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A difficult H1; H2 to see some improvement in fortunes

Gujarat Gas (GGL) has delivered a strong 53% YoY increase in EBITDA and a 62% YoY jump in net earnings to Rs4bn in Q2FY23, despite a material 33% YoY dip in overall volumes. Earnings came in ahead of estimates of Rs6bn EBITDA/Rs3.8bn PAT. The YoY jump in Q2 has been driven by a record high gross margin of Rs13/scm and an EBITDA/scm of Rs9.2/scm, with lower volumes negating the need for expensive spot LNG and no pass through of the cost benefits across segments. H2FY23 prospects remain subdued for volumes, with combined impact of high input costs, logistical issues and propane pricing discount to gas. However, with price competitiveness to propane an unattainable objective in the near term, we believe margins will remain well above the historical levels over FY23 and 24E. This is due to limited pricing reductions expected and low spot LNG requirements for GGL, driving our material EPS upgrades even as we cut volume estimates for the period. TP, however, sees a lower upgrade due to lower volume growth estimates over FY23-26E. Reiterate ADD.

* Volumes dip on unfavourable gas-propane economics: GGL had earlier in Q4FY22 cut industrial volumes to minimum guaranteed offtake (MGO) levels in order to keep the percentage of spot LNG low in the portfolio and control blended prices vs propane (alternate fuel for Morbi). While the situation reversed briefly in the beginning of Q1FY23, propane to gas price economics remained mostly in favour of propane over the last 6 months. This, coupled with higher number of units building capability for dual fuel, drove volumes lower in Q2FY23, with H2FY23 prospects also suffering on lower volumes expected from Morbi and continued propane price weakness.

* However, longer-term volume growth prospects remain best in class: Even at conservative estimates in near term, growth potential of GGL’s geographic areas remains unmatched among peers. We see the following key drivers for the same: i) Volume growth visibility from 11-12 new areas developed over the past few years, ii) development of seven new areas won over CGD rounds IX-X, iii) the recent transfer of the lucrative Amritsar/Bhatinda area from parent group and iv) significant legal win over Adani Gas to win the Ahmedabad extension area. All this adds to the already significant volume growth potential from Morbi and other extant areas. We estimate a volume CAGR of ~6% over FY22-FY28E.

* Maintain ADD: We have turned a bit cautious on the next 12-18-month horizon for GGL due to i) continuation of adverse propane to gas economics for Morbi, ii) slower traction from new areas, iii) our estimates of spot LNG prices reverting to US$38-40/mmbtu for FY24e and iv) still healthy valuations of ~21x FY24E EPS, 12.5x EV/EBITDA. Reiterate ADD. Key risks: 1) Renewed LNG price escalation, 2) inability to take price hikes, and 3) failure to execute the company’s ambitious network expansion plans.

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