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A difficult H1 in prospect, H2 to see some improvement in fortunes

Gujarat Gas (GGL) had a weak start to FY23, with 16% YoY dip in EBITDA to Rs6.1bn and 20% YoY drop in PAT to Rs3.8bn (EBITDA down 13% QoQ, PAT down 16%). While the numbers were in line with street estimates, they fell short of our estimates of Rs8bn EBITDA and Rs5.4bn PAT. The miss in Q1FY23 was due to i) volumes of 9.75mmscmd, down 3% YoY, 1% QoQ and below I-Sec estimates of 10.1mmscmd, ii) lower margins: Gross margin of Rs9.8/scm and EBITDA/scm of Rs6.8, while being well above FY19-22 average of Rs7.5/scm gross and Rs5.1/scm EBITDA, dipped 6% YoY (gross margin) and 14% YoY (EBITDA/scm). Q2FY23 prospects remain subdued for volumes, with a 1-month shutdown announced by Morbi likely to see Q2 volumes dip by ~2mmscmd QoQ. H2FY23 is likely to see some revival in volumes to 11mmscmd by the end of the year, with gas costs likely to remain relatively manageable due to tie up of spot LNG requirements at US$25-26/mmbtu price till Feb-Mar 2023. We have cut estimates for FY23-24E by 3/8% and DCF-based TP (cut) to Rs540/sh, at 17% upside. Reiterate BUY.

* 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 Q1, propane to gas price economics remained mostly in favour of propane over Q1. This, coupled with higher number of units building capability for dual fuel, drove volumes lower in Q1, with Q2 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) the 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 ~9% over FY22-FY28E.

* Maintain BUY: The 32% dip in GGL stock price over the past six months belies the long-term prospects and more than adequately factors near-term stress on volumes/margins. We see the current valuations of 23.4xFY24E P/E and 13.6x EV/EBITDA offering excellent risk-reward – with our revised FY24E DCF-based valuation implying a 17% upside from the CMP. 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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