access to gas supplies, debt-free balance sheets, a healthy cash kitty and strong return ratios are key strengths of both. Most analysts are, thus, positive on the listed company, IGL.

  India’s leading CGD player, - Gujarat Gas, is however a play on the industrial gas segment, three-fourths of its revenue. In this backdrop and given the price band, MGL’s offer for sale of equity appears fairly valued.

The MGL Initial Public Offer of equity is entirely an offer for sale (GAIL and Shell are selling a part of their 45 per cent holding each), which means the IPO money will not flow into the company. At the price band of Rs 380-421 and assuming a 10 per cent growth in net profit in FY17, the issue is priced between 11 and 12 times the FY17 estimated earnings. MGL is thus priced at a discount to larger peer IGL, which trades at 15 times the FY17 estimated earnings.

On the business front, apart from a benefiting regulatory environment, the fundamentals are also turning favourable. With crude oil prices firming up again, CNG’s cost-effectiveness versus competing fuels such as petrol and diesel has improved further. This gives a fillip to the process of vehicle conversion from the traditional automobile fuels. While a significant fall in crude oil prices could lead to some pressure on these companies’ volumes in both the CNG and industrial segments, the long-term prospects remain healthy, given the preference for cleaner fuels. An important risk for these companies, however, is a potential loss in the case regarding end of marketing exclusivity. Both await the Delhi high court’s verdict on the issue. An unfavourable ruling would mean they have to distribute other competing companies’ gas through their own pipeline network, for a pre-determined rate. They could then lose customers and margins to new competitors, while emerging as common carriers or contract carriers earning income from gas transmission and distribution services.

Rajeev Mathur, managing director, MGL, in a media meet, said: “Our marketing exclusivity ended some time back but we have not witnessed increased competition from other players yet. We are hopeful of receiving a favourable verdict in the case.”

As an effort to reduce the impact of any such adverse ruling, both have started bidding for CGD contracts in other cities and have also become more aggressive on acquiring smaller CGD entities. While these moves will enable them to diversify their revenues geographically, it is a gradual process and will take some time to contribute meaningfully to their financials. In fact, 11 new cities in Maharashtra and 60 in the rest of India are coming for bidding. This reflects the growth potential for CGD companies. MGL is also ramping up its reach in Thane and Raigad.

Both MGL and IGL source their key input, natural gas, from the ministry of petroleum and natural gas (MoPNG) under the administered price mechanism, wherein gas prices are low. Any change in government policy on this front is a potential risk, as they might have to source gas at a higher price. While falling global LNG prices is a positive, both source about 85 per cent of their requirements from the domestic market and buy imported LNG only for the industrial business.

Unlike IGL, a large part of CNG sold by MGL is on the network of oil marketing companies. MGL currently pays Rs 2.74 per kg to the latter for using their CNG filling stations. In case its exclusivity period ends, MGL could face competition and might have to make higher payments to these companies.

Overall, as things stand, the prospects of both appear good. While the end of exclusivity remains a key monitorable, their plans to venture and scale up operations in other cities will offset some pressure.