Growing demand makes Gujarat Gas a good long-term play

As economic growth picks up, the demand for natural gas as a fuel for industries and automotives is increasing. This puts Gujarat Gas Company Ltd (GGCL), the country’s largest private player in natural gas transmission and distribution business, in a sweet spot.

Business
A subsidiary of British Gas Group plc, GGCL has proven expertise in distribution of piped natural gas (PNG) and compressed natural gas (CNG) and has a wide range of customers. The company’s operations are spread across various industrial areas of Gujarat including Surat, Bharuch, Valsad and Ankleshwar.

GGCL currently supplies close to 3 million standard cubic meters per day (mmscmd) of natural gas to over 2.8 lakh retail and bulk industrial, commercial and domestic customers and serves over 109,000 CNG users; through a pipeline network of approximately 3,300km.

GGCL sources natural gas from domestic suppliers like PMT, GAIL, Cairn, and NIKO apart from sourcing spot RLNG to meet the shortfall. Volume break-up for the last quarter was around 65% from PMT and GAIL, 8% from Cairn, 9% from NIKO and 18% from spot R-LNG. The gas on being received at various receiving stations is subjected to filtration, addition of odorant and change of pressure before being supplied into network for distribution.
GGCL also builds pipelines required to make the gas available to the end customer. The company is also engaged in leasing of gas connections and natural gas fired cogeneration units.

Investment rationale
GGCL has strong presence in the second-most industrialised state in India, which offers huge demand potential for natural gas across different industries. The current unmet demand from its existing areas of operation itself is around 4mmscmd. Also, as gas supply in India increases, natural gas would become a better and cheaper alternative to naphtha and fuel oil used by industries in fertiliser, power and steel segment. Similarly, the number of vehicles using CNG as fuel is expected to rise to 33 lakh in the next five years from 7 lakh at present, according to PNGRB estimates. GGCL is well-poised to take advantage of this increasing demand.

GGCL is also looking to increase its presence in new industrial areas of Gujarat. It has already submitted expression of interest for expansion with PNGRB for areas of Kutch and Bhavnagar.

Besides, GGCL is also awaiting PNGRB authorisation of its 73km Hazira-Ankleshwar Pipeline. The company intends to spend around Rs 140-150 crore per year over the next few years to enhance its capacity and set up new CNG stations. It has 30 CNG stations at present and is looking to add 4-5 stations per year.

A strong focus on the industrial retail market and the CNG business segment will drive profit growth for the company in the years to come. Over the past few years, the company has been successful in increasing the volumes of the high-margin industrial segment, while the share of the low-margin industrial bulk segment has come down.

The LNG segment, which offers maximum realisations, would benefit from upcoming LNG stations.

GGCL has long-term contracts with the domestic suppliers, which provides for better revenue visibility. Though the company has been facing supply side constraints to high growth, the management hopes to resolve this in the coming quarters. GGCL is expected to receive some allocation from the next tranche of 20mmscmd out of the total 80mmscmd KG D6 gas, apart from sourcing RLNG through medium-to-long term deal. The combined average volume from these two sources would lead to around 1mmscmd supply and reduce dependence on PMT.

GGCL’s supply contracts for the purchase of gas are mostly dollar denominated. Hence, current stronger rupee is favourable for the company to procure more of imported RLNG at reasonable rates. Moreover, GGCL has a strong balance sheet with zero debt and positive operating cash flow.

Concerns
GGCL still sources the bulk of its gas from GAIL and is thus vulnerable to disruption in supplies on account of lower gas allocation. Also, it faces currency risk as any significant dollar appreciation will lead to higher cost of procurement, affecting margins. Any delay in getting expected additional gas from KG D6 block will also affect revenues. The company may face regulatory risk if marketing margins come under PNGRB purview in future.

Valuations
Driven by higher volumes on account of increased supplies from KG D6 block and spot RLNG deals, GGCL’s revenues are expected to grow at a CAGR of 20% over CY09-CY11E. Also, its net profit is expected to grow at little lower 18% as it focuses on volume growth.

At the current market price of Rs 254 per share, GGCL trades at a price-earnings ratio of 15.45x CY10E earnings per share of Rs 16.44 and around 3.22 times its book value for CY10E. In view of its improving supplies, strong presence in a high-demand market, healthy earnings outlook and strong fundamentals, investors can keep a watch on the stock from a long-term perspective.
(Disclaimer: The writer does not hold any shares in the company)