Hopes of margin recovery in FY24 may keep City Gas Distributors in focus

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Market mavens believe City Gas Distributors (CGDs) could see margin recovery in FY24, and this would be mainly driven by the Kirit Parikh Committee (KPC) recommendations to cut domestic gas costs.

Given the Indian government’s thrust on natural gas (less polluting fuel) consumption, by pushing expansion of the CGD network across the country, Sumit Pokharna, Research Analyst and Vice President at Kotak Securities, is bullish on the sector.

Even ICICI Securities has a positive outlook on the gas space for FY24. This is due to several reasons: KPC recommendations to reduce domestic gas costs for a priority sector like CGDs, rising domestic supplies, relatively moderate cost of liquefied natural gas (LNG), and stronger prices of industrial fuel alternatives, it said.

The optimism for the sector is visible in foreign institutional institutions (FIIs) buying shares of CGD companies like Indraprastha Gas Ltd (IGL) and Mahanagar Gas Ltd (MGL).

Pokharna highlighted that even as FIIs are cautiously selling Indian equities, they have started buying shares of CGD companies. “We have noticed that FIIs have already started increasing stakes in CGD companies like IGL and MGL. Just to highlight, FII holdings in IGL has increased from 19.88 percent in March 2022 to 21.76 percent in December 2022. Similarly, FII holdings in MGL has increased from 24.98 percent in March 2022 to 29.73 percent in December 2022.”

KPC, and the importance of its recommendations

In September 2022, the government of India set up the Kirit Parikh Committee (KPC) to review the pricing formula for gas produced in the country. The intention was to ensure a fair price even as global prices for gas remained high.

Gas is an input for making fertiliser as well as generating power, and it is also converted into compressed natural gas (CNG) and piped to household kitchens.

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The government sets the price of gas every six months, on April 1 and October 1, each year, based on rates prevalent in gas-surplus nations, such as the US, Canada and Russia in one year with a one-quarter lag.

As per a news report, the Ministry of Petroleum and Natural Gas will very soon seek cabinet approval on the recommendations of the KPC report on suggesting fair price of natural gas to the end-consumer. A cabinet nod is required for implementation of the policy.

Analysts have pointed out that any delay beyond April 2023 in getting a green signal for KPC recommendations could result in material downside risks to FY24 estimates.

Margins on the mend

Earnings of CGD players continued to see margin pressure and muted volumes, and IGL and MGL missed estimates in the quarter gone by. Nevertheless, the government accepting KPC recommendations on the cap on domestic gas prices, removes the overhang for CGDs, while a steep correction in international gas prices would mean Administered Pricing Mechanism (APM) gas price could remain in the range of $4.5-6.5 per metric million British thermal unit (mmBtu). These augur well for volume growth visibility and sustained margin recovery for CGDs, explained Sanjeev Hota, Vice President and Head of Research at Sharekhan by BNP Paribas.

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He went on to explain that supportive government policies to cap domestic gas prices and a potential normalisation of international gas prices would remove the high gas cost overhang and drive margin recovery for CGDs over FY2024-25.

“We expect operating leverage to kick in for CGD players from FY24 onwards, and reasonable valuation at current levels offers favourable risk-reward for both IGL and MGL,” Hota said.

Even CLSA is of the view that Gujarat Gas Ltd (GGL), IGL and MGL should see strong margin in the March quarter. It highlighted that spot LNG prices have halved compared to the December 2022 average to $14 per mmBtu, which is a clear positive for most Indian gas names.

The foreign brokerage firm also said that demand for Indian gas or LNG has rebounded 2 and 3 percent month-on-month (MoM).

Meanwhile, ICICI Securities said that in case of prices remaining as per the prevalent formula, domestic gas prices could rise steeply to $14.5 per mmBtu for the first half of FY24 and reduce to $11.5 per mmBtu for the second half of FY24. This will imply requirement of a steep rise in sales realisation, it added.

Better realisations would mean improvement in profitability of CGDs.

The requirement would be about Rs 15.3- 22.6 per kg increase in sales realisations for CNG and about Rs 8.7-12.1 per Standard Cubic Meter (scm) for the domestic sector to maintain margins for FY24, the domestic brokerage firm said. However, it cautioned that despite price increases getting passed through, volume growth of CGDs could take a hit, adversely impacting earnings.

In the CGD space, Pokharna likes IGL with a fair value of Rs 495, MGL with a fair value of Rs 1,100, and GGL at a fair value of Rs 522. He also likes Gujarat State Petronet and believes the fair value is at Rs 375.