Gujarat Gas

Investors with a high-risk appetite and medium-term perspective can consider investing in Gujarat Gas Company Ltd (Gujarat Gas), which primarily distributes natural gas in the South Gujarat regions of Surat, Bharuch and Ankleshwar.

The company, a British Gas-controlled entity, caters to around 280,000 customers across the industrial, domestic, commercial and bulk segments, through a pipeline network of around 3,300 km. It also supplies compressed natural gas to around 115,000 vehicles through 33 retail outlets.

Strong demand dynamics in its areas of operation, high-margin tilted sales mix and good pricing power are the company's strengths. The company's success in tying up LNG supplies has enabled it tide over challenges posed by domestic gas supply constraints.

At the current market price of Rs 282, the stock discounts the trailing 12-month earnings by around 18 times. (The company closes its accounting year in December). Given the strong results posted by the company in the recent March 2010 quarter and favourable demand-supply dynamics, the stock's prospects appear good , despite its sharp run-up (up 180 per cent from 2009 lows).

Supply constraints mitigated

Despite growing demand for natural gas due to increasing industrialisation and urbanisation in its areas of operation, Gujarat Gas' performance was subdued over the past two years. This was primarily due to gas supply constraints arising from the transfer of marketing rights of the Panna-Mukta, Tapti gas from the British Gas-operated consortium to GAIL in April 2008. This is the company's main gas source accounting for 76 per cent in FY 2008 and 65 per cent in FY 2009. Consequently, Gujarat Gas' distribution volumes declined from 1,196 million metric standard cubic meters (mmscm) in 2007 to 1,089 mmscm in 2008 and further to 1,035 mmscm in 2009.

However, with the company entering into spot contracts for sourcing LNG in 2009, the supply bottleneck eased in the latter part of 2009. LNG purchases accounted for 13 per cent of gas sourcing in 2009 compared with nil in 2008. Going forward, the company in addition to entering into spot contracts, also plans to secure gas on long-term contracts.

The company's attempts to tie up firm LNG, if it is fructifies, will bolster supply security and be a positive trigger for the stock. Besides, the company has been allotted 0.60 million metric standard cubic meters per day (mmscmd) of KG-D6 gas on a fallback basis, which it is in talks to bring into system. In the past, Gujarat Gas has managed growth in both sales and profits, despite facing challenges such as the decline in distribution volumes and sourcing at higher prices (LNG being costlier than domestic gas). This is primarily due to improvement of its sales mix by focusing more on the high-margin industrial retail segment, and away from the low-margin bulk segment.

Industrial retail accounted for 81 per cent of the volumes in 2009 compared with 65 per cent in 2007.

The share of the bulk segment declined progressively from 24 per cent in 2007 to a negligible 1 per cent in 2009. Also, the company enjoys good pricing power and has been able to pass on cost hikes to customers at regular intervals, the latest price hike being effected in December 2009.

Strengthening Financials

Sales which grew at 29 per cent annually on average during 2005-2007 rose by a tepid 2 per cent in 2008 and improved somewhat to a 9 per cent in 2009 (to Rs 1,387 crore), due to the aforementioned supply issues.

Also, profit which grew 25 per cent annually on an average during 2005-2007 registered low growth of 5 per cent in 2008 and 8.5 per cent in 2009 (to Rs 174 crore).

However, recent quarters have seen a marked improvement in performance, with sales and profits growing 18 per cent and 43 per cent in the December 2009 quarter over the previous year.

In the recent March 2010 quarter, the company has posted strong results with sales up 35 per cent over the previous year to Rs 401 crore and profits growing 69 per cent to Rs 62 crore. This was driven primarily by increased gas supplies, which expanded 25 per cent over the previous year to 291 mmscm.

While low base helped, a combination of spot LNG purchases and improved domestic supplies were the major drivers. We expect growth momentum to continue.

Gujarat Gas has been able to maintain operating margins around 22 per cent and net margins around 13 per cent. Return on equity (around 24 per cent) and on capital employed (around 30 per cent) is also quite healthy.

An almost zero-debt capital structure buttresses the financials. The company had declared a 1:1 bonus in the third quarter of 2009.

Risks

Gujarat Gas continues with its capital expansion plans in its markets, even as it awaits authorisation from the downstream regulator. A setback on this front, though quite unlikely, remains a risk.

Expansion plans to other areas in Gujarat such as Bhavnagar and Kutch, if the company's succeeds in future bids, is also contingent on timely regulatory approvals.

Sharp spike in the price of LNG may impact margins, if the company is not able to pass on high costs to customers.

via BL